Testing the Waters

Last month’s announcement from Bahrain’s largest Islamic lender about the oversubscription to the initial public offering (IPO) of its Syrian unit comes, at first glance, as a glimmer of optimism on a hitherto stygian IPO landscape across the Middle East. If recent history is any indicator, though, analysts and investors will likely proceed with caution following this rush of activity from the Al Baraka investment bank. As has been demonstrated throughout the region’s financial systems, a sudden spurt like this can often be a deceptive Potemkin village, fueling false optimism and insidious herding behavior on the part of investors. Regardless of how this particular case fares in the long term, though, it serves, at the very least, to highlight the great dearth of IPO development in the region as a whole—a paucity that could prove to be a significant hurdle to long-term and large scale economic growth.

IPOs are, in essence, a company’s way of testing the waters of a public exchange, and a principal means by which they can procure extra capital. By issuing common stock, available to individual consumers and investors, a company basically sends a message to the market that it’s ready to expand and looking to grow—a message that, if resonant with savvy investors, can be met with substantial inflows of private capital. At the same time, though, going public normally requires a company to disclose proprietary information, without which people would not be able to make educated investment decisions. This indeed may be a sacrifice in comparative advantage (especially in extremely innovation-dependent, competitive sectors, like technology); ultimately, however, such disclosure remains a benefit for market players and investors as a whole. If there exists a well-governed and enforced level of uniform transparency across a public exchange, capital flows more freely and surely—and a formerly cloistered economy can more easily liberalize and open its doors.

As recently as the last fiscal quarter, though, growth in the Middle East IPO market has dropped off, as a report released by Ernst & Young shows. According to the company’s Middle East IPO Update for the third quarter of 2009, just four companies listed in the Middle East raised a total of $871.79 million in the last quarter, down from the $1.021 billion raised by five companies in the previous quarter. By comparison, in the third quarter of 2008 alone, 14 IPOs raked in $3.74 billion. Through the first three quarters of 2008, a cumulative total of $12.44 billion was raised. This year? Just $1.97 billion. 

Ernst & Young Managing Partner Phil Gandler speculates that the decline in activity may be due to hesitancy on the part of investors and companies who may not be entirely convinced of regional recovery following the global financial crisis. He went on to say, though, that “once there is evidence of a sustained recovery in the region, there is likely to be an increase of fund-raising on the regional stock markets, and the 152 announced, delayed or rumored IPOs would be anxious to list.”

Rapid IPO subscription itself, however, does not necessarily imply a healthy market. In 1997 and 1998, for example, the UAE saw a precipitous rise in IPO activity and investment, only to be followed by a proportionally steep decline. The initial burst was spurred by a single IPO listing, from Dubai Investments, which reinvigorated an IPO market that had been comatose for decades. On the heels of this initial successful foray into the public exchange, several other companies followed suit, and, as in the Al Baraka case, they experienced exorbitant oversubscription rates. The problem was, though, that many of these IPOs were not actual, in fact, tangible companies, but oftentimes assets or projects—mere “paper.” With this kind of historical precedent, the biggest regional obstacle may, in fact be trust—the trust of investors in freshly public companies, as well as the reasoned faith of hesitant companies that a venture into the open market will indeed be met with open ears (and wallets) in the public.

It’s too early to tell whether Al Baraka’s IPO overload is a harbinger of future trends, or whether it’s just another Trojan horse blip on the radar screen. With the global economy gradually on the mend, though, and with oil prices steadily rising, investors should soon have more free capital. And if the region wants to capitalize on this rebound, and steer their financial systems on the path to salubrious and sustainable growth, a mature and thriving IPO market is crucial. Getting there safely, though, will require harnessing raw investor sentiment and channeling it through a sieve of due diligence, caution, and, most crucially, collective trust.

The views expressed in this article are those of the author, and do not reflect the policy or views of the OECD