A Case for Launching Securities Exchange Market

Over the past decade, initial public offerings (IPS), real estates, and lease auction prices have been riddled with hype and follies. They have been accompanied by so much pain on the pockets of home buyers and investors whereas the lease land bidders who have offered mind-boggling prices, which were based on Ponzi schemes, spared themselves of enormous misery due to weakness in the lease process. And the money they offered has never materialized. They lost their bid bonds.

The public auction by Awash International Bank (AIB) held last week to sell shares has revealed one more extraordinary folly. During the auction, the price of its shares with par value of 1,000 Br went up as high as 14,000 Br. This value cannot be justified by any finance fundamentals. It is rather a folly that dwarfs many of the cases observed in financial history.

Share valuation is governed by finance fundamentals. In mature industries, it is a reasonably simple exercise. It is when novel business comes to market, the valuations become trickiest and speculative hype kicks in, in part due to uncertainty arising from the novelty of the idea.

The finance sector in Ethiopia is an established sector, where information is abundant and reliable forecast about the future can be made. There should be little room for overvaluation. Reality has however uncovered a price that is completely incomprehensible.

The gross dividend per share (DPS) of AIB for the year ended June 30, 2016, was 264 Br (238 Br net). The person who has offered 14,000 Br for a share needs to wait 59 years to recover her investment, provided that AIB will continue to pay the same dividend amount every year. If the past seven years of performance in the industry serve as any guide, competition has driven DPS down considerably. And there is hardly any reason not to believe this trend will continue.

No doubt the payback period for this buyer will be much longer. If we see the matter from a different vantage point, the gross return of the prospective investor will be 1.9pc. This is a third of the most flexible saving deposits’ interest rate and one seventh of the return that could be earned by investing in shares of Nib International Bank (NIB), which is currently on sale across its branches at a premium of 40pc.

A financially sensible person would think twice before investing in a share that brings a return of 1.7pc while there are flexible saving deposit options paying more than five per cent and a share that pays about 14pc. With very generous assumptions, the shares of AIB should not be valued more than 3,500 Br, for the buyer of shares from Awash Bank would find it difficult to recover his investments and incur considerable losses should she be interested in selling them again.

Offering 14,000 Br for a share of a bank such as Awash illustrated to me how buyers are not well informed on how finance works.

There are multi-faceted problems associated with primary shares trading and the recent auctions for land lease. Various lot sizes with distortionary impact on prices, lack of information, limited investment options for smaller developers, non-existence of properly functioning markets and poor regulations have created an environment where many people make wrong decisions and suffer the consequences.

In principle, even one share can be tradable. Current auctions and other trades show that share certificates of various lot sizes are traded. There is a high concentration of bidders at the lower end whereas, in the higher end, the bidders are few. During last week’s auction, as the competition was intense for lower lot sizes, the premiums were pushed up. Higher lot size shares commanded premiums that could be arrived using conventional valuation techniques. This proves that the price at the higher end is more sensible than at the lower end.

In the current economic environment, investors and pensioners do not have many options but to put their money on the sort of financial instruments that are thought to be rewarding and tailored to their needs. There are always rushes to grab shares of financial institutions, which are considered to be secured and rewarding. Those who hold shares of these institutions hang on to them indefinitely as there are no other alternatives to invest on if they liquidate their holdings.

It is customary practice that businesses, especially those that are well established, set a minimum number of shares to be bought by potential investors when they issue shares to the public. Dealing with larger funds and less number of investors make their job easier. But, it deters a considerable number of smaller investors from having stakes in such institutions.

The difficulties new ventures and less-known businesses encounter to raise funds are enormous. Bank finances need lengthy negotiations and security, while they are costly and short to medium types. The ease with which banks and insurance firms raise money from the public is due to the regulatory protection afforded to them and the high profit arising from it.

There cannot be better times to deliberate on establishing securities exchange other than now. Setting up an exchange attracts various financial investment products while at the same time enabling public confidence knocked down by IPSs scandal. They help to source financing and raise funds for new ventures; yet, it helps to expand options and balances risks for ongoing interests by allocating resources efficiently, protects investors, supplies adequate information, and regulates the market well.

The exchange also opens up an opportunity for all sorts of state and corporate bonds, which have a very limited market, for tradability. An ideal exchanges market only needs a regulatory framework, physical location, technological infrastructure and human resources.

Some ground works that create a conducive environment for setting up securities exchange are already in place in the country. IFRS and IAS with five years implementation period have been adopted. A board is set up for regulation of financial reporting and external audit. This improves the quality of financial information and auditing. The central bank already has corporate governance and risk management directives and guidelines. By extending these to other publicly owned entities, the regulatory success can be repeated.

Developing a regulatory framework by taking into account existing rules can be the first step. Remember? We have an experience, despite huge differences, of setting up a commodity exchange. We can take some lesson from it. We even can share experience from our neighbours such as Kenya.

By Abdulmennan Mohammed Hamza
He is a financial analyst based in London.

Published on Feb 25,2017 [ Vol 17 ,No 877]



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