How to glean the facts they don’t want you to know
I am sure you understand that company statements and annual reports tend to present only the shiny side of the corporate coin. But there is one time when companies are obliged to reveal themselves to investors, warts and all. This is when their shares are first quoted on the stock market, and they are required to publish an Admission Prospectus. This contains plenty of information that may never be seen again, and includes certain things that the companies would no doubt rather keep to themselves.
It is well worth trying to get hold of these documents, especially if a company is still fairly fresh to the market. Sometimes companies publish them on their website. Otherwise don’t hesitate to contact the company directly and request a copy – in my experience there is usually a stack left over from the initial print run.
The prospectus includes much standard information that will be found in subsequent annual reports, and there is a certain amount of meaningless box ticking. So I am going to concentrate on the information that you might not find elsewhere. And as a real live example I am going to use a recent entrant to AIM, Interactive World plc, which as you will see, perhaps, has more to hide than most.
1) Where are the shares coming from?
A company must make some shares available for trading on the market. These could either be newly issued shares, raising fresh capital or else – and this should ring a warning bell – they could be coming from existing shareholders who are selling out. Often it is a combination of the two. In the case of Interactive World the answer is that 2,739,727 new shares are being issued, while 6,849,316 are being sold by the company’s principal shareholder, David Sullivan.
If that name sounds familiar, it is because Sullivan is notorious for having made his fortune out of pornography, was owner of Birmingham City Football Club, and owns the Daily Sport.
2) How many shares are being sold?
Most companies will set out to raise a nice round sum, say £5m or £10m, or to sell a round number of shares, say 10m or 20m. But they don’t always achieve their target. They might, for instance, find that investors are only willing to stump up, say, £3.7m out of the £5m that they hope for. But having got this far, and run up huge bills to advisors, they think that they might as well press on. This is a bad sign, because it signifies some scepticism on the part of investors, and possibly that the company will have to return to the market at a later date to try to raise more cash.
In the case of Interactive World it sold a total of 9,589,043 shares, of which the 2,739,727 new shares raised a round £2m at the issue price of 73p. I would not draw any conclusion in this instance, partly because Interactive World is cash-generative and can quite easily finance its existing business.
3) What are the expenses of the sale?
Although Interactive World raised a gross sum of £2m, only £1.37m found its way into the company’s bank account. The rest was spent on the costs of the whole flotation exercise itself. The company has a Nominated Advisor and Broker (commonly called a Nomad), an auditor and a solicitor. Then there are the charges of the stock exchange and the company’s registrar. And there is a rather large payment to a mysterious outfit, called Pathfinder Partnership LLP, which is raking off a fee of £220,000 “upon a successful completion of... a listing”.
I will say more about advisors’ fees later, but the message here is twofold. First, you should check how much of the cash being raised from investors is actually going into the business, rather than straight into the pockets of professional advisors. And second, be aware that advisors will tend to demand higher fees for issues that are perceived to be difficult to market.
4) What percentage of the equity is being sold?
Or to put it the other way round, how much is left in the hands of the existing owners? In this case, David Sullivan will still own 64% of the shares after the flotation, which means that he still controls the business. As a minority shareholder you will have no control over the business, so you have to be satisfied with this arrangement. There have been instances of majority owners riding rough shod over the interests of minority shareholders, but, on the other hand, Sullivan clearly has a strong interest in seeing this company succeed.
5) What does the company do, and what is the strategy?
A prospectus will include a rather fuller than usual description of a company’s business. Here is what Interactive World is about: “The Company was established in 1999 initially delivering content over the internet and subsequently through mobile networks... at present most of the content provided by the Group is of an adult nature... Interactive World has a number of relationships with Content Providers, including a five-year exclusive agreement with Sport Newspapers Limited.”
That much could be easily discovered but a prospectus has to say a bit about the competitive environment and the business strategy, two important subjects which are more or less ignored in subsequent statements. For instance, the prospectus admits that “while providers of digital content to mobile phones have historically concentrated on ring tones and logos, it is feasible that they could branch out into other areas and become competitors.”
And as to the strategy, Interactive World wants to “build on its position in the UK... develop its business overseas... develop new revenue streams through the provision of high quality content... and broaden its content offering to include gaming and dating, where it can market to its existing user base.”
6) What will the fresh capital be used for?
If you subscribe for shares in a new issue, or for that matter buy the shares in the aftermarket, it is basically your cash that the company is using. Don’t forget that! Interactive World will use the cash to (i) facilitate future fund raising and growth, (ii) to attract and motivate key staff through the grant of share options, and (iii) to pay for potential acquisitions through the issue of new shares.
All this is rather vague. Interactive World is already strongly profitable and cash-generative – in other words, capable of financing its plans. Option schemes tend to benefit directors and staff more than shareholders. And as any company might make an acquisition, it would be nice to know a little more about Interactive World’s possible targets.
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