With all the excitement surrounding many IPOs (initial public offerings), it's easy to lose sight of the basic business principle at play. A company issuing shares is aiming to raise the maximum amount of money to reinvest and drive the business forward. The shareholder, believing in its long-term prospects, supplies those funds with the purpose of making a return.
The traditional way for a company to raise funds
A book build is the process employed by one or more brokers associated with the float, to allocate their allotment of shares to their preferred clients. A float price is based on the demand from institutional and preferred clients. Upon announcement of a capital raising, the stock is suspended until completion of the book build. Things did not auger well for the upcoming float if the average investor was contacted and offered stock!
Following the collapse in 2009 of Lehman Brothers, Australian companies found capital hard to raise as the debt markets were frozen. As a result, they bolstered their balance sheets via a flood of capital raisings.
Investment banks and brokers dined out on the related fees and commissions, while fund managers and preferred clients of the brokers acquired stock at a deep discount to the prevailing market price. Currently about 80% of the capital raising cost for the company is the discount. This often just rewards hedge funds and traders who sell out after the stock resumes trading.
Financial planners are allocated shares by brokers, as they had garnered goodwill by routinely using full service (higher commission) brokers, which ran counter to the best interests of their clients. This resonates with the sentiments expressed by Scott Phillips in his recent open letter to Tony Abbott.
Meanwhile, the ordinary shareholder was completely overlooked and now owned a smaller share of the company due to the additional shares on issue.
The ASX's new alternative
The Australian Stock Exchange (ASX: ASX) is promoting greater fairness and transparency by introducing an additional tool (ASX BookBuild) for brokers and investment banks to consider when advising companies on how to price and allocate new securities. Now, all eligible investors may access the book build via any ASX broker and a live auction price can be viewed, as the ASX is allowing the market to set the price.
From the company perspective, it will provide more choice and flexibility when raising funds and a higher float price due to greater price tension. From the ordinary shareholder's perspective, they may not obtain huge profits because of the lesser discount, but they will have access to the majority of floats and capital raisings.
It is not mandatory for companies to adopt this service. However, companies will likely feel obliged to adopt this fairer system, unless they want to incur the wrath of ordinary shareholders.
Investment research house Morningstar suggests there will be 21 IPOs before the end of the year. This is a reflection of an increase in market confidence, as there were only 36 IPOs in 2012. This increased activity should be a positive for both Computershare (ASX: CPU) and IRESS (ASX: IRE). The former benefits via the provision of integrated investor services and corporate market action expertise, while the latter's forte is in share market and wealth management systems.
The ASXBookBuild service opened for business on October 8 and WAM Capital (ASX: WAM) is the first company to use the facility.
Foolish takeaway
In a clear breakthrough, the new ASX BookBuild facility will allow ordinary investors to contact their own brokers and participate in the majority of new floats or capital raisings. It will now be incumbent upon the investor to stay informed of upcoming floats.
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Motley Fool contributor Mark Woodruff does not own shares in any of the companies mentioned in this article.
