Despite all the delays, the 2012 annual report by the online translation company Babylon is signaling through its financial reporting that its long-awaited initial public offering on Wall Street is on the way.
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The company’s 2012 financial report, published three weeks ago, showed the company had booked a NIS 4.9 million asset on its balance sheet for the expenses it had run up through the end of last year connected with the planned offering.
They were tagged as “pre-IPO costs.” At the same time, the company classified these costs in its cash-flow report as financing costs. Those costs grew in the last three months of 2012; at the end of the third quarter, this IPO-related asset had been reported as NIS 1.7 million.
The only explanation for Babylon’s reporting the IPO costs this way is that Babylon regards them as “recoverable,” meaning through the completion of the share offering.
Under normal conditions, expenses related to a stock offering are regarded as a capital expense, which is why they are subtracted against the amount of capital that is finally raised. However, an interesting situation occurs when the offering is delayed. On the one hand, the costs grow over time, and on the other, the offering hasn’t been completed by the date the company’s balance sheet has closed.
Under IFRS standards, so long as the chances of the share offering occurring are greater than that it will not, the related growing costs are booked as an asset that will be discounted from the capital raised in the planned share sale.
Babylon announced back in September it was exploring the option of an IPO in the United States and filed a prospectus that was not disseminated to the public. At the beginning of November, it publicly filed with the U.S. Securities and Exchange Commission a draft registration statement for listing its shares in the U.S., including a preliminary prospectus. At the end of November, following an announcement by the company about the timing of a pre-IPO roadshow, some reports claimed that the IPO was being delayed due to unfavorable market conditions.
Last month, Babylon, headed by chairman Noam Lanir and CEO Alon Carmeli, reported that it has still not decided on an appropriate date for the offering, which would be announced when it determined that market conditions were favorable. It said it would update its prospectus for the SEC to reflect its results for 2012.
Along this entire process, Babylon has never said the offering was certain. But it is important to note from an accounting perspective that the company continues to book its IPO-related costs as an asset rather than as an expense. In other words, an offering is still planned and the company is spending to keep its prospectus and other documents current.
Delaying the costs of the offering (capitalization) in expectation that it will eventually go through is not a trivial matter in light of the fact that that the decision to go ahead with it hinges on market conditions – a factor that is not in the company’s control.
Costs entailed in preparing a shelf filing are as a rule not deferred due to insufficient certainty about whether the offering will go forward. Otherwise there would be no reason to carry the costs at all.
The extent of this problem is illustrated by the fact that SEC rules require that a company that delays an offering by 90 days to book its costs in its profit-and-loss statement, without any right of appeal. In Babylon’s case, it should be noted, six months have passed since it filed its first non-public prospectus.
Another important distinction should be made between the costs of the offering itself and the cost of registering the stock for public trading. Registering for trading is not a capital-raising expense, so IFRS standards require it be booked as a current expense.
Since an initial public offering, as distinct from a follow-on offering, joins these two elements together, for all practical purposes it is impossible to separate these two cost items and everything is booked as a capital expenses. In any event, registration costs are relatively small compared to offering costs.
An interesting signal given off by a company concerning its expectations to list its share appears in the financial reports of Housing & Construction Ltd. Until the second quarter of 2012, the company had expected to register for trading shares via its Housing & Construction Real Estate Ltd. subsidiary by the end of last year.
Until the second quarter, the company booked other expenses of NIS 9 million that one can assume were connected with a note in the report that it had made a provision for the subsidiary’s failure to date to float the shares as it had promised its institutional investors. Without entering into the issues of disclosure, it does show the company had changed its assessment of when it would be able to register the stock for trading.
The background to this obligation comes from 2009, when Housing & Construction sold a 21% stake in the unit to the insurance companies Harel, Clal and Phoenix for NIS 300 million.
Housing & Construction committed to ensuring the shares would be publicly traded by the end of 2012 and that its failure to do so would entail a financial penalty that could reach up to NIS 12 million, depending on how long the delay would be.
So long as the company was of the opinion that the shares would not be registered for trading, it had to book an expense. Until the second quarter, Housing & Construction was confident that it would indeed list the shares by the deadline.
In its third-quarter financial report, which was published last November, the company said it was in talks with its investors about delaying the deadline for registering the shares. In exchange it would pay a small sum. It said that if the delay was not accepted, it was still planning to list the subsidiary for trading by the end of 2013.
It should be noted that the process of registering a closely held company for trading is not obvious because it is a major undertaking, and because of the obligations that come with being a public company.
Shlomi Shuv is an IFRS consultant and deputy dean (accounting) of the Arison School of Business, Interdisciplinary Center (IDC), Herzliya.