Why IPOs do not mix well with falling stock markets

Now while a successful IPO is a cause for cheer, is it such a success when helps to wipe $90 billion off the value of shares which is what happened in Saudi Arabia on Monday and Tuesday?

At the same time the UAE Central Bank and economy ministry held a meeting to regulate IPO issues in the UAE, and agreed that simulaneous IPOs were to be avoided in future. The recent IPOs for Tabreed and the second UAE telecom operator raised more than one-and-a-half times the GDP of the UAE, and drained the local stock market of liquidity, and ended a recent rally in shares.

If we go back to basics, what is an IPO? An IPO is a new issue of shares into the pool of shares represented by a national stock market. At a time of rising share prices then an increase in the supply of shares will be welcome, and not adversely affect other share prices.

Fuelling a crash

But when a stock market is falling - and all the Arab stock markets have fallen one after another this year - then holding an IPO is like throwing petrol on a fire: you add to the supply of shares which is already more than the market can handle, and depress prices further by encouraging the sale of existing shares to buy the IPO.

It is therefore obvious that holding IPOs in falling markets is unwise, though clearly for the company concerned and its financial advisers holding an IPO can still make sense. However, this does depend on the IPO share price, for with share prices falling there is a danger that new shareholders will find their shares worth less than they paid for them and be none too happy.

Perhaps IPOs will not stop until one goes badly wrong, and some of the parties involve end up losing money. But that will not stop the damaging effect of each successive IPO on the general health of the local stock markets.

Time to rethink IPOs

What is really needed is a pause to the whole IPO process in the region, and a rethink by the authorities on how they are done. Maybe there should be minimum and maximum subscription levels to stop the liquidity drain. Possibly IPO issue prices should be determined by market forces and not government departments so that they do not offer the potential for huge profits, albeit illusory due to the massive oversubscriptions.

There is no doubt that the stock markets of the GCC should have more listed companies and that this would be beneficial to business in the region through promoting greater transparency and offering more opportunities for corporate finance. But this needs to be done in a sensible way that does not result in a stock market crash for each IPO.