Underpromise, overdeliver?

We have recently seen a welcome pickup in equity listings in the local market. Even more welcome has been an apparent move towards more realistic valuations, offering a more attractive investment proposition for the incoming investor. In far too many instances, IPOs factored in overly optimistic assumptions and were effectively priced to perfection.

The table shows actuals against projections.

This performance is a fairly damning indictment of the reasonableness of projections in previous IPOs, or in the assumptions that have been made while preparing such forecasts. Instead of projected wealth creation of €56 million, we have had an actual loss of €16 million. Merlin the wizard would be impressed.

We make these observations not to denounce any company in particular, but to candidly state the facts and express our view that such a situation is sub-optimal and needs to be improved. Certainly, when dealing with forecasts one must always bear in mind that we are dealing with future events.

While it is highly improbable that actual results will match exactly forecasted profits, it is the scale of the difference that we are highlighting here.

The objective for any investor is to pay less than what something is worth. These projections have induced investors to pay more. Whether this was done inadvertently or not is beside the point. Any investment in equity is an investment in the future stream of income of that company.

If companies are prone to miss their own forecasts by such large margins, then investors are likely to have precious little confidence in buying into that proposed income stream - and perhaps ought to question more ardently the preparation of such forecasts.

However, the way I have phrased the above is slightly misleading. It implies that the investor/investee relationship is a zero sum game. In other words, a gain for one is at the expense of the other. In theory, it doesn't have to be viewed that way. It is more accurate to look at it as a non-zero sum game in the sense that it is the co-operation between the two parties which gives rise to the possibility that wealth is created for mutual benefit.

Of course, such a moral high ground is unlikely to be reached in practise and the reality is that both investor and investee will be tempted to strive for an asymmetric distribution of wealth.

Where supply and demand for investment opportunities is an efficient market with depth, competition for wealth generating resources (whether labour or capital) will help ensure more equitable pricing.

Unfortunately, however, Malta has not been such a market in that there is an inherent mismatch between investment opportunities and the ability to finance them. This gives rise to the possibility that those wishing to raise funds will be tempted to exploit this inbuilt excess demand to their advantage.

This suits the company in question, but at the expense of confidence of the market in general.

Happily, we see signs that this will not wash anymore.

It is imperative that it does not, for the very viability of a sophisticated economy depends on the ability of its companies to attract capital, equity capital in this case. This is less likely to happen if investors get a raw deal.

Now that we are in Euroland, we can for the first time invest in blue chip, world class companies without taking a currency risk. Furthermore, investors will not incur foreign exchange transaction costs.

Investors, both institutional and private would do well to compare more closely, and as a matter of course, the opportunities available to them both locally and overseas.

And while the local company may prove to be the more attractive option due, in the first instance, to its close geographic proximity, this should not be at the expense of accepting higher valuation metrics and lesser transparency of management.

This increased optionality will hopefully lead to more equitable pricing locally, to the benefit of investors and ultimately our economy. In this respect, companies earn premium valuations not by telling a good story, but by delivering on promises made.

Martin Webster is an equity analyst at Curmi and Partners Ltd. Curmi & Partners Ltd is licensed to conduct investment services business by the MFSA and is a member of the MSE. The value of investments and the income derived there from may rise as well as fall. Past performance is no guarantee of the future. Any opinions expressed are those of the author.