Humphries Lewin, left, and Iton
WHY SHOULD a company go public? Are there any advantages to be gained? The answer is that there are in fact significant advantages in going public. One of the most important is that going public enables the objective valuation of a company.
When a company goes public, there is a substantial increase in value to its owners. In the first place, it is easier to arrive at a reasonably objective valuation for a public company than it is for a private company. That by itself is of value. A company has both tangible and intangible value. Tangible value refers to what the company is worth financially. There are several ways of determining this. However, the most frequently employed method for a listed company is by its Price/Earnings or P/E ratio, within the context of a company's estimated future growth prospects.
Also known as the multiple, the P/E ratio makes is possible to identify readily how much investors are willing to pay for a company's earning power based on past performance and how much they would likely pay at some future time, when the P/E has been based on projected earnings.
Other methods of valuation employed with privately-held companies include the assessment of market value of balance sheet assets; the discounted cash flow method, both of which may also apply to a public company and the capital market comparison method, by which a privately-held company is compared with a public company of a similar size and industry grouping and estimates drawn. These methods all include a level of uncertainty and negotiation between buyer and seller that would not arise under the Price/Earnings approach.
A company's intangible value results from an estimate of the fair market value of assets such as goodwill, customer lists, technical expertise, intellectual property and trade or brand name. In addition, owner's sentimental value often looms large when trying to arrive at a value for a company's intangible assets.
There are international standards for valuing a company's intangible assets, such as the Financial Accounting Standards Board (FASB) Rule 142. Under this rule, intangible assets are categorised by type, then by identifiable remaining useful life. Expert valuators would then assign fair market values.
There are no comparable guidelines in Jamaica. "In practice, whatever a buyer is willing to pay in excess of a company's net book value may be considered the value attributed to intangible assets," according to Richard Downer of Price-waterhouseCoopers, who specialises in corporate matters. According to the Capital Markets Group in the United States, private companies fortunate enough to find a buyer usually sell at four to six times net earnings while public companies usually go at an average of 25-30 times net earnings. An analyst in Jamaica estimates that comparable figures here would be 2-4 times net earnings for a private company and 9-12 times for a public one.
When should a company go public?
Internationally, the best candidates for going public are companies that have a pattern of growth and can anticipate continued future growth. However, historical growth is not the only route to the stock market, JSE general manager, Wain Iton, explains. "If a start-up can win investors' confidence by virtue of the integrity of its promoters, the known skills or calibre of its management team or by the anticipated success of its business approach and products, then the market can accommodate such a start-up."
DB&G is a case in point mentioned by Iton. DB&G raised $37.5 million through a private placement as a start-up in 1992 and was subsequently listed on the market later in the year. As at the end of business the 5th June 2002, DB&G had a market capitalisation of $1.1 billion.
"Preparedness is key to becoming a public company", Mr. Iton emphasised. "A company must be prepared to be transparent, it must be prepared to keep the investing public informed and above all, its accounts must be accurate, up-to-date and in place."
Other essential criteria are highlighted in the Jamaica Stock Exchange's publication, Going Public, which may be viewed at the JSE's Web site: www.jamstockex.com or collected at the Stock Exchange.
When the necessary groundwork is in place, the best time to go public is when the investors are likely to be interested, the publication points out. This would coincide with periods of heightened public interest in the stock market for example, during a bull market. The required planning and preparation should also precede a public offering. Perhaps the most important pre-condition for going public according to JSE chairman Roy Johnson is that the company's founders and owners must take a decision that their future, their company's future and the nation's future can best be served by sharing ownership with the public.
Mr. Johnson is of the view that when companies share ownership through public listings, this encourages their own customers to save and invest, thereby assisting them to participate in the process of wealth creation and economic growth. While the requirements for going public are exacting and require high standards of disclosure and transparency, the company will be better off in the long run. The company's ability to compete will be enhanced through its improved management practices and its strengthened capital structure. As a result, the company will enjoy greater confidence among policymakers and with the general public.
Going public is not only a pivotal step in a company's growth strategy. It also provides a foundation for long-term management succession and for a planned exit strategy for the owners by cashing out portions of their interest over time. This is the important point about going public, according to Barita Investments chairman Rita Humphries Lewin. It must be part of a long-term view a vision of future success. Immediate benefits include the fact that the company gains prestige in the public view and that its market determined value is displayed daily. While some owners of listed companies and of unlisted companies that are good prospects for listing are concerned that the Jamaican market undervalues companies as reflected in the low P/E ratios, this will not always be the case, Mrs. Humphries Lewin said. "A stock market anticipates and reflects the economy as the economy strengthens, so too will the P/E ratios. Current indications are that the economy will strengthen within the next five years." The fact is that P/E ratios have moved up from an average of around six to nine times earnings within the past five years and over the same period and companies listed on the Jamaica Stock Exchange have grown by an average of 70 per cent in terms of revenue and 153 per cent in profits after tax.
(This column is part of an on-going public education programme of the Council of the Jamaica Stock Exchange)
