What is an IPO? - The Definitive New Zealand Guide
No IPO is like another; this guide outlines how an IPO works, why companies do them, the pros and cons, what to watch out for as an investor, and some key New Zealand examples in recent years
Updated 31 March 2021
When companies get to a certain size, and it makes sense for them to do so, they may list on a public stock exchange in what is known as an Initial Public Offering (IPO).
Why have we published a guide to IPOs?
Our view is that capital markets have never been more accessible to New Zealanders, but this brings a danger of inexperienced investors unknowingly buying shares in companies that possibly don't meet their long-term wealth creation goals. Many IPOs in New Zealand have ended in disaster - CBL and MOA are of two two recent examples. To help explain IPOs in detail, our guide covers:
Background - The NZX and IPO History
When companies get to a certain size, and it makes sense for them to do so, they may list on a public stock exchange in what is known as an Initial Public Offering (IPO).
Why have we published a guide to IPOs?
Our view is that capital markets have never been more accessible to New Zealanders, but this brings a danger of inexperienced investors unknowingly buying shares in companies that possibly don't meet their long-term wealth creation goals. Many IPOs in New Zealand have ended in disaster - CBL and MOA are of two two recent examples. To help explain IPOs in detail, our guide covers:
- What is an IPO?
- Three Must-Know Facts to Help Understand How IPOs Work
- IPOs - Advantages and Disadvantages for any Company Listing on the Sharemarket
- Frequently Asked Questions
Background - The NZX and IPO History
- The National New Zealand Stock Exchange was first established in 1983, amalgamating several regional stock exchanges that originated in the gold rush of the 1860s.
- Since then, the NZX has listed hundreds of New Zealand companies and provided a platform for New Zealand companies to access further capital.
- Some notable IPOs on the NZX have been Xero, TradeMe, Air New Zealand, Fletcher Building and Spark (originally listed as Telecom).
What is an IPO?
An IPO is typically the first time a company allows its stock to be traded to the general public (in this case – "public" refers to ordinary New Zealanders). Companies will look to issue new stock, similar to how companies raise Series A/B/C funding. The key difference here is they are raising from public investors rather than private investors. In a Series A, there may be two or three VC firms that "lead" a round, whereas in an IPO, there will be many smaller investors looking to get a piece of the IPO alongside institutional investors. Recent examples include thousands of New Zealanders buying shares during the IPO of My Food Bag, Cannasouth and Napier Port.
Know This: The majority of companies in the world are private. A private company is typically one which has grown through bootstrapping (using your own money), family and friends, angel investments or venture capital money. Companies that get to a certain size typically look for the next step in the growth journey, and sometimes the private markets can be limiting. However, just because a company is progressing with an IPO doesn't mean it's a reliable investment. There are many New Zealand companies who IPO'd because banks won't lend to them any more, and/or their original investors don't want to put any more money in. Be cautious about any IPO and never believe the hype - lots of money is made by existing investors by talking up the company to potential investors.
How an IPO Works
In an IPO, the first step is to price the company's shares. This is typically done by an investment bank that will conduct due diligence (look into the business's fundamentals and financial statements). A company will hire investment bankers to value the business, gauge demand from buyers, set the price and date, "underwrite" the transaction (underwriter breakdown below).
An IPO consists of two steps: (1) pre-market phase and (2) IPO itself.
Steps of an IPO for a Company wanting to list on the sharemarket
Know This: The majority of companies in the world are private. A private company is typically one which has grown through bootstrapping (using your own money), family and friends, angel investments or venture capital money. Companies that get to a certain size typically look for the next step in the growth journey, and sometimes the private markets can be limiting. However, just because a company is progressing with an IPO doesn't mean it's a reliable investment. There are many New Zealand companies who IPO'd because banks won't lend to them any more, and/or their original investors don't want to put any more money in. Be cautious about any IPO and never believe the hype - lots of money is made by existing investors by talking up the company to potential investors.
How an IPO Works
In an IPO, the first step is to price the company's shares. This is typically done by an investment bank that will conduct due diligence (look into the business's fundamentals and financial statements). A company will hire investment bankers to value the business, gauge demand from buyers, set the price and date, "underwrite" the transaction (underwriter breakdown below).
An IPO consists of two steps: (1) pre-market phase and (2) IPO itself.
- The first step is to advertise to underwriters (Investment Banks) that the company is looking to IPO and will receive submissions from these banks looking to win the company as a client and do the associated work.
- Once the underwriters are selected, they will lead the due diligence process (preparing documents, filing, marketing, valuation, etc.).
Steps of an IPO for a Company wanting to list on the sharemarket
- The company chooses its underwriter(s).
- The underwriter will value the company and choose the structure (with board approval).
- The company works with accountants, lawyers and the company to formulate documents.
- The company and its advisors prepare the initial filings and work with regulators (i.e. the FMA and NZX) to comply with listing requirements.
- Executives of the company (i.e. CEO, Chairman/woman) go on a "roadshow", which effectively involves management and the investment banks to pitch the company to prospective public investors (hedge funds, fund managers, pension funds etc.
- The company's bankers conduct a "Bookbuild" with the prospective investors to understand the indicative price and quantity each party is willing to buy and sell at. Once this is identified, a market can be identified, and an indicative price can be set for the IPO price.
Know This: How to determine whether or not an IPO has the interests of new investors at its heart
There are many factors to consider. Some examples of things to consider include:
- The strategic rationale for the IPO - Are they raising capital to expand? If so – this is a good indicator. If they're raising money to pay out the early investors (i.e. MyFoodBag), then it can be a negative indicator.
- The founders' ownership stake: High levels of retained ownership post-IPO is (generally) a good sign. The owners are committed and are likely to do a better job of running the company. If the owners are reducing their stake, this is typically a cause for concern. If the founders had faith in the company, they would be holding onto their stakes. Whilst certain circumstances make sense (i.e. needing cash to settle a divorce, pay off debts, stepping down from top management), the majority of founder sell downs can be done for the wrong reasons. Example: The My Food Bag early investors sold 75% of their existing shares in the business on IPO day – which is typically a bad sign. The existing private equity investors and founders were able to sell down $282 million worth of shares on IPO day.
- Reasonable valuation – this one is more difficult to gauge, but typically equity research reports drafted from investment banks like Jarden, UBS and Goldman Sachs will outline the valuation. This is also commonly found in the Product Disclosure Statement (PDS).
When is the "right" time to buy into an IPO?
It depends on the company being listed. Some IPOs will increase by 100% on day one, while others will drop by 50%. Every IPO is unique, and each company will differ in the way it is valued, marketed and supported. There is no general "right time" for many reasons.
It's difficult to say whether an IPO will be overvalued, but in general – the investment banks do a very good job of pricing the company such that:
Whilst this isn't the case in every IPO, a banker's priority is ensuring all stakeholders are happy. The majority of the time, a large drop on the first day of trading does not keep existing or new investors happy, so it is in the company's best interests to underprice the stock rather than overprice it. Whether this is the case for a particular company will vary.
It's difficult to say whether an IPO will be overvalued, but in general – the investment banks do a very good job of pricing the company such that:
- The early investors are happy with the valuation and aren't angry if they're selling their stake too cheaply
- The institutional investors buying into the IPO aren't paying too much for the company (such that they will see it drop on day one)
- The company "pops" on the first day of trading, typically leading to positive media posts and reporting.
Whilst this isn't the case in every IPO, a banker's priority is ensuring all stakeholders are happy. The majority of the time, a large drop on the first day of trading does not keep existing or new investors happy, so it is in the company's best interests to underprice the stock rather than overprice it. Whether this is the case for a particular company will vary.
Three Must-Know Facts to Help Understand How IPOs Work
1. Compliance requirements is designed to protect investors from dubious IPOs
As an IPO is an offer to the public, the company must ensure the accounts, financial projections, and representations are correct. Public investors may not have the understanding or specialisation necessary to understand a business, so to protect the general public/retail investors, certain compliance standards are required to list on the stock exchange. These requirements can be relatively expensive to do.
2. Underwriters play a vital role
Underwriters act as a bridge between the company and investors. The underwriters will typically commit to buying a portion of the IPO amount, effectively providing a floor for the company if public investors do not purchase the shares. This is to provide some certainty to the company that the IPO will do "well", and the price will stabilise.
A "Greenshoe Option" is a provision in the underwriter agreement that allows the underwriter to sell investors more shares than initially planned if demand exceeds a certain threshold (typically up to 15% more). This provides stability and liquidity to the markets and provides buying power to the underwriters in the case that share prices fall.
3. There is usually a lock-up period to protect new shareholders
Underwriters (i.e. investment banks) are likely to get existing investors to sign agreements preventing them from selling their stakes (known as an escrow period) to stabilise the stock price once it has publicly listed. Lock-up agreements are legally binding contracts. Typical lock-up periods can range widely, but typical lock-up periods last anywhere from 3-24 months (with 12 months being most common). There is typically significant volatility (large price movements) around lock-up dates.
Why do lock-up periods exist?
To protect the share price in at least the short to medium-term, the promoters of an IPO require original investors to withhold from selling their shares and dropping the share price. For example, if a company had an IPO on March 10 and then an early shareholder sold millions of shares on March 15, the share price would, in most cases, fall significantly. To protect investors, lockup periods give certainty about how many shares will be sold off by the original investors.
As an IPO is an offer to the public, the company must ensure the accounts, financial projections, and representations are correct. Public investors may not have the understanding or specialisation necessary to understand a business, so to protect the general public/retail investors, certain compliance standards are required to list on the stock exchange. These requirements can be relatively expensive to do.
2. Underwriters play a vital role
Underwriters act as a bridge between the company and investors. The underwriters will typically commit to buying a portion of the IPO amount, effectively providing a floor for the company if public investors do not purchase the shares. This is to provide some certainty to the company that the IPO will do "well", and the price will stabilise.
A "Greenshoe Option" is a provision in the underwriter agreement that allows the underwriter to sell investors more shares than initially planned if demand exceeds a certain threshold (typically up to 15% more). This provides stability and liquidity to the markets and provides buying power to the underwriters in the case that share prices fall.
3. There is usually a lock-up period to protect new shareholders
Underwriters (i.e. investment banks) are likely to get existing investors to sign agreements preventing them from selling their stakes (known as an escrow period) to stabilise the stock price once it has publicly listed. Lock-up agreements are legally binding contracts. Typical lock-up periods can range widely, but typical lock-up periods last anywhere from 3-24 months (with 12 months being most common). There is typically significant volatility (large price movements) around lock-up dates.
Why do lock-up periods exist?
To protect the share price in at least the short to medium-term, the promoters of an IPO require original investors to withhold from selling their shares and dropping the share price. For example, if a company had an IPO on March 10 and then an early shareholder sold millions of shares on March 15, the share price would, in most cases, fall significantly. To protect investors, lockup periods give certainty about how many shares will be sold off by the original investors.
IPOs - Advantages and Disadvantages for any Company Listing on the Sharemarket
IPOs have advantages to both companies and investors, but there are also clear disadvantages. We list the below to bring light to the reasons why some companies IPO and the risks, obligations and costs associated with doing so.
Advantages of IPOs
Access to deeper capital pools - There are millions of potential investors for a public stock. An IPO opens the gates for companies to get greater access to funding and grow faster where the private markets may have limited ability to provide funding. The public market presents an opportunity for these millions of investors to invest in a company's equity. These investors may not have had the prior access to invest in the stock, and as such, demand may significantly outstrip supply on IPO day.
Brand Visibility - Taking a company public typically improves the company's exposure, prestige, and public image, which can, in turn, help the company's sales and profits. An IPO is also seen as a "milestone" for many companies (alongside $1bn USD Private unicorn valuation, becoming profitable etc.).
Cash-Out Opportunity - An IPO provides a chance for early employees and founders to have the option to cash out (providing liquidity to these early investors when and if they need it).
Increased Transparency - Listing on a public stock exchange improves the company's overall transparency for investors. It also raises the standard of oversight for the board of directors, which can lead to better governance.
Brand Visibility - Taking a company public typically improves the company's exposure, prestige, and public image, which can, in turn, help the company's sales and profits. An IPO is also seen as a "milestone" for many companies (alongside $1bn USD Private unicorn valuation, becoming profitable etc.).
Cash-Out Opportunity - An IPO provides a chance for early employees and founders to have the option to cash out (providing liquidity to these early investors when and if they need it).
Increased Transparency - Listing on a public stock exchange improves the company's overall transparency for investors. It also raises the standard of oversight for the board of directors, which can lead to better governance.
Disadvantages of IPOs
The Process is Expensive - IPOs typically have fees associated with the listing, mainly contributing to ongoing maintenance and compliance. These can typically be a lot higher than raising money through private placements (e.g. $16m in listing fees was paid by MFB to IPO on the NZX).
Compliance Costs - Higher scrutiny and increased disclosure requirements exist as a result of being a public company. Ensuring the correct information is presented in the right formats will typically cost a company more money than if they were to stay private.
Reporting Takes Time - When you're private, you only have to appease your investors, whereas once you're public, you're obligated to disclose things you likely didn't need to as a private company. This can be a significant drain on staffing and resources.
Misaligned Incentives - A public company may have compensation packages of their executives tied to shareholder value. As a result, the stock price's daily fluctuations can impact employee morale, board incentives, and workplace culture. This may lead to short-sighted thinking by management (where they may only focus on improving next quarter's results at the company's expense). These skewed incentives may impact the company's long term future profitability and competitiveness.
Compliance Costs - Higher scrutiny and increased disclosure requirements exist as a result of being a public company. Ensuring the correct information is presented in the right formats will typically cost a company more money than if they were to stay private.
Reporting Takes Time - When you're private, you only have to appease your investors, whereas once you're public, you're obligated to disclose things you likely didn't need to as a private company. This can be a significant drain on staffing and resources.
Misaligned Incentives - A public company may have compensation packages of their executives tied to shareholder value. As a result, the stock price's daily fluctuations can impact employee morale, board incentives, and workplace culture. This may lead to short-sighted thinking by management (where they may only focus on improving next quarter's results at the company's expense). These skewed incentives may impact the company's long term future profitability and competitiveness.
Examples of Recent New Zealand IPOs
My Food Bag (MFB)
Cannasouth (CBD)
- My Food Bank listed on the New Zealand Stock Exchange (NZX) and the Australian Stock Exchange (ASX) on the 4th of March 2021 at an IPO price of $1.85.
- The price subsequently declined and is sitting at $1.57 as of the 26th of March 2021 (a decline of around 15% since listing at the start of the month).
- The listing fees (to the NZX) were over $16 million. The company raised $342 million at a valuation of $450m.
- Waterman Capital (Private Equity firm) and founders selling down their stakes. This is a red flag as outlined by this Stuff.co.nz opinion column.
Cannasouth (CBD)
- Cannasouth was listed on the NZX on the 19th of June 1019 at a share price of $0.50.
- The price subsequently declined to $0.40 on IPO day and is currently sitting at around $0.50 as of the 26th of March 2021.
- On IPO day, Cannasouth did not have any existing revenue and lacked assets.
Frequently Asked Questions
IPOs are popular in overseas markets (the ASX and NYSE see IPOs weekly), but few and far between in New Zealand. When they are announced, the media often debates the prospects of the underlying business and its management. To help you understand whether or not the company being IPO's has strong foundations, we address (in detail) the most common queries below.
The founders are exiting as part of the IPO. Is this an issue?
It depends. In most instances, it is completely normal for a founder to sell a smaller stake to the general public. This is usually to demonstrate that they support the IPO by offering shares and providing liquidity to the founder (a founder may have been working for a decade without a significant payday apart from an average salary).
If the founder still maintains a relatively large stake in the business and is committed to growing the business, there is usually no issue with a small exit. However, where the founder is substantially reducing its stake or exiting the business entirely can pose an issue. The question then is - why would I invest if the owners are selling out?
If the founder still maintains a relatively large stake in the business and is committed to growing the business, there is usually no issue with a small exit. However, where the founder is substantially reducing its stake or exiting the business entirely can pose an issue. The question then is - why would I invest if the owners are selling out?
NZX vs ASX vs NYSE – which exchange is best for an IPO?
Almost always – the bigger, the better. A larger exchange comes with more complexity and compliance and comes with better liquidity, brand presence and prospective buyers. Many New Zealand-based companies seek to do dual-listings on the ASX and NZX or directly list on the ASX (companies like Laybuy have taken the latter approach). Alternatively, Rocket Lab has recently listed on the NYSE through a Special Purpose Acquisition Company (SPAC).
What is a Dual-Listing?
A dual listing is where a company lists on more than one exchange – typically made up of more than one legally registered corporation that operates as a single business. For example – My Food Bag is dual-listed on the ASX and the NZX.
How do I get access to invest in an IPO?
Typically you won't be able to get into IPOs at the "bookbuild" stage, but you'll likely be able to get access to the share if you have a sharebroker who is allocated shares. If you don't have such an arrangement, you can buy the share on the first day of trading. Most retail trading platforms provide this access, including Sharesies, Hatch, Stake, as well as ASB Securities and Direct Broking.
What is a Direct Listing? Is it the same as an IPO?
A direct listing is an IPO without any underwriters (no investment banks). A company effectively sells stock on the public exchange with no price guidance (no valuations are done, there are no marketing materials, nor is there underwriting). Direct listings are typically considered riskier as no bookbuild is done, meaning the share price is entirely set by the market. This can lead to massive increases or drops in the stock price on day one. Given the lack of roadshow and marketing, companies that have a well-known brand in an attractive market are likely to do well.
Notable direct listings in the last few years include Slack, Spotify, Palantir and Asana.
Notable direct listings in the last few years include Slack, Spotify, Palantir and Asana.
