Recent Stock Price Declines and Implications for Capital Raising

The recent decline in prices of stocks listed on the Nigerian Stock Exchange has significant implications for capital raising activities. Though few market watchers expect a full blown credit crunch or drying of the capital markets as witnessed in the US and Europe in the last twelve (12) months, it is widely believed that the markets will be a little more discriminating about the quality of the issues that will get financed. What this means is that while high quality companies with well-priced and well packaged issues will still be able to raise equity
capital, it will be more difficult for poorly run companies with questionable valuations to raise capital from the Nigerian Equity Capital Markets.

I believe a relative scarcity of capital is a good thing, as access to capital should be a reward for competent management, clear vision and efficient execution. A number of poorly run companies have been able to raise capital easily in the last one (1) year through Private Placements that were many times over-subscribed as investors sought to take a position in the company pending the eventual listing, and almost certain price appreciation, of the company's ordinary shares. This mentality copupled with ever rising stock prices, led people to invest in companies
they did not particularly undertstand as long as the companies were going to list on the Stock Exchange and scarcity effect was going to push up its share price.

The end result of this over-optimism was that little or no due-dilligence was done by prospective investors and many poorly run or ill-prepared companies were able to raise large sums of money from investors. I believe this situation has grave consequences for corporate performance and the Nigerian Economy as a whole as companies without the structures or operations to deliver good returns on capital employed were raising large sums of money. I believe one of the hallmarks of capitalism is "creative destruction" or the ability to "shoot the mortally wounded"
situations through which companies with crumbling operations and incompetent management are denied funding and allowed to die (to make room for new and innovative companies) instead of being propped up with infusions of capital that will be eroded through bad results.Giving
huge sums of money, in form of equity subscription, to poorly performing companies with questionable strategy and incompetent managements who do not feel the pressure or obligation to deliver value to shareholders is like giving an M16 Assault Rifle to a child soldier and will eventually lead to destruction of shareholder value and long term negative return on capital invested.

The difficulties that I believe poor performing companies will have in raising capital in the near future will have practical implications for the development of Private Equity industry in Nigeria. The ease with which companies have been able to raise money, has placed Private Equity funds in an uncomfortable position as promoters of many small, struggling companies have not been willing to work with such funds. Many promoters and managers of private companies, if given the choice, will opt for private placements rather than receive funds from a Private Equity
Investor. This is because capital raised through Private Placements or Public Offers comes with fewer strings attached to it than Capital raised from Private Equity investors. This is mainly because Private Equity funds usually have higher due dilligence requirements and take a more hands-on approach in monitoring the performance of companies in which they invest and this may not sit down well with company promoters and management that may not want to share control of their companies with a PE investor.

However if struggling companies become constrained in raising capital, they may have to turn to one or more of the new Private Equity funds that have been launched in the last 18-36 months. Private Equity investments can be mutually beneficial to both the PE firms and company promoters and management. This is because PE funds tend to be hands-on investors with significant financial, strategic and operations competencies and are in a position to add some value, apart from capital infusions, to companies in which they invest. The increased levels of monitoring by PE firms, through board memberships and direct executive appointments, will put management "on their toes" and is likely to lead to more disciplined management with the resultant improvements to corporate performance and shareholder value.