AN INVESTORS GUIDE TO PARTICIPATING IN INITIAL PUBLIC OFFERINGS (IPO)

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LAWYER’S GUIDE ON INITIAL PUBLIC OFFERINGS (IPO); MTN IPO INSIGHTS

What are IPO’s, what does “going public” mean for Companies? Why do companies go public? What factors should investors consider before participating in the initial public offerings (IPOs)? These are some of the questions reasonably asked by companies and investors before venturing; this article attempts to respond to the FAQ’s and

On 11th October, 2021, MTN Uganda officially opened its initial public offering for the sale of a 20% stake at 200 Ugandan shillings ($0.0558) per share. The MTN IPO will close on November 22 and Shares will start trading on December 6.

Shares issued by companies going public are commonly offered below their market-clearing price, rewarding the public with a handsome return that can be measured by the difference between the offer price and the higher price attained in early trading which is why MTN Uganda underpriced its shares at low value of 200 Ugandan shillings per share.

  1. What are IPO’S?

IPOs are a type of public offering in which shares of stock in a company usually are sold to institutional investors that in turn sell to the general public, on a securities exchange, for the first time.[1]

Corporations may raise capital in the primary market by way of initial public offerings. Old and young companies undergo IPO but many companies cannot go public because they do not have the characteristics to induce public market investors to participate and other companies choose not to go public because of the semantics of owners who desire to remain private.

  • What does “going public” mean for Companies?

The decision to become a public company is concretely materialized in initiating and conducting an initial public offer of shares (IPO – Initial Public Offer), according to the stock market regulations.

The company that wants to finance an investment project or for other activities offers a number of shares for sale to those investors who have sufficient money and want to gain by opening a long position on those stocks or simply to gain.

Investor’s sentiment plays an important role in the decision to become a public company because no company will go public unless it’s completely sure about investor’s sentiments.

Another influencing factor for the company that wants to go public is the choice of the capital market on which it will be selling the new issued shares. From a natural inertia, generally, a new issuer prefers the national market where it is already or can be easily known and where it can get a higher value for shares.

According to Ding, Nowak and Zhang (2010), a company chooses a foreign market, to list, in order to signal an important step in the implementation of long-term growth strategy. This explains why MTN decided to go public on a national level because listing on a foreign capital market comes along with lots of compliance reporting requirements.

In “going public” the shares offered for sale to the public may be newly issued shares or they may be a portion of the shares already held by the owner of the company. Where the shares sold are those newly issued by the corporation, the issue is known as a “primary offering.” Where the shares offered are those belonging to owners of the company, the issue is known as a “secondary offering.”

The idea that the decision to become public under information asymmetry becomes appropriate when the market is optimistic and inclined to over valuate shares as a mean of managers to exploit investors. However, According to the pecking order theory[2], opening to the public investors for a company appears as a last resort of financing, being preferred self-financing, bank loans and the issue of bonds and the decision to become a public company is much more complex.

Preliminary steps to going public

Before a company goes public, there are steps that have to be complied with and these include;

  • Selection of an underwriter and an independent public accountant (The underwriter endorses the prospectus and is liable for any damage to those purchasing or selling the securities on the Exchange if caused by a reasonably avoidable error or omission in the prospectus). NB MTN Uganda IPO is not underwritten.
  • Capital requirement; determine amount of stock to be sold and whether the owners will sell some of their shares.
  • Registration procedure; registration statement requires disclosure of large amount of information pertaining to the company, its officers, directors as well as financial statements certified by an independent certified public accountant.
  • Why do companies go public (advantages and disadvantages)?

There are a number of advantages that usually influence the company to go public;

  • The ability to procure necessary cash resources from investors is one of the reasons companies go public. According to the Prospectus released to the public on Monday under 9.13.2 page 74, MTN Uganda is indebted to a tune of 194 billion and USD 45.3 million respectively as of 30th June 2021and arises out of unsecured syndicated loan facilities obtained from several banks. Therefore, by going public, MTN Uganda will be able to get the necessary cash resources to finance their debts.
  • Going public will increase the company’s equity if the market is successful. So if MTN Uganda is lucky and the public responds by purchasing as many shares as possible, its equity will rapidly increase.
  • Going public gives least additional publicity to the companies and its products. It also increases the owner’s personal prestige and reputation due to the company’s public nature
  • Going public gives the company a continuous possibility to test the market feeling. This helps the company to decide whether to issue more shares and how much. MTN Uganda is now selling 20% of its stock shares and if the market is readily available, they might choose to offer more 10% depending on the market environment.
  • Going public provides a company with a better dispersion of shares and a different market value.

The other advantages of going public include access to capital from a large existing pool of ready investors for debt repayment and/or growth, valuation of stock for employee owners including founders, and increased public recognition and visibility for individuals among others.

However, there are disadvantages of going public as summarized below;

  • Going public is costly because the company going public must incur a lot of expenses to meet the requirements of going public in accordance with sector policy regulations that govern listing of shares. For instance, UCC indicated that MTN was required to comply with the listing obligation by 30th June, 2022. Therefore, the transparency requirements on reporting are cost effective. Pagano, Panetta and Zingales (1998) draw attention in their study upon the danger imposed by these requirements of transparency, given that a company is required to disseminate information that may be crucial in the fight with competition.
  • Another disadvantage of going public is that the company opens entry into the company’s shareholding to every undesirable investor. According to Boot, Gopalan and Thake (2006), the fear of losing the autonomy in decision makes many companies avoid opening to the public investors.
  • Going public increases attention to shareholders expectations. Once the company becomes a public one, it must pay attention and respond to shareholders expectations, especially to those of institutional investors which prefer dividends and are interested in obtaining also capital gains in the short term.
  • What factors should investors consider to participate in the initial public offerings (IPOs)?

Initial public offerings (IPOs) play an important role in the financial system, enabling companies to raise equity finance and providing investors with a tradable asset.

Sameulson, 1992; Gitman & Joehnk, 2002 all agree that different investors have different investment opportunity sets and the choice of investment depends entirely on the utility (that is tastes or preferences) that the investor gets from a particular choice. Since investors are faced with many different investment opportunities, they would go for those investments that would give them maximum benefits.

Gitman & Joehnk, 2002 also notes that the choice of investment by individuals depends on the motives and rationale behind the investment. Since investments are carried out throughout the individual’s life cycle, the choice of investment will be very much dependent on the financial goals of the investor. For instance, they could be near term – high priority goals which are shorter term financial objectives such as buying a house, a car, or a trip. Secondly, they could be long-term-high priority goals which will be for retirement purposes. Lastly, there are those lower priority goals which are not critical and may include buying a new car every few years or refurnishing a house.

Individual investments are undertaken for several reasons which include;

  • Liquidity purpose: investments enhance current income by earning dividends or interests.
  • Saving for a large future expenditure: individual invest because they want to save for a major expenditure in future.
  • Retirement plans: some individuals invest to supplement the amounts of their social security because they feel it won’t be enough to meet their retirement plans.
  • Speculative purposes: Since investors will invest purely because of speculative reasons such as if an economy expects a boom in the future, or a company is just about to realize huge profits, or going international.
Factors to that should influence your decision to invest in shares

Investors should consider a number of factors when choosing to invest., Samuelson, 1992; Reily & Brown, 1996; Hurt & Block, 1993; Fisher and Jordan, 1996; Bhalla, 1979; Gitman & Joehnk, 2002; Elton and Gruber, 1981 have all hinted on the factors that should influence the investors decision to invest in shares and these factors include;

  1. Profitability of the Company: Businesses do exist mainly to maximize profits and shareholders wealth. Investors invest so that they make gain from the profits made by the company. If a company is known to be profitable, it will attract investors. On the other hand, no rational investor would buy shares from a loss making company. MTN Uganda is a profitable company with services like mobile money, mobile data and calls that are mostly used by over 15 million Ugandans.
  2. Company’s asset structure: Before investing, you should look at the company’s asset structure. High value asset is a sign of stability while low value asset is a risk. If a company has assets, it is more stable as compared to one which does not and is considered as unstable. Liquid assets will enable a company to meet its short term financial needs without necessary rushing into other sources of financing. Investors do prefer companies with assets in form of liquidity with a high value. In the prospectus at page 78, MTN highlights some of its assets for you to analyse and find out what MTN holds in assets.
  3. Monetary and fiscal policies of the government: Taxes, interest rates, inflation and government compliance fees should influence or discourage your decision to invest in shares. If taxes are high, then I discourage investors like you from investing in securities and vice versa. Before investing in shares, one should know that MTN Uganda is one of the biggest tax payers in Uganda and there is no single year it will fail to meet its tax obligations and other discrete compliance obligations from UCC. For instance MTN Uganda paid USD 100 million for NTO License and MTN Uganda is aware that these fees might increase and failure to meet the NTO license obligations might have diverse effects on the company.
  4. Industrial factors: Competition determines how well the company performs and so the more competitive a company is, the more investors would prefer its stock since competition is a sign of good performance and so the returns are expected to be equally high. There is no doubt, MTN Uganda is one of the leading telecom companies with over 15 million users, and this is ready market which keeps growing. The market for their services is available and the performance will definitely yield a lot of returns and therefore investing in its shares is advisable for long term future plans.
  5. Financing policy and capital structure: This will determine the actions of management in as far as financing the company’s operations are concerned. For instance, does the company issue new shares to raise funds and will the existing shareholders portion be diluted by this action? What is the ratio of debt to equity and what is the cost of capital? If the company will spend its earnings in servicing debt financing, then as an investor you should be careful when investing in such company’s shares. Under section 9.13.2 page 74 of the prospectus, MTN Uganda is indebted to a tune of 194 billion and USD 45.3 million respectively as of 30th June 2021 but this needs not worry you because most companies thrive on controlled corporate borrowing for many years while making profits.
  6. Returns: Individual investors should relate expected returns from investment to overall market return and the cost of capital before deciding on whether to invest or not. If expected returns are lower than the market returns, then you should think twice before investing in shares. If you are to invest in shares, buying 500 shares at 100,000 ugx would not yield much for you in return because it’s a rule of thumb that the more you invest the more you get in return (don’t expect to earn more from dividends than someone who purchases 500,000 shares worth 100,000,000 million).
  7. Risk: As an Investor, you should always consider risks associated with every investment before making a choice. The future outcome is always uncertain, i.e. either favorable or adverse, and investors must predict the possible outcome.

Investing in shares is a risky business because it comes with uncertain risks in future, investing in shares is investing in the company’s future prospects, it might make profits or not or at worst of all, it ceases operation.  Section 8 of the prospectus highlights some of the risks that MTN Uganda is prone too and some risks are uncertain.

  • Dividends: Companies are under no obligation to pay dividends. The directors may choose either to declare dividends or not in a year. Dividends may be paid in form of cash or stock dividends. Each company chooses its own dividend policy that it deems best to serve its investment and shareholder interests so as to maximize the shareholder wealth. Therefore, it is important to do a proper analysis that will enable you to select an investment that earns you good returns in form of dividends and capital gains now and in the future. Investing in shares requires patience because you are investing into the company’s future and therefore, you should not expect to be paid dividends in a period of 8 months, if that’s your expectation, you really need not to participate in this MTN Uganda IPO.
  • Other factors: This includes factors like future expansion plans, diversification into new markets, management and staff of the company etc. These will affect the Company’s ability to retain or to distribute dividends and how to raise the additional capital required for such expansions. Such actions would either benefit the individual investor or make him loose. 

An investment is a commitment of funds made in the expectations of some positive rate of returns and the decision should be taken carefully

CONCLUSION

Before you choose to participate in the MTN Uganda IPO, you should have it at the back of your mind that, investing in shares is risky, dividends will not be paid as soon as you expect, and purchasing shares as low as 500 at 100,000 Ugx will not benefit you compared to some who buys 500,000 shares. Section 8 of the Prospectus highlights MTN’S known specific risk factors that might affect the company adversely, the section also acknowledges that there are more factors not known that might have adverse effects on the company’s business, basically the rationale of this section is to bring to the investors’ attention the risk involved in investing in shares (caveat emptor – “let the buyer beware”) you must be aware of what you are venturing into.   But If the investment is properly undertaken, the return will commensurate with the risk the investor assumes.

REFERENCES

Geofrey A. Hurt and Stanley B Block, 1993, “Fundamentals of Investment Management”, 4th edition, USA Richard D. Irwin Inc.

Samuelson Paul A, 1992, “Economics”, 14lh edition, McGraw-Hill International editions

Nelson, T. (2003), the persistence of founder influence: management, ownership, and performance effects at initial public offering. Strat. Mgmt. J., 24: 707-724 available at. https://doi.org/10.1002/smj.328,

Afacerilor, F.D.E.Ş.A., the Decision of Going Public–When, Where and Why? Availbale at Https://Core.Ac.Uk/Download/Pdf/27178804.Pdf

Fisher and Jordan; security analysis and portfolio management 7th edition

Keith C. Brown, Frank K. Reilly; Analysis of Investments and Management of Portfolios.

Chien-Ting Lin & Shou-Ming Hsu (2008) Determinants of the initial IPO performance: evidence from Hong Kong and Taiwan, Applied Financial Economics, 18:12, 955-963, DOI: 10.1080/09603100701367393

 The author is an LLM Student at Makerere University & a legal associate at Nabasa & Co. Advocates

[1] https://en.wikipedia.org/wiki/Initial_public_offering accessed on 12th Oct, 2021

[2] In corporate finance, the pecking order theory (or pecking order model) postulates that the cost of financing increases with asymmetric information https://en.wikipedia.org/wiki/Pecking_order_theory