Challenging change

By Uditha Jayasinghe

Why should a company list on the stock exchange? What are the benefits that can be gained? What are the plus and minus points? These and many more points are discussed that the forum organised by the Merchant Bank of Sri Lanka (MBSL) titled ‘How to take your company public and success stories of listed companies in the share market’.

Laugfs Group of Companies and Janashakthi were presented as case studies at the event. But first MBLS presented an overview of the Colombo Stock Exchange (CSE) and what procedures need to be followed in order to list.

It was pointed out that business growth needs capital and the growth depends on the ability to source funds. In a post-war expansion time more and more companies are interested in listing as they can use it to increase capital.

“A company can raise capital through issuing shares. They can get borrowings and issue of debt instruments. It is also positive to leverage on the CSE, which is one of the best performing stock markets in the world,” explained MBSL Deputy General Manager A.M.A Carder adding that a company can also offer a part stake to the public and invest in better yielding projects.

The challenge faced by closely held companies is that control is held by a few individuals or family members. Under this closely held structure of management the continuity, expansion and survival are constrained resulting in some companies faring badly.

Among the external challenges is the inability to adapt swiftly to intense competition resulting from globalisation and rapid changes in technology and other forms of innovation. Internally the informal management structure, low skilled second line management and preference of ownership over growth pose problems. “Some companies overcome these challenges whilst some fail and hence look for an exit route either through public sale, trade sale or going public,” he pointed out.

The benefits of going public are multi-pronged. It gives access to public funds, namely issue of shares and debt securities to the public, access to low cost debt capital and reduction of dependency on bank borrowings. Listing a company       can give it an enhanced public image. This will improve normal business, increase brand perception, boost employee morale and increase prospects for joint ventures and mergers.

Since it is easier to divest shares there is an increased liquidity, expansion through subsidies and prospects for wealth enhancement. The growth prospects of a listed company is higher than a privately held company, hence the wealth of the owners will increase due to a high market price. Listed companies also have shares that are strong collateral for borrowing.

How to list

Shares of an entity may be listed on the CSE by way of an officer for subscription, offer for sale or an introduction. A subscription is an invitation to the public by or on behalf of an entity to subscribe for its shares. Offer for sale refers to an invitation to the public by or on behalf of the holders of shares to purchase their shares. In the third instance an introduction is the listing of shares on the CSE without the requirement of an Initial Public Offer (IPO).

In the event of an Offer for Subscription or Offer for Sale shares shall be issued for cash only. If shares are to be listed by way of an Introduction, such shares should be allotted at least six months prior to the date of application to the CSE unless such shares have been offered in terms of a Prospectus.

Private placement

Private placement, Carder said, means broad base the shareholding through a Private Placement document. “This is a quick process of raising equity capital from a selected growth of investors under urgent capital needs. However it should be noted that in terms of the recent Security and Exchange Commission (SEC) directives, if shares of any public company are allotted to any person within a period of one year prior to its listing on the CSE the entire shares allotted during the period of one year prior to its listing shall be locked in for a period of one year from the date of allotment of such shares.”

Eligibility to be listed on the CSE Main Board depends of several factors. One is that the stated capital should be not less than Rs. 500,000,000 (five hundred million rupees) at the time of listing. Another is that net profit after tax for three consecutive years’ preceding the date of application. Positive net assets as per the consolidated audited financial statements for the last two financial years immediately before the date of application.

A minimum Public Holding of 25% of the total number of shares for which the listing is sought which shall be in the hands of a minimum number of 1000 public shareholders holding not less than 100 shares each. CSE may accept a percentage lower than 25% of the total number of listed shares if they are satisfied that such lower percentage is sufficient for a liquid market in respect of such shares.

Eligibility for the Diri Savi Board

For the Diri Savi Board stated capital should be not less than Rs. 100,000,000 (one hundred million rupees) at the time of listing. Positive Net Assets as per the consolidated audited financial statements for the financial year immediately before the date of application, Net Assets means the total assets after deducting the total liabilities, preference share capital and advance against the share capital.

A minimum Public Holding of 10% of the total number of shares for which the listing is sought which shall be in the hands of a minimum number of 100 public shareholders holding not less than 100 shares each. An operating history of at least one year immediately preceding the date of application is also a must.    

Public holdings

Public holdings means shares of an entity held by any person other than those directly or indirectly held by its parent, subsidiary or associate companies. It also refers to the fact that shares cannot be held but the company’s directors, chief executive officer, their spouses or children under the age of 18. Any single shareholder that holds more than 10% or more shares also to not fall into this category.

Steps to making at IPO start with structuring the company to go public; deciding on the timing, size and price of the issue, preparing of the listing application, prospectus and other supporting documents as well as obtaining the necessary consents and approvals. Once these steps are completed the IPO can be done and shares will be listed.

“When you go public it is very important that the company’s financial strength should be visible and poised for growth. The company’s future strategies should be aggressive and clear. The drive of the management must be at a high level to make these plans reality. Looking at the macro picture is also important, the industry in which the company is engaged in should have growth prospects and overall market conditions should be encouraging.”

Structuring the company to go public can be an onerous task. It is essential that the capital structure should be simple and clear to the public. To achieve this each company has to reorganise capital and share holding structure, where possible convert all instruments into ordinary shares, if necessary raise capital through private placement of shares and subdivide shares to make the price within marketable range.

Making the necessary amendments to the existing Articles of Association of the company or adopting a new set of Articles of Association suitable for a public company, converting the private company to a public company and implementing corporate governance practices. The latter should include appointment of non-executive independent directors, recruiting a reputed firm of auditors and appointing many committees such as audit committees and remuneration committees. “These days it can even mean whistle blowing committees.”

Issue size and pricing

Size of the issue must be sufficiently large and should contain adequate free float to attract investor interest. Pricing will depend on past current and future performance, general market conditions, pricing of similar companies, investor feel for the stock and good corporate governance practices.

Approval for listing must be obtained from the board of directors, existing shareholders and CSE and SEC. Any other persons concerned in terms of any agreements entered or licenses obtained must also give their consent, for example the Board of Investment, Central Bank, debenture holders and other significant lenders. The consent of the company auditors, lawyers, bankers, managers and registrars to the issue is needed. Permission of third parties is needed for inclusion in the prospectus.

Carder observed that underwriting an issue is not mandatory but gave an explanation. “Underwriting is a guarantee given to the company by the underwriters, usually a syndicate of financial institutions led by the managers to the issue, that in case the shares that are offered to the public are not subscribed in full the under subscribed shares will be taken up by the underwriters.”

In such an event a ‘Underwriting Agreement’ will be entered into between the company and the underwriters. Underwriting is not mandatory but the advantage is that it reduces the risk of the issuer and creates investor confidence. Underwriting fee is based on the issue value and devolvement free is based on the value of the shares involved.

In a listing timing is everything, generally three to four months is required to list in the CSE. This is from the date of submitting the listing application by way of an offer for subscription or offer for sale. A period of one to two months is needed to list a company in the CSE from the date of submitting the listing application, by way of an introduction. Cost includes prospectus printing charges, listing fees, brokerage, cost of stamp duty for issue of shares, underwriting costs, publicity campaigns and fees payable to managers to the issue.

Pix by Upul Abayasekera

Case study 1

The Janashakthi story

DESCRIBING the decision to list on the Colombo Stock Exchange (CSE) as a “happy one” Janashakthi Insurance Marketing Director Ramesh Schaffter outlined the challenges that were faced by the company in launching an Initial Public Offering (IPO) when the market was suffering under war-gloom.

“When Janashakthi decided to list in 2008 it was seen as a bold step as no companies had listed for two years previously. However, when the company was started in 1994 it was with the intention of eventually becoming a listed company. In fact there was a private placement in 1994,” he said.

As the company grew the life and general insurance merged into one branch but with legislation going the opposite way Janashakthi may have to separate the two again in the years to come. In 2007 the company reached Rs. 5 billion in revenue but the market was not good and many international investors disappeared with the intensifying of the conflict.

However, with a strong countrywide branch network and client base Janashakthi set itself to separate management from ownership with even qualified family members having to step down from management roles.

“We appointed five independent directors and the CEO was also a professional to ready the company to eventually go public. Since we were a company that started with the intention of going public the structure of Janashakthi was made to be conducive to this aim. We always had a professional approach to business and had a fully independent board.”

In the run up to going public Janashakthi invested heavily in publicity to boost the image of the company among the masses. They also realised that selling the shares through their branches would stand them in good stead and heightened training of human resource. The only thing that Janashakthi failed at in this period was setting up shop in the Maldives. “There was a legislation change that left us in the lurch,” Schaffter admitted, but added that they were contemplating a return.

After months of audited accounts and strengthening their IT systems the company felt confident enough to launch an IPO. Thirty-three million shares were available at Rs. 12 a share and given that there were no IPOs for two years before the Janashakthi launch the company considered it being four times oversubscribed very good news indeed.

“We were very happy with the outcome,” recalls Schaffter, adding that even though it is now normal for an IPO to be oversubscribed 10 or 20 times over the risk margins at the time were so high that 100% margins had to be given to banks. The Rs. 396 million that was raised from the IPO was invested in human resource training, IT development and retiring debt.

“The results were that we had to become responsible to our shareholders, increased regulations to follow, extra transparency, better financial reporting and heightened governance. In fact we had in-house seminars to educate our senior managers on their shares so that they would not inadvertently get caught for insider trading.”

Yet Schaffter insisted that the company was “very happy” with the results and were leveraging on their value additions to do more business.

Case study 2

IPO no Laugfing matter

Every company should understand the listing process before they

launch an IPO, cautions Laugfs Group Chairman W.K.H Wegapitiya.

PRESENTING his IPO experience at the seminar, Laugfs Group Chairman W.K.H Wegapitiya choose to take a more personal view of the initiative and admitted that the decision to list was a personal one.

“I come from a very poor family. When I came to Colombo to study for my degree my mother sent me with just Rs. 200 in my pocket. When Laugfs Gas was incorporated in 1995, we had only Rs. 2 million as seed capital. But today it has over Rs. 15 billion turnover and a net worth of Rs. 50 billion. At present there are 20 companies under Laugfs.”

Having achieved so much, the Chairman was curious to see how much he was really worth. “I wanted to know the value of what I and a few close associates had created. That was my main reason for listing.” Nonetheless, this move to evaluate the value of his creation came with challenges.

“There are many instances when an entrepreneur starts a company and it is passed on to his heirs, possibly dying out once the main person has retired. The company does not make it to the next level. There is no sustainability in having only one person at the head. I don’t want to see this happening to my company so I wanted to take it public.”

Transforming an enterprise to the next level, broad-basing ownership, strengthening management practices, raising funds for growth to tap into post-war potential and improve the brand image were the other reasons for listing. Therefore Laugfs Gas, Laugfs Eco, leisure and property development were the four arms that were included in the IPO.

“Before you take a company public it is very important to get the right team or you will be taken for a ride. You must agree to the basis of divesting and justify your expectations. Otherwise there is a danger of the whole enterprise being unsuccessful.”

Wegapitiya also pointed out that balance sheet improvement, appointing of independent directors, getting the legal work done and creating awareness within and outside of the company were key components of launching an IPO.

“We held road shows in Singapore, Malaysia and India to promote Sri Lanka as a vibrant place for investment. More than promoting the company I wanted to promote the country,” he recalled. In addition reviewing financial statements, streamlining business processors and taking a step back to view the company proved to be a fruitful experience.

An informative, transparent and user friendly prospectus should be made, he advised. “After the listing there were a couple of negative points, one was the fact that the decision making process was longer. Earlier a few of us would sit around a cup of coffee and next day millions would be moved to implement our decisions. Now I have to call a board meeting and most of the independent directors don’t know the subject so there are hundreds of questions to be answered. Moreover we have to stick to the goals that are outlined. There is no time to relax.”

Positive about the well-disciplined company, the Chairman applauded the IPO but insisted that a thorough knowledge was necessary beforehand.