Walking through a Baltic IPO

  • 2005-04-27
  • By Eriks Blumbergs, partner at Glimstedt & Partneri law firm
If past performance is a measure of future success, we may soon see an upswing in the number of initial public offerings in Latvia.

The successful sale of SAF Tehnika shares on the Riga Stock Exchange in May 2004 could be the precursor to more equity sales this year. The securities market has become more attractive since the RSE joined the SAXESS trading system of the OMX Exchanges, which, in addition to the other Baltic exchanges, includes Stockholm, Helsinki, Copenhagen and Oslo. A Baltic list has been established for investors to gain simultaneous access to all Baltic stock markets, and the Baltic index is to follow.

With the growth of insurance companies, pension and investment funds and middle-class spending power, banks and other capital market custodians are willing to shop around for local securities as part of their investment portfolios.

Given the favorable tax treatment of securities trading in all Baltic countries, the timing seems to be right for an explosion of private IPO activity.

Unlike a private sale of company shares to a close group of buyers, a public sale may produce significantly higher yields for the seller. Instead of being tricked into an evaluation dispute, the sellers, who are often the founders of the company, may steer the allocation process and thus secure a stronger pricing basis. Sellers may choose to float newly issued shares only or to join the offering during the IPO process to obtain instant cash.

For those sellers who dislike the lengthy and emotionally stressed share purchase agreement negotiations, the IPO prospectus is a uniform document printed by the issuer and distributed to the general public. Management should present only the pre-rehearsed roadshow.

Once the company decides to make the public share offering, a proper review of its financial and legal affairs must be undertaken in order to avoid the risk of misrepresentation. Thorough documentary housecleaning must be carried out both from the financial and legal standpoint. Potential investors will frown upon any ongoing related party transactions between the company and its management or shareholders, which may turn into tax risks or insider dealing possibilities. Material agreements should be verified for completeness and enforceability, and proper minutes provided throughout the years of operation.

Local companies often misperceive due diligence as something akin to a state audit. No doubt corporate managers in Latvia are often extremely reluctant to disclose any material information; restricted access to data by the outside legal counsel is often considered part of the local corporate culture, which is unfortunate. For an underwriter, it is important to stress to the issuer that pre-listing due diligence is more risk-averse than a regular acquisition.

The results of preliminary review form part of the prospectus to be filed and registered with the Financial and Capital Markets Commission. Not only the positive features of the issuer should be presented but also certain identified risks, which could reasonably affect the company (for example expiry of some important agreements). Based on the assessment of an issuer's business, a price-offer corridor may be established in the prospectus.

For those entities that operate as limited liability companies (SIA), the shareholders' meeting must first adopt a decision to transform the company into a joint stock company (akciju sabiedriba). Only shares issued by the joint stock company may be listed on the Riga Stock Exchange. All public registration information must be up to date and the Charter reflecting no unusual practices with regard to management of the company. The company's auditors should become involved in the process of reviewing the interim financial results as soon as possible, and they should seek permission to reprint the auditor's statements for previous years as part of the prospectus. It is often the verification of exact financial data that delays the prospectus' submission to regulatory authorities. The ultimate aim for running the preparation stage of the IPO is for the management board to declare to authorities and investment community that, to the best of its knowledge, information contained in the prospectus is accurate and complete in all material respects and does not omit any material facts.

Once the IPO is launched, the underwriter or the issuer itself collects the subscription orders from potential buyers. The lead underwriter usually performs order book-building to establish a sufficient spread of allocations to the buyers for a healthy start to the floating. The final offering price may be set subject to demand, and the underwriters inform the prospective bidders of the exact price shortly before settlement. It is also possible to organize an auction by the Riga Stock Exchange between the retail and corporate investors to perform the allocation.

To be sure, there are still certain unresolved legal issues in Latvian law for IPOs. For example, the Commercial Law requires that upon subscription to newly issued shares, the entire share premium is paid. If the shares are steeply priced, this imposes a settlement risk for the IPO. Once the share premium is prepaid as part of the purchase price, the company may amend its charter to reflect the new increased share capital.

The current law does not state whether blocking the purchase price with the custodians is sufficient to constitute payment for the shares before settlement and whether registration of the new share capital and amendment to the charter is possible before the settlement is carried out pursuant to the delivery-versus-payment rules. Usually, corporate investors are unwilling to prepay for the share offering, and no blocking of cash may be expected to satisfy the subscription requirement. Consequently, the issuer may not provide the investors valid title to the shares before receipt of the purchase price. To solve this, the underwriter could deposit the share premium for the entire share allotment; however, this costly exercise would not be required if the Commercial Law was amended to permit down payment of the share premium within a fixed period of time. This dilemma is not relevant for the already issued and paid shares that are offered by the company's existing shareholders as part of the IPO.

Only after the shares are allocated to buyers and trades are settled, the listing may commence at the RSE. However, due to the settlement time of T+3, it is permissible to begin trading even sooner, and the actual first day trading results are usually settled together with IPO allocations.

Over time the regulatory requirements for all Baltic stock exchanges have been harmonized. After a successful IPO, the issuer should not only enjoy the financial result of the share offering but also obey the market standards of disclosures and compliance measures to secure a long-term investor confidence.