The Evolution of Initial Public Offerings in Italy

The Evolution of Initial Public Offerings in Italy Giovanni Sabatini Giovanni Sabatini

Agenda Introduction Reasons to go public/stay private The evolution of IPO’s in Italy Empiricalevidence Final considerations Giovanni Sabatini

Introduction • The role of stock markets in financing investments, monitoring companies, reallocating corporate control varies greatly among developed capitalistic economies. • Market-oriented Systems • In Anglo-Saxon countries the stock market plays a central role in those functions • Bank-oriented Systems • In most Continental European countries and in Japan banks have played a major role in financing companies Giovanni Sabatini

Introduction • IPO stands for initial public offering, i.e. when a company sells its shares to the public for the first time. • Initial Public Offerings (IPOs) have represented the traditional way of raising capital for high-growth firms. Until ’90 IPOs have been limited to US and UK, where capital markets are more developed • In the ‘90s, large privatization programs in European markets led to a new wave of IPOs • Internet boom created another wave of IPOs worldwide (late ’90s) Giovanni Sabatini

Reasons to go public • Strategic • Growth: Raise capital - Investments too large to be provided by the founders • Diversify (dilution effect) - Share business risk among many owners • Commercial • Enter Global competition – Acquisitions (cross-borders) become more feasible • Increase visibility – (e.g. listing on the NYSE) • Financial • Rebalance capital structure • Cost of credit Increased bargaining power with banks • Exploit mispricing - If some stocks are mispriced, the entrepreneurs recognizing that other companies in the same industry are overvalued, have an incentive to go public • Reputation • Transparency - Increase the accountability of the firm and improve the reputation by reducing information asymmetry • Improve Corporate Governance - listed companies have to comply with a Code of Discipline Giovanni Sabatini

Reasons to stay private • Maintain the control over the firm • in widely held companies, dispersed shareholders do not participate in the annual meetings (they “vote with their feet”, selling the shares) • the control of the firm is held by strong managers who act for their own interest • Avoid outside control (eg. regulatory bodies, auditor, financial analysts) - Public firms must regularly report to the Authorities and to the investors • Avoid underpricing - The IPO is expensive as the offer price is set at low levels to attract investors • TAX opaqueness • Direct and indirect costs of going public Giovanni Sabatini

The IPO process • Approval of the BoD and appointment of the advisory team • General meeting of the shareholders and appointment of the sponsor and legal advisors • Meeting between the management and the advisors • Due diligence • Preparation of the prospectus of the offer and application for approval (CONSOBB) • Application for listing at the Stock Exchange (Borsa Italiana SpA) • Within two months the Stock Exchange informs the firm and the Authority and publishes the decision • The firm has six months to make the offer • Roadshows to present the issuer to the institutional investors • Bookbuilding: institutional investors set their offers in terms of quantity and price of the shares • Start of trading (and stabilization of the price, where allowed) Giovanni Sabatini

The pricing Mechanisms to set the IPO price: • Auction • Fixed Price • Price range (binding) • Price range not binding Giovanni Sabatini

Allotment • The offer differs depending on the type of investor to whom it is addressed • Private placement (to institutional investors) – this implies that before the offering the underwriters contact potential IPO subscribers and collect indicative bids, with or without limit price (book building) • Retail offer (to the public) – there is no discrimination among investors • The prospectus normally prescribes a minimum number of shares to be allotted to the public and a maximum number to institutional investors Giovanni Sabatini

Special clauses • Green shoe option – allows the underwriter to place a further fraction of IPO shares on the market (generally between 10-15% of the IPO shares within 30 days from the listing) • Overallotment – the underwriters assign an amount of shares to IPO subscribers that is larger than the IPO size; the short position is covered after the listing (by exercising the green shoe option or by repurchasing the shares) • Lock-up agreement – controlling shareholders and other insiders commit not to sell their portfolio shares within a certain period of time after listing (signalling their positive expectation about the firm value) • Bonus shares – additional shares assigned for free to investors retaining IPO stock up to a certain deadline (used in privatization offerings) • Remedy share – commitment by the IPO promoters that additional shares will be assigned for free to subscribers, in the event that the business targets declared in the prospectus will not be reached Giovanni Sabatini

ITALIAN STOCK EXCHANGEFacts & Figures MTA N. listed firms N. delisted firms Capitalization Capitalization Turnover N. IPOs Div/P Earnings/P Euro/billion Euro/billion % GDP 199 20,3 81 213 14 18 2,1 6,9 1996 310 30,2 174 209 14 18 1,7 4,6 1997 484 44,8 423 219 25 15 1,6 3,9 1998 714 64,4 503 241 28 6 1,5 3,4 1999 790 67,8 839 237 16 20 2,1 4,5 2000 575 47,3 637 232 13 18 2,8 6 2001 447 35,7 562 231 11 12 3,8 5,9 2002 475 36,6 567 219 9 21 3,4 6,4 2003 569 42,2 641 219 7 7 3,4 6 2004 EXPANDI NUOVO MERCATO Capitalization Turnover Capitalization Turnover N. listed firms N. listed firms Euro/billion Euro/billion 3 .. 31 1996 5 1 26 1997 4 2 20 1998 5 1 17 7 4 6 1999 6 1 15 22 30 39 2000 5 .. 12 13 21 44 2001 5 .. 13 6 10 44 2002 5 .. 11 8 14 41 2003 5 .. 13 7 19 37 2004 Source: Relazione annuale 2004, Consob Giovanni Sabatini

Characteristics of Italian Industral Structure • Limited firms size • Highly Concentrated Ownership • Family- Owned • Leverage • Limited presence in high-technology business Giovanni Sabatini

The Italian IPO waves • There are waves in the history of Italian IPOs: • 1985-1988 (bullish market): 69 IPOs firms, of which 32% financial, 58% industrial (mainly construction and electronics) and 10% services. Most were carve-outs • 1989-1994: only 19 IPOs (52% of which were financial companies) • 1995-1997: 34 IPO (76% of which were financial companies) most of them were small-medium companies taking advantage of the tax benefits granted by the “legge Tremonti”. No carve-outs • 1998-2000 (dot.com bubble): 85 IPOs, most were high-tech firms in the services category (media, software, information technology) • 2001-2004 (slowdown): 35 firms, the majority of which the were public utilities • Today: 13 firms, of which 4 listing in the Expandi segment • The pattern supports the evidence that firms tend to time the IPO when the moment is more convenient (“window opportunity”) Giovanni Sabatini

Ipo filed in Italy from 1985 to 2004, by year of listing (Borsa Italiana, 2005) Giovanni Sabatini

The evolution of Initial Public Offerings in Italy • IPO firms in the recent years have different characteristics than the early IPOs: • Smaller and younger • Less concentrated ownership • More frequently participated by pre-IPO private equity investors • IPO pricing in Italy has become more efficient • Italian IPOs adopted several clauses of the going public process in the US (green shoes, lock-ups, book building) Giovanni Sabatini

Features of the IPO firms: issue type • Equity carve-outs have been frequent from 1985 to 1988 when listed companies took advantage of the bullish market momentum to spin-off subsidiaries (this is consistent with the evidence that carve-outs can time better the IPO). Independently newly listed firms are largely predominant from 1995 • Privatizations have been frequent across the whole period (privatizing companies account for more than 15% of the IPO activity of the last 20 years in Italy) Giovanni Sabatini

Features of the IPO firms: age, total assets, net profits • The average age of the IPO firms has reduced • Total assets vary across the periods, with small firms alternating with large firms • Net profits are always positive, as profitability is a listing requirement (contrary to US, where firms with negative earnings can go public) • Statistics about the accounting value of consolidated assets and revenues are very dispersed and reveal that large companies alternated to smaller firms during the period Giovanni Sabatini

Median age of companies that made an IPO in Italy, USA, and in Europe (Belgium, France, Germany, the Netherlands, UK) (Borsa Italiana, 2005) Giovanni Sabatini

Fraction of IPO companies that reported zero or negative profits at the year before the listing, in Italy, USA, and in Europe (Belgium, France, Germany, the Netherlands, UK) (Borsa Italiana, 2005) Giovanni Sabatini

Features of the IPO firms: net proceeds and control • The mean value of IPO proceeds is biased by large privatizations in the early 1990s • The firms are generally closely held by large shareholders before the IPO, and they generally hold more than 50% after the IPO Giovanni Sabatini

LISTING REQUIREMENTS(Italian Stock Exchange) MTA (Large and medium size firms) • firm’s ability of generating positive revenues in normal business conditions • minimum floating of 25% of the equity capital • publication of the previous three years’ financial statements with the last year’s financial statements audited • minimum capitalization of € 5 million Nuovo Mercato (Small and growth firms) • firm’s ability of generating positive revenues in normal business conditions (even with present negative earnings) • minimum floating of 20% of the equity capital • financial statements audited • minimum capitalization of € 1,5 million • lock- in clause (commitment of the management team to keep at least 80% of the shared owned at the time of the offer, for a period of minimum 1 year) • For start-up firms (with life less than 1 year), the lock-in clause lasts for 2 years Giovanni Sabatini

Agenda Basics Reasons to go public/stay private The evolution of IPO’s in Italy Empiricalevidence Final considerations Giovanni Sabatini

Empirical evidence:the opinion of the financial community Survey on the IPO effects (Osservatorio M&A, Bocconi University, Milan) • IPOs help growth: • after the IPO, the firms continue to grow (average of 18% revenues increase) • 79,6% of the interviewed firms stated that the growth rate without IPO would have been lower; 43% stated that without the IPO most investments would have been cut off • IPOs sustain the acquisition process: • 76,4% of the interviewed firms made at least one acquisition after the IPO • the average acquisition number is 4 Giovanni Sabatini

Empirical evidence:the opinion of the financial community(continue) • IPO helps capital structure optimization • Immediately after the IPO, the leverage decreases • In the following years the leverage increases and returns to previous levels after three years • 68% of the interviewed firms consider the re-leverage process the main reason for the IPO • The re-leverage is convenient because after the IPO the firm has increased its bargaining power with banks • IPO improves the communication with the stakeholders • Institutional investors • Regulators • Shareholders Giovanni Sabatini

Empirical evidence:underpricing • In the first day of the offer there is a positive return from the offer price to the closing market price (underpricing) • The long-run performance shows different patterns across time Giovanni Sabatini

Giovanni Sabatini

Underpricing and longterm performance • In the recent years the mean underpricing level in Italy has been decreasing • One interpretation (Giudici, Paleari) is that the reduction is related to the adoption of book building as opposed to previously used practices of setting the price (i.e.: fixed price) and to greater involvement of institutional investors in the placement • The long term underperformance is still present but less than in the past Giovanni Sabatini

Empirical evidence: money left on the table • Money on the table is the number of shares sold times the difference between the first-day closing market price and the offer price (the average IPO leaves $9.1 million on the table) • This is approximately twice as large as the fees paid to investment bankers ($13 billion), and represents a substantial indirect cost to the issuing firm (Loughran and Ritter, 2000) • In Netscape’s August 1995 initial public offering (IPO) with Morgan Stanley as the lead underwriter, 5 million shares were sold to investors at $28.00 per share. With a closing market price of $58.25, $151 million was left on the table • Why don’t issuers get upset about leaving money on the table? • The discount is the condition imposed by financial intermediaries in order to ensure the success of the placement • For 15 IPOs with first-day returns in excess of 60% that subsequently conducted follow-on offerings, all 15 retained the lead underwriter from the IPO (Krigman, Shaw, and Womack, 2001) Giovanni Sabatini

Giovanni Sabatini

Empirical evidence: valuation and ownership • IPOs are typically valued using comparable multiples • For a sample of technology firms in the Internet boom period, Chanine (2002) finds that these firms are priced at a larger discount than non-tech firms, consistent with the higher first-day returns on tech IPOs • The discount is larger if the incumbent shareholders do not lose the control after the IPO (Zingales, 1994) • This has been for decades the case of Italian IPOs, where the owners, typically families, maintain the control of the firm after the listing Giovanni Sabatini

Empirical evidence: IPO waves • IPOs follows waves, with intense periods followed by periods of low activity • A first wave occurred in US in the 1990-1994 • A second wave occurred in US and in Europe in the late 1990s • Historically, continental European IPO market has been dwarfed by the US IPO market. In 2000, however, in spite of high volume of IPOs in the USA, continental European IPO volume exceeded that of the USA • One explanation is that in times when the market is over valuating certain industries, the firms in those industries will likely go public to exploit the mispricing Giovanni Sabatini

Empirical evidence: size and age effect • Large firms are more likely to go public as they can better afford high fixed costs of the IPO • Large firms leave less money on the table as their offer price is normally higher due to less uncertainty in valuation • IPO firms in Italy are larger than IPO firms in US • The size effect does not apply when the IPO regards a subsidiary of an holding company (carve-out) – fixed costs are indirectly borne by the holding company and the discount is lower as there is less uncertainty over the issue • Younger firms should go public more often than older firms because they need capital to finance investments • IPO firms in Italy are older than IPO firms in US Giovanni Sabatini

Agenda Basics Reasons to go public/stay private The evolution of IPO’s in Italy Empiricalevidence Final considerations Giovanni Sabatini

Final considerations • Italian IPOs in the past not driven by small high-growth firms; • Successful IPOs require developed capital markets and good corporate governance systems; • In recent periods the Italian IPOs adopted pricing strategies and arrangements (special clause) in line with US market practices; • Whatever the reason to go public (finance growth, become more visible, exploit mispricing, etc.), IPOs help market development and improve firms’ accountability to investors. Giovanni Sabatini

The Evolution of Initial Public Offerings in Italy