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Corporate finance: IPO v trade sale - the pros and cons Back  
While the upfront costs for going public can be prohibitive, with the transaction costs of the two most recent additions on the Irish Stock Exchange, eircom and C&C, estimated at €47 million and €19 million respectively, there are also many advantages, and research indicates that the valuation achievable at IPO exceeds that of a trade sale by 22 per cent, writes Philip Kearney.
The recent flotation of three Irish companies has marked the reversal of a trend of exits from the local market that has been in place since the last Irish flotation in December 2000. Eircom’s return and C&C’s belated debut are welcome developments for the Irish stock exchange. Together with Kerry-based CNG Travel’s listing on AIM, these developments may be indicating that the market for initial public offerings (IPO)s has finally re-opened.

Since Paddy Power floated almost three and a half years ago a raft of companies have left the Irish exchange. Alphyra, Arnotts, Green Property, Smurfit, Riverdeep and Sherry Fitzgerald have all since gone the MBO route, or at least had significant management participation in their exits. Barlo came close to going the same way until the Quinn Group upped the ante. First Active, Golden Vale and Athlone Extrusions have been acquired by other public companies. Not only have numerous companies left the exchange but many of those mooted to be coming have failed to materialise.
Spectel tried but the offering was later withdrawn, Norkom Technologies and Orbiscom were at one time thought to be close but never quite made it. The perennial Aer Lingus rumour remains, for the moment, just that.

This dearth of IPOs has not been peculiar to Ireland. The number of companies electing to go public in the US in 2003 was almost 70 per cent below its ‘irrationally exuberant’ peak in 2000. This trend was even more marked in Europe with those choosing (or being deemed worthy) to float down over 90 per cent.

So why have so many public-to-private and private-to-private deals taken place? In an environment where interest rates were low and getting lower, where banks were eager to lend, and where equity valuations were depressed the potential rewards for ambitious and frustrated management teams were attractive. Management and venture capitalists with long-term investment horizons (and without monthly relative performance peer comparisons to concern them) were able to take advantage of institutional investor risk-aversion and short-termism. Some members of the local institutional investment community have made attempts to resist some of these deals. At Hibernian Investment Managers (HIM) we have rejected a number of these bids on valuation grounds but have eventually found ourselves compulsorily taken out once acceptances have reached the required threshold.

In the U.S. the impact of the new Sarbanes-Oxley corporate governance legislation has prompted management of many U.S. companies to re-assess the costs and benefits of being publicly quoted. Irish companies with a dual listing on Nasdaq are also subject to this legislation. We believe that such legislation and our own IAIM corporate governance guidelines are vital in protecting shareholder interests but many business managers believe the Sarbannes-Oxley reforms and their ilk impose excessive bureaucracy and are part of a regulatory over-reaction to Enron, and other corporate scandals. Significant extra costs do arise from the regulations relating to internal controls. There are also increased legal costs stemming from required legal opinions on matters such as company ethics codes. There are higher fees to be paid to directors, who are more wary of liability and who are more anxious to spend more time on their board responsibilities. In addition, companies’ directors and officers liability insurance has risen sharply.

However, the costs of such corporate governance legislation are often overplayed and they are certainly lower in an Irish than in a US context. What may, in fact, be more discouraging is the cost of a listing particularly in the US and more significantly still the onerous quarterly reporting requirements required by SEC legislation. Such expense may well put potential Irish debutants off floating on Nasdaq but the less burdensome reporting requirements on the ISE and on AIM should not provide the same discouragement for IPOs.

The initial up-front costs of flotation can also be expensive, as evidenced by Eircom’s €47 million and C&C’s €19 million IPO related spend (excluding debt restructuring). These costs are often relatively higher for smaller companies but rarely to the extent that they are prohibitively expensive. Using fewer, and Irish-based advisors, can go a long way to reducing these expenses without impacting on the ability to get the offer away. In general, IPO related costs work out at 3-5 per cent of the value of the offering, whereas investment banking fees for trade deals tend to be in the order of 1-2 per cent of deal size.

Resources and confidentiality are also a constraint. Significant management depth is required to be able to cope with the time-consuming preparation required.

Despite these factors it is clear from the number of IPOs this year that companies are again seeking to go public. The number of companies floating in the US in 2004 to date already matches the number that floated in the whole of 2003 and in Europe the number already exceeds that of last year. The real change that has occurred, of course, is that of investor, rather than corporate, sentiment. The IPO market may not be ‘hot’ but it is at least luke-warm. As uncertainty over global economic recovery dissipates so to does investors risk aversion towards public offerings.

The rewards for taking a company public remain attractive. Recent US academic research finds that the valuation achievable at IPO exceeds that of a trade sale by 22 per cent. This 22 per cent premium far outweighs the costs of going public. But the primary driver of the decision to go public should always be access to capital. While the advantages of raising initial capital are obvious, the ability to raise five per cent of the total shares in issue at any time without the need to seek the approval of shareholders provides tremendous financing flexibility and should not be underestimated.

Typically about one third of all IPO issuers return to the public market within five years. Likewise, the ability to use stock as currency for acquisitions is a key attraction.

Retaining control of the organisation, while realising some liquidity, valuing your remaining equity stake, diversifying your personal wealth and maintaining a share of the future upside are just some of the benefits for founders from bringing a company to market that can’t be fully achieved through a trade sale.

A public offering of stock can also help a company gain prestige and build public awareness. This can be very helpful in recruiting and incentivising key employees and in marketing products and services. The transparency of a public quote can also provide a competitive advantage over a private enterprise particularly when selling goods and services to another public company. This is important for industries where success requires customers and suppliers to make long-term commitments.

The publicity received from a public offering encourages new business development and strategic alliances. Analyst reports and daily stock market tables contribute to the awareness of the consumer and of the financial community.

In the recent past many smaller companies that were destined for the market viewed an IPO as an integral part of the business plan and being public as a panacea. Many now realise that being public is not an end in itself. It is one of many possible gateways to future financing and liquidity and is only right for the right company. The concentration of the industry, the high-tech industry status of the private entity, the ‘hotness’ of the IPO market, the current cost of debt, the percentage of insider ownership maintained in the firm, and the size of the entity are all positively related to the probability that a firm will conduct a successful IPO.

The ideal candidate for flotation is a company that has existed for more than five years, that has been through the teething pains of being a young enterprise, that may have changed management in response to such pains, that are leading players in their chosen domain, that has developed sales beyond Ireland, that has an enterprise value of €250m+, that has real growth prospects and where funds are being raised to fund this growth. While the costs and requirements of maintaining a public listing are significant such companies should be publicly quoted if they are to maximise their opportunities and the Irish stock exchange represents a viable home for such a quotation.

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