Dr. Sharif Nurul Ahkam :
There have been fairly extensive discussions on Pre-IPO placements in various circles, such as, TV programs, Security and Exchange Commission, and traders and brokers in the stock market. SEC has been prompted to take some actions. It has been made out in the media that the recent stock market decline had been due to the fairly active Pre-IPO placement activities. I may be alone in my opinion, but I believe that the worry is misplaced, and the actions taken are ill conceived and very harmful from an economic perspective. I also object to steps that sweepingly benefit one group (especially a small group that is interested in gambling), hurting the group that is supplying long-term capital embracing significant risk and uncertainty in building plants, buying machinery and equipment, setting up an operating system, and bringing actual production and utilities in the economy. Once this major uncertainty and risk (whether there will be an actual economic unit) is removed and after economic activity is ensured, the stock is placed in the stock market, the value of the company can be ascertained in terms of its productivity, profitability, and generation of cash flows.
Let us first see what Pre-IPO placement does. I want to discuss this because, in all the deliberations, the discussion on this is missing. Pre-IPO placement has been presented as a villain completely ignoring the crucial purpose it serves. If a proposed company needs to raise 100 crore taka, it will typically raise at least 50 crore taka from investors who are willing to risk their money even before the factory is built, even before there is a history of business, even before there is a proof of profit. This relieves the burden on the merchant bankers who must ensure that necessary amount is raised. There are not a lot of people who can commit several crores of taka without any expectation of getting any return on the money, but with the full possibility of losing all the money committed. This is a process that ensures that an IPO will not be undersubscribed. If you point out that IPOs are typically oversubscribed, let me point out that (1) the number of issues offered to the public is significantly lower because Pre-IPO investors have already taken up a large number of shares, reducing the supply, (2) the commitment in the Pre-IPO raises the confidence of likely ordinary shareholders in the potential of the company, and (3) risk element whether the company will engage in actual business is mitigated.
If you just consider the above paragraph, you will realize the magnitude of risk undertaken by Pre-IPO shareholders and the risk undertaken by ordinary shareholders post-IPO involves only market volatility and noise. Ordinary long-term shareholders have earned an average annual return of 30 percent and above in the stock market in a time span of 1999 to 2018. Given the risk taken by the Pre-IPO investors, the expected return on pre-IPO placements will naturally and theoretically be higher. The risk undertaken by ordinary shareholders is anywhere near what Pre-IPO investors do.
There is no justification to expect the stock market to relentless go up without limit. Sometimes, the stock market will decline. That is the nature of the stock market. The stock market showed sign of life after the National Election, but it could not maintain the upward trajectory. It is not that unusual. When a market declines by ten percent, the market is thought to be in the correction phase, and the market goes through correction phases not that infrequently. It is very common right after a significant run-up, like the one we had in January 2019. I am not saying that there is nothing to be concerned about the decline in the stock market. But, the concern has been misplaced.
When a market goes through these phases, it is customary and fashionable to say that this was due to market manipulation, some devilish machination, some syndicates, some dark forces behind the screen of the stock market, and so on. This time, somehow, Pre-IPO placements got the most bum rap. I suspect, some influential player in the market unexpectedly lost some money because their game did not turn out exactly the way they hoped. That is supposed to happen once in a while and the regulators should not react to just about any complaint if this comes from the “influential” group.
*Next part of the article will be published tomorrow.
(Dr. Sharif Nurul Ahkam, Professor of Finance and the Director of Graduate Studies, North South University)
There have been fairly extensive discussions on Pre-IPO placements in various circles, such as, TV programs, Security and Exchange Commission, and traders and brokers in the stock market. SEC has been prompted to take some actions. It has been made out in the media that the recent stock market decline had been due to the fairly active Pre-IPO placement activities. I may be alone in my opinion, but I believe that the worry is misplaced, and the actions taken are ill conceived and very harmful from an economic perspective. I also object to steps that sweepingly benefit one group (especially a small group that is interested in gambling), hurting the group that is supplying long-term capital embracing significant risk and uncertainty in building plants, buying machinery and equipment, setting up an operating system, and bringing actual production and utilities in the economy. Once this major uncertainty and risk (whether there will be an actual economic unit) is removed and after economic activity is ensured, the stock is placed in the stock market, the value of the company can be ascertained in terms of its productivity, profitability, and generation of cash flows.
Let us first see what Pre-IPO placement does. I want to discuss this because, in all the deliberations, the discussion on this is missing. Pre-IPO placement has been presented as a villain completely ignoring the crucial purpose it serves. If a proposed company needs to raise 100 crore taka, it will typically raise at least 50 crore taka from investors who are willing to risk their money even before the factory is built, even before there is a history of business, even before there is a proof of profit. This relieves the burden on the merchant bankers who must ensure that necessary amount is raised. There are not a lot of people who can commit several crores of taka without any expectation of getting any return on the money, but with the full possibility of losing all the money committed. This is a process that ensures that an IPO will not be undersubscribed. If you point out that IPOs are typically oversubscribed, let me point out that (1) the number of issues offered to the public is significantly lower because Pre-IPO investors have already taken up a large number of shares, reducing the supply, (2) the commitment in the Pre-IPO raises the confidence of likely ordinary shareholders in the potential of the company, and (3) risk element whether the company will engage in actual business is mitigated.
If you just consider the above paragraph, you will realize the magnitude of risk undertaken by Pre-IPO shareholders and the risk undertaken by ordinary shareholders post-IPO involves only market volatility and noise. Ordinary long-term shareholders have earned an average annual return of 30 percent and above in the stock market in a time span of 1999 to 2018. Given the risk taken by the Pre-IPO investors, the expected return on pre-IPO placements will naturally and theoretically be higher. The risk undertaken by ordinary shareholders is anywhere near what Pre-IPO investors do.
There is no justification to expect the stock market to relentless go up without limit. Sometimes, the stock market will decline. That is the nature of the stock market. The stock market showed sign of life after the National Election, but it could not maintain the upward trajectory. It is not that unusual. When a market declines by ten percent, the market is thought to be in the correction phase, and the market goes through correction phases not that infrequently. It is very common right after a significant run-up, like the one we had in January 2019. I am not saying that there is nothing to be concerned about the decline in the stock market. But, the concern has been misplaced.
When a market goes through these phases, it is customary and fashionable to say that this was due to market manipulation, some devilish machination, some syndicates, some dark forces behind the screen of the stock market, and so on. This time, somehow, Pre-IPO placements got the most bum rap. I suspect, some influential player in the market unexpectedly lost some money because their game did not turn out exactly the way they hoped. That is supposed to happen once in a while and the regulators should not react to just about any complaint if this comes from the “influential” group.
*Next part of the article will be published tomorrow.
(Dr. Sharif Nurul Ahkam, Professor of Finance and the Director of Graduate Studies, North South University)
