IPOs show the danger of youthful capital markets

'Can anyone explain what is happening?' said a visiting German investment banker the other day. 'Is there so much money in this country that any IPO will be 175 times oversubscribed like Sorouh? Does this not mean that the IPOs are not being priced properly?'

The logic of the Teutonic guest is inescapable but out of tune with current capital market realities in the UAE. Local investors, and with few exceptions these are UAE nationals, have become convinced as a tribe that any IPO will succeed. And the arcane company valuation procedures and listing requirements mean that IPOs are offered at a significant discount.

Indeed, the regional jeweler Damas has just decided on a private placing instead of an IPO, reportedly because the valuation offered by the authorities was too low. It is notable that the new IPOs tend to be start-ups, although the best ones have some kind of a Government concession to exploit.

So the twist is not in the value offered to investors. At least superficially these IPO companies are being sold at a discount to market value. However, the level of enthusiasm and the propensity for investors to borrow to buy IPOs has made it very difficult for the crowd to make any real money.

What happens is this: investors obtain say 0.6% of the shares they apply for, and while they can re-sell at a profit in the stock market this profit is not enough to pay the cost of borrowing the money used in the application.

The only participants who really win in the IPO process are therefore the financial institutions involved and the promoters or founder shareholders.

The financial institutions make money by lending to the public investors, and also charge fees for arranging the IPO. The promoters keep say 45% of the stock of the company which has an IPO and watch the value of their holding soar from Day One of trading.

Does the UAE economy benefit from the creation of more companies? Clearly if they have good business plans in areas of the economy that require expansion, then this is so. But stock market listings in developed economies normally need a three-year track record in order to demonstrate that the company can do what it says it can do in terms of creating profits for shareholders.

The investor in IPOs in the UAE does not have this comfort factor, and the fact of the matter is that share valuation levels have been pushed to levels that many analysts think are unsustainable.

Therefore, the likelihood of an unfortunate conclusion to this round of IPOs can not be ruled out, with investors left with shares worth a faction of their peak value.

A little more caution on the part of public investors, who seem to think that IPOs are a license to print money, would seem called for. Surely local investors will soon notice that this is actually no longer true!