The inelegant dance of IPOs

17:00, Aug 10 2013
FAR FROM GRACEFUL: Bookbuilds are a lot like dancing with a pantomime horse.

One of the most useless questions marketers can ever ask is: "How much would you pay for this?"

Answers will invariably range from "nothing" to "I'll swap you for this fluffy, slightly soft Mentos lolly I found in my pocket".

You really only get the answer when people pony up hard cash.

Hence, when you're selling something that hasn't been sold before, such as company shares, you engage with buyers in a time-honoured dance of "I'll show you mine if you show me yours".

The bookbuild, as it is known in financial circles, is part of an initial public offer process that has all the awkwardness you would expect when dancing partners get together for the first time. And although there is some choreography involved, for retail investors the steps are as comprehensible as the courtship ballet of the blue-footed booby.

With that in mind, it may be useful to relay what I have learned in failing to buy shares in the IPO of Z Energy.


Being a slow sort, I spent some time reading the documents, talking to other investors and generally mulling things over. As a result, I did not respond to my broker's request for expressions of interest until the morning of August 2, the day the offer officially opened.

By this stage, the horse had bolted and there was no longer any stock available to purchase. Oh well, never mind.

The reason for the empty shelves was related to the way the offer was structured.

In Z's case, there was no public pool, which means retail investors could not apply to buy shares from Z directly. Instead there was a "broker firm offer" in which sharebrokers buy shares and sell them to the public.

This isn't some sale-or-return deal though. Sharebrokers must commit to buy a specific number of shares and hope to sell them to clients by the time the bill falls due for payment. In Z's case, New Zealand brokers had to confirm the amount they would buy on the morning of August 1 and were told that evening how much stock they had been allocated.

Brokers based their orders on an educated guess of likely demand after sampling expressions of interest from clients over the week since the prospectus was registered on July 25. The time between the offer opening date and the closing date on August 15 will be spent signing off sales to clients and collecting their money.

Bearing in mind they did not know the selling price at the time - pricing is to be finalised in the bookbuild on August 15 and 16 - brokers were clearly dealing with much uncertainty. Get it wrong on the high side and they have to spend their own money buying stock to unload on market after listing. Get it wrong on the low side and they have many dissatisfied clients who couldn't get the stock they wanted.

Thus, broker demand for a share offer will match their view of its likely popularity with clients (which is not necessarily the same thing as their view of its merits).

However, since broker bids are submitted before the price is set, they can effectively be regarded as indicating demand at the top of the price range of $3.25 to $3.75 a share.

With the retail bid in the bag, Z and its advisers can then assess demand from fund managers in the institutional bookbuild - basically a sort of auction process in which the funds indicate how many shares they are willing to buy at certain prices.

This is known in the trade, apparently, as a "back-end" bookbuild, because it takes place at the end of the offer process. Back-ends are favoured by international institutions, so share offers with an international component are structured accordingly.

One alternative to a back-end, naturally, is a "front-end", in which the bookbuild takes place and the price is set before the prospectus comes out. An example of front-end was Moa Group last October, which offered shares at the fixed price of $1.25.

The front-end is good for investors because they know how much the shares will cost but, because the prospectus follows the bookbuild, it means brokers must bid for stock before they can realistically assess demand from clients, so it would be less popular with them for anything other than small deals.

In between the front-end and the back-end is the . . . wait for it . . . "mid-point", in which the prospectus is registered with an indicative price range for shares, followed by a bookbuild involving brokers and institutions. Then, once the price is set, the broker firm offer opens and investors can buy stock.

One IPO with a mid-point bookbuild was Synlait last month.

To me, the mid-point looks like a sensible approach for the retail market but there are many nuances with the various methods. Ultimately, the deal will be structured in the way that suits the vendor best - the vendor usually wants the highest sale price and the most certainty.

Buyers meanwhile want the lowest price and the ability to back out of the deal until the last moment.

With such opposing interests, it is absurd that they should be represented by the same firms, even when split by Chinese walls. Yet that's how the industry still works for the most part, like a gumboot pas de deux on the back of a pantomime horse.

It may take great skill, but it's far from elegant.

Tim Hunter is deputy editor of the Fairfax Business Bureau.

Post script: Thanks are due to sharebroker Craigs Investment Partners, which has arranged to sell me Z Energy shares I was unable to obtain from my own broker. I hope it will turn out a better buy than Mighty River Power.

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