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Friday, 18 April 2014 03:51 - - {{hitsCtrl.values.hits}}
Need for increasing awareness on capital markets
Speaking on the need of educating the business community in this regard, SEC Officer-in-charge and Deputy Director General Dhammika Perera pointed out that although Sri Lanka boasts about its 92% literacy rate, its financial literacy is not very sound.
“It is imperative to increase awareness so business will be well equipped knowledge wise to raise capital when their company is in need of funds 
to fuel its growth. With interest rates coming down one should understand that saving in a bank will not give an attractive return. Therefore it is invariable that the market is becoming attractive for investors. In that I can see a huge potential for the business community to come into a market,” Perera told the audience.
With the country seeking to project itself as a knowledge hub, he stressed the need to develop the IT services industry, which can be achieving by listing. He opined that with listing, IT companies will be able to better strengthen their internal structures and become more accretive to potential strategic investors who would value transparency and governance.
“The dynamic engagements of SLASSCOM members are in a borderless and competitive environment and many benefits of being listed will allow a new breed of entrepreneurs to capture this as another window of opportunity,” Perera noted.
Need for local IT companies to go public
With the It industry having gone through a tremendous growth trajectory in the last few years, SLASSCOM Chairman Madu Ratnayake said that 2014 is an “opportune moment” for local IT ventures to start looking at different avenues of raising fund for their companies.
Sharing that the industry this year will grow by 25%, he stressed the need for IT entities to raise capital through stock market, private equity and multiple asset class.
“There are companies at different growth stages in the industry and there are many who are at the point where they can take equity shares to help them in their journey. It is exciting to see those in the industry wanting to become closer to the capital markets,” said Ratnayake.
While there haven’t been many local IT companies that have gone public, Ratnayake expressed hope on this year being a start of a new chapter in the IT industry.
Valuing companies for listing: Special reference to the IT sector
Traditionally due to the lack of collateral and the lack of salvageable assets in a debt company, it is difficult for IT companies to raise debt through financial institutions. This is because the assets the tech companies will build over time will link to the technology they work with.
Teach companies are essentially financed by venture capitalists. However, the fact that a venture capital firm needs to go out and scout for buyers has a liquidity risk premium, i.e., they will demand a higher rate of return from the investment from a tech firm. “If Sri Lanka can create a culture of listing tech companies then potential venture capital investors will be willing to invest at a less profitable tech investment. This will end up in creating an ecosystem of cheaper and larger funding for the tech industry in Sri Lanka,” said Copal Amba Vice President Asanka Herath during his presentation titled ‘Valuing your company’.
Although numbers are not all what investors look at, their concerns are on few key areas that have a profound impact on the valuation of these companies.
The first is the diversified geographical exposure. Since 2007 the key two offshore markets for outsourcing, the US and Europe, have intermediately gone through sluggish economic growth which resulted in a drop in discretionary IT spending, creating an impact on the demand for IT services companies. Thus, investors are more likely to be attracted to those companies which happen to have adequate level of diversified exposure to avoid volatility in revenue growth.
The other key factors to be considered are the growth drivers for the IT services companies that have varied between Europe and US. In 2013 Europe was noted as the key growth market for IT services companies and in 2014, US was indentified to be leading as a key growth market.
Herath explained this is due to US being on an accelerated real GDP growth which will result in an increase in overall demand for IT services. However, he noted investors are always aware of the risk of a sudden slowdown in the EU geographies.
“Investors are likely to pay a higher premium to those companies that have a presence in growth markets accompanied by diversification elsewhere, to avoid impact from sudden slowdown,” said Herath.
“Cost inflation in offshore destination results in the cost of living in business to raise faster than that the rates in end-shore destinations. This has an impact on cost arbitrage which is a prime reason for the workflow to move from North America to key offshore destination in the last 
three years,” he added.
In India the operating cost per employee has risen faster than the average revenue per employee. While this does not mean that companies can look at significant cost measures, retaining top talent is key catalyst for the industry. It is imperative for companies to be able to strike that balance between retaining top talent through competitive salary structures while at the same time managing the revenue and cost growth per employee. Therefore, companies who are better able to manage that will attract a higher valuation from investors, noted Herath.
Due to the sluggish economic growth rate in North America and Europe there has been increasing concerns about the level of unemployment and its impact on offshoring. He pointed out there are certain downside risks posed by restrictive measures from the Government. Investors are all too aware that given the sluggish environment such down side could persist.
Valuing a software development company is different from the valuation of an IT services company. According to Herath, a software company is similar to valuing a movie production business since the value of the company depends on the future pipeline.
While is tough to place a value based on projects that are on the pipeline, a high level of R&D to sales over a long period of time indicates that the company is forced to invest a greater portion of the sale into R&D to sustain sales growth.
A key concern an investor will have when looking at technology product development company is the sustainability of the company. “At the end of the day the revenues depend on the pipeline. So the question would be if they can continue to generate the same level of revenues and then again, can they continue to have the same level of structures with innovation,” said Herath.
Benefits of listing in the Colombo Stock Exchange
Affirming that a capital market entry will further fuel the growth of and industry and company, Colombo Stock Exchange (CSE) CEO Rajeeva Bandaranaike highlighted the advantages on being listed.
The primary reason for listing is to raise capital to support an organisation’s growth. Usually companies turn to this option when bank financing 
is no longer adequate and going public allows one to have access to the required funds.
With there being three methods to go public, most companies go about this effort by issuing new shares through IPOs or opting for Offer for Sale. At some instances a listing company opts for both.
The third method, which is not very popular in Sri Lanka, is to go through introduction which allows an organisation to discover the price of their shares.
Speaking on the importance of being listed, Bandaranaike said: “Till a company remains unlisted it will not realise its true potential. When they come to the market a value will be placed in their shares. When looking at the previous IPOs that have taken place in Sri Lanka, many companies have been successful in unlocking value and creating wealth for their shareholders.”
Listing also provides a company to have enhanced corporate visibility since it will come to the public domain. Regardless of the industry, entering the capital market adds value to a company’s brand. Moreover, it allows potential customers to have easy access to information, making them comfortable in terms of dealing since the governance provides assurance the provided information is accurate.
Going public provides another fundamental advantage, which is that it acts as a currency for mergers and acquisitions. Although this is less popular in Sri Lanka, globally it is used as a growth strategy.
With regard to unlocking value, when comparing listed verses unlisted companies, the latter will be at a discount. It is the listed companies that attract a premium, Bandaranaike pointed out.
While there are venture capitalists and angel investors who are keen on being a part of an IT company’s growth, investors look for an exit strategy where they can move out with a profit, and this option is available once the capital market is entered.
Seven common misconceptions in going publicIn an attempt to clear the air on certain views on local capital markets, Colombo Stock Exchange (CSE) CEO Rajeeva Bandaranaike at the forum titled ‘Unlock the value of your company’ presented and clarified seven common misconceptions on being listed. Going public would mean losing control: A complete myth. Even if listed on that main board a company will have to give only a 25% holding to the public and for the Diri Savi board it is 10%. So the listing company holds majority of the shares. The company will lose the ability to keep business secrets: A Myth. At no point will the SEC push a listed company to reveal its secrets that will give an edge to the competitors. Within the industry it is noted that listed companies are doing better than unlisted companies. We don’t need funding. There are plenty of private investors to put their money in: Even where Private Equity (PE) is concerned, investors will look for an exit strategy and listing is one way to get about this. With IPO it is difficult to get long terms investors: Every IPO that has taken place in Sri Lanka has attracted good strategic long term investors. This is a common fear many companies have. Listing will lead to hostile takeovers: Will happen only if there is a small shareholding in the company. The share price will fall if I miss my earnings estimates: Merely because one or two earnings estimates are missed the market will not punish a company. However, if it continues, the share price will suffer as investors will eventually lose confidence. Once listed the SEC and CSE will haunt the life out of the company: Untrue. The SCE and SEC are open to suggestions and are very friendly. The two institutions follow an investor-friendly regime where they constantly amend regulations that allow companies to be and remain listed. |
