IFR Mid East 2006 - IPO market back on
Equity markets in the Middle East remain at an early stage of development, with rules and regulations often out of sync with international practice. But the speed of growth is astonishing. Owen Wild reports.
The steady flow of Middle East IPOs is creating volume exceeding that of European emerging markets, excluding Rosneft. Much of this activity is unrecognisable as the companies that IPO and the method of listing are very different from those of any other region.
Stock exchanges across the Middle East traded strongly through 2005 and the IPO pipeline looked strong for 2006, but the fall in markets since March has led to some lengthy delays. This has since been compounded by instability in the region, but some companies are confident investor demand has not generally been impacted by this.
As a result, Gulf Navigation Holding in UAE and Saudi-based Emaar the Economic City launched IPOs in July. The companies are the first to brave the market in their countries since March, with most companies dissuaded from attempting a listing. This is little surprise when the Dubai Financial Market was down almost 60% for the year to Emaar's launch.
Also helping to support the deal flow are government privatisations, which have boosted exchanges previously. These trades tend to be the largest but there is an increasing pipeline of private companies looking to tap the markets for capital. At present there is sufficient cash available to support deals due to the strong oil price and concurrent desire for locals to diversify their assets. However, the dynamics of deals have meant that there can be massive demand for an IPO that disappears in the aftermarket. The most recent example of this was the IPO of UAE Sharia finance company Tamweel in March.
The Dh550m offer was priced at par, as regulations for the local Dubai Financial Market (DFM) require. As a result, investors willingly participate as they have come to expect massive immediate returns as the stock is under-priced and tightly allocated. Allocations must be completed by scaling back all orders equally so initial trading can be strong as some investors look to boost their positions as others take their quick gains. This has tended to translate into a gain of around 3x issue price in the first days of trading. Tamweel followed this pattern with a debut that saw the stock close at Dh2.91, up from an issue price of Dh1, but the stock then fell by more than 10% the following day as initial demand began to fall away.
The company was a typical example of the different use of equity markets in the Middle East compared with the rest of the world. Tamweel had an operational history of about 10 months by the time it came to market. In Europe, such a short timeline would lead a company seeking funds to venture capital investors, but the lack of VCs in the Middle East has led to equity markets taking on this role. Individual investors are happy to fulfil this role as they have excess cash that they wish to invest and, irrespective of what stage of development companies are at, they come to market undervalued.
Local market for local people
This leads to one of the main criticisms of why equity markets are not developing quickly. Due to an overabundance of cash in the region, the market continues to be inward looking and is hard for internationals to penetrate. A large proportion of the region is closed entirely to international investors, which has meant that the development of markets is taking longer than it could.
However there are signs of a gradual move towards opening up. The Dubai International Financial Exchange (DIFX) is the most obvious of these as it offers companies the opportunity to list on an international exchange as well as their own closed market. The IPO of hotelier Kingdom Hotel Investments of Saudi Arabia showed the effectiveness of this by using DIFX to access a much wider pool of capital than that allowed on the local exchange in Saudi Arabia. The company did not need to tap international investors as it should have been able to find demand locally, but it wished to gain a realistic value for the company and its international assets, which is difficult to achieve in Saudi Arabia.
IPOs on Tadawul tend to be structured with stock sold at par and participation limited to Saudi investors. The par value of stock is decided through negotiation with the Capital Markets Authority (CMA) and is significantly below the actual value of shares, leading to 300% gains on issue. Kingdom Hotel Investments elected to domicile itself in the UAE and list on DIFX as that would allow it to follow a standard IPO process, but improvements can be made to the process on Tadawul.
National Commercial Bank led the IPO of Saudi Dairy & Foodstuff (Sadafco) in May 2005 as the first ever IPO to use a bookbuild to set the price. The deal was capitalising on the changes to rules that allowed equity offers to be sold above par value. Price discovery was improved but was still limited in its success. The deal was priced at SR260 and the stock closed its debut at SR505.5, leaving the first day gain at a comparatively modest 94.4%. Despite this apparent success, the bookbuild has not been replicated in any IPO. This is because its use is limited by having to view all investors equally. When small investors have to be treated the same as high-net worth and institutional investors, it is difficult to move pricing higher as retail will look at the bottom of guidance.
The dominance of retail is another criticism levelled across the region. This is an issue as the strong demand from small retail investors often disappears in the aftermarket.
"Currently, there is strong interest in Saudi IPOs, with the demand until recently being retail-led," said Oscar Silva, head of corporate and structured finance at National Commercial Bank. "However, the IPO of Emaar the Economic City shows the willingness of the regulator to allow subscriptions by high-net worth individuals, as the maximum subscription has jumped from 5,000 to 25,000 shares."
This change should ensure larger allocations to institutions and large retail investors, and more orderly trading as a result in the secondary market. March 2006 also saw the regulator finally implement another rule to build secondary volumes by allowing resident foreigners to open trading accounts. The access provided took a long time to implement due to various complexities introduced by other Saudi laws. The foreigner would only be allowed to trade while resident in Saudi. The complication was that if a foreigner's job ended, then Saudi law says they must leave the country and it was widely debated how this should impact on his trading account and holdings.
Once these issues were resolved the rule came into effect, but as yet it remains unclear how large an impact this has had. Part of the issue with this is that everything related to the market is in Arabic. Foreigners are, therefore, often unable to understand any filings and statements by companies as these are rarely translated, and if they are it is not timely. A further difficulty in calculating the impact is that the change in the rules came as the market began falling and volumes jumped massively. Until April, trading volume on Tadawul rarely exceeded 75m shares and average volumes were around 50m. This has increased rapidly, with volume around 150m per day in April and 300m in May, reaching a peak of 516m on June 12. July saw volumes fall back to around 100m.
The massive increase in volumes coincided with the dramatic fall in the market that was reflected across the region. While European and North American markets saw a correction and period of volatility in the second quarter, Middle Eastern markets suffered much more substantially for a longer period. The Tadawul all share index reached a 12-month high of 20,634 on February 25, only to lose 28% of its value over the next three weeks. Market weakness continued through to the summer, with the Tadawul all share index languishing at 10,443 in mid-July, down 38% for the year to-date and at a level that hasn't been seen since March 2005.
"There is still a lot of interest and volume on the secondary market at Tadawul," said NCB's Silva. "For a time, the focus was on volatile tier two or three names, but recently this has gradually switched to household/blue-chip names."
New structures, new investors
Despite the step towards wider investor participation thanks to allowing its use by resident foreigners, the Saudi market shows how slow some markets are developing. The auction IPO of Telecom Egypt that used the model pioneered by Google shows this isn't always the case. There has been discussion on the inclusion of internationals on Saudi IPOs but this has yet to lead anywhere. At present, even GCC investors are not invited into IPOs, but bankers suggest that this is likely to change soon as the CMA accepts that the market must continue to move forward and deepen liquidity. As part of this effort the CMA is already implementing initiatives on disclosure and corporate governance as well as making IPOs more efficient.
International banks are also entering the Saudi market and are keen to develop new strategies to improve the efficiency of deals. HSBC was the first international bank to win roles in Saudi Arabia, though its local retail footprint means some view it as a local. The bank has also been happy to accept the current way of running deals, but others are less keen to do so. The appearance of internationals on local-only deals takes advantage of the law regarding bank participation in the Kingdom and the alternative services they can offer.
"International banks are coming at deals with the proposition of providing research coverage rather than market making," said Chris Laing, co-head of Emerging Europe and Middle East origination at Deutsche Bank. "Half of Saudi retail branches have to be included in IPOs anyway, so the lack of local retail distribution is less relevant."
The introduction of research could be an important aide to an efficient market as it is presently very limited across the GCC region. Some local banks provide coverage but it tends to be limited to a handful of stocks. The lack of research can also lead to some dramatic trading patterns, such as the case of Dana Gas.
UAE-based Dana Gas had a wildly successful IPO in October 2005 on the domestic Dubai Financial Market. The deal was open to GCC residents and saw such strong interest that flights from Saudi Arabia to the UAE were booked solid for days with men carrying suitcases of money. Sold at par, the company found demand of 140 times the Dh2.06bn (US$550m) deal size. There was concern at the time that investors paid little attention to what the company did and might not have been aware of the risks involved. The IPO represented an investment in a new pipeline from Iran that was due to open later in the year.
The result of such substantial oversubscription in the deal was a debut price of Dh4 and a high of Dh5.5 just two days later. Unfortunately, this was a brief high as the stock has fallen since it became clear the pipeline would not open due to delays on the Iranian side. By early August, the stock was trading at Dh1.76, up 76% from IPO but down almost 70% from its high.
The increasing availability of research should help to avoid such results, but internationals also believe it is possible to improve the IPO process to avoid artificial pricing. However, this does not necessarily mean moving to a structure that would be recognised by international investors. Bankers suggest that a refinement of the current processes is needed rather than the adoption of a bookbuild as it is of limited value, as the Sadafco IPO illustrated.
Deutsche Bank's Laing said: "We are looking at various novel pricing mechanisms to help realise value for the seller rather than the present system of negotiating a fixed price with the CMA. Also, we hope to move to directed allocations that recognise the importance of institutions and high-net worth individuals."
The appearance of internationals is not limited to just Saudi deals though, as Merrill Lynch is expected to be sole bookrunner in the privatisation IPO of Middle East Oil Refinery (MIDOR). Though this will be open to only Egyptian citizens, in an effort to share some oil wealth, an international bank was preferred by the government to run the deal, leading to a bake-off with Morgan Stanley at the final stage of pitching. This decision is in part down to the success of the IPO of Telecom Egypt in December 2005, which pioneered the use of an auction process in the emerging markets through Credit Suisse.
Rather than set a price range, the Telecom Egypt bookbuild was launched with a notional minimum price for institutions and a maximum price for retail. Orders were then submitted with price and volume and the VWAP calculated to give a final price. This ensured that pricing was a meaningful blend of orders and was not pushed too high, despite being multiple times covered. The deal was open to international investors and allocations were balanced across the Middle East, the UK and the US. Despite the best efforts of Credit Suisse and EFG-Hermes, the stock still rocketed by 50% on its debut, much like Google following its IPO that pioneered the auction pricing model, but was still seen as a success.
Recent deals have seen two distinct tranches based on order size to separate the small retail orders from high-net worth individuals and institutions but are still required to be allocated pro rata, ensuring little benefit. The IPO of dairy company Almarai was believed to have been planned with international institutional participation but this was cancelled prior to launch.
DIFX – Mixed success
The Dubai International Financial Exchange was established a year ago in an attempt to solve these issues. The exchange was formed within the DIFC so that it was outside of local laws and could therefore adopt a regulatory model based on the UK's FSA. There were initial difficulties that delayed trading on the exchange. As a result, Investcom completed its IPO in October 2005, but trading began on January 27 2006. Fortunately, there were also GDRs listed in London that did trade during that time. Despite this delay several IPOs have now taken place but the exchange has been slow to attract listings.
Prince Alwaleed used DIFX for the US$400m float of Kingdom Hotel Investments but has seen the stock gradually fall ever since. As a result, the US$3bn IPO of his holding company Kingdom Holdings in the fourth quarter will be a purely local affair on the Tadawul, despite the international nature of its assets.
Ports operator DP World is in a different situation and as a result will bring its US$3bn IPO in October. The company has a more international asset base since its acquisition of P&O and will be the only global ports operator listed globally, so wishes to take advantage of this. The offer is expected also to involve a GDR listing in London and to come after Ramadan in October. It is possible to complete deals during Ramadan, but only if a company is Sharia-compliant. DP World operations involve shipping alcohol so it is not compliant, but international marketing could be completed during this period.
There are several other IPOs planned in Saudi Arabia, though little else across the region. Following Emaar the Economic City is Red Sea Housing Services, a temporary housing company, in late August and fashion retailer Fawaz A Alhokair Group in October. More significant in the pipeline is the SR2.9bn (US$773m) IPO of Saudi Petrochemical Company (Sipchem), which will be the largest underwritten deal from the region. Underwriting has become more important since the market fall, with Emaar the Economic City the first IPO to be underwritten at par. Sipchem will not use a bookbuild but will have a fixed price at a premium to par.