The Government sell-off of a major stake in Royal Mail was controversial in many ways. It proved to be even more so when the placing price of £3.30 was rapidly eclipsed by a market price which rose to as high as £6 although it’s been mostly downhill since (at the time of writing it’s 420p). The long term holders who were given priority in the share allocation soon turned out to be anything but with 44% of the shares changing hands on the first day of trading and 84% within two weeks.
Private investors were also disgruntled by the fact that the allocation process was not disclosed in advance and in reality most private investors either got none or an allocation that was trivial in size.
The process of establishing an “orderly market” in the shares turned out to be totally defective and many people alleged the Government lost a substantial amount by under-pricing the issue. For example a Committee of M.P.s suggested as much as £1billion was lost by the defective process.
So Vince Cable who heads the Government’s BIS Department commissioned a panel of experts to report on Government IPOs. Headed by Lord Myners, everyone’s favourite financial authority, he has now issued their report.
The conclusions are that the process of “bookbuilding” is not perfect but there may not be better alternatives. But they do suggest that “it is inevitable that bookbuilding will transition over time to a more digital online auction with more transparent rules“. They suggest that would address the conflicts of interest inherent in the current process and reduce fees.
In the meantime, they suggest a number of detail improvements to the existing process. They also comment on the need for a retail offer which they say adds “price tension” (don’t ask me what that means) to the sale process and increases complexity and “rigidity” which might impede price discovery.
Comments: This in essence is surely a pretty simple problem. The Government does not know what is a fair price for the shares it has on offer. Even consulting a few experts may not help a great deal because as with any stock, the price is what people are willing to pay. There was probably a great range of views on the value of Royal Mail as a business. I thought at the time that 330p was high having read the prospectus and considered all the risks but there then developed a kind of mania for the stock probably driven by index tracking funds having to buy the stock and others enthusiastic about buying a good dividend paying monopoly. Only the wisdom of crowds, and the market, will ever give you a good consensus on what is a fair price for a publicly listed company.
The book-building process and the “pilot fishing” process used in this case is an attempt to determine what people might pay for the stock without getting them to put their views on the line. It is simply an attempt to avoid an open and potentially volatile market and determine a price which can be agreed by the seller as politically acceptable. But an auction process with the Government setting a reserve price, or limiting the amount of stock for sale at different price levels, would just as easily provide a stable and fair market price. It would also enable the inclusion of retail shareholders who could participate in the same auction on an equal basis.
An auction or tender process is much more transparent than the existing bookbuild process (as the report points out), so would avoid the suspicion that City insiders are exploiting the process to their own advantage. In this case the bookbuilding price discovery mechanism grossly underestimated what level the free market would actually set the price to.
You can read the full report on the web if you want to learn the complexities of the existing process and the details of the panels conclusions.