Change in BPH free float reflects deeper WSE problem
The WSE currently has a market capitalization of about zł. 107 billion ($26.75 billion), up more than three times from the market's value of zł. 24 billion ($8.8 billion) at the end of 1996. However, analysts note that the market still suffers from liquidity problems, which ultimately can stunt its development.
"According to my calculations, about 25% of the WSE is in free float," said Marcin Materna, a broker with BIG Bank Gdański brokerage house. "It's very low."
Free float is the amount of a company's shares that can actually be traded, meaning they are not part of large blocks held by individual investors who are not looking to sell. The free float is especially important for large investors, who may find a stock less attractive if it has a small amount of freely tradeable shares and so is not very liquid. Without adequate liquidity, it is more difficult for an investor to buy or sell large blocks of shares without causing large price swings.
The importance of free float to fund managers and institutional investors was seen last week in an announcement by FTSE International, the manager for the main London Stock Exchange index. In a rules change that will take effect next year, weightings for individual stocks in the FTSE index will be restricted if a company has a free float of less than 25%. If a company's free float is less than 15% it will not be included in the FTSE index, according to Reuters.
Some WSE watchers have blamed government privatization policies for the lack of liquidity on the market and the small free floats of many important companies.
Lesław Paga, president of Deloitte&Touche and former chairman and founder of the Securities Commission (KPWiG), said that privatizations so far have resulted in large packages of shares either being sold to one, strategic investor or being left with the Treasury Ministry.
"Revenue to the budget mattered, not the capital market's development," he said of the decision to privatize in this way.
"Such a situation is not good for the market," Materna said. "(The market) develops slower because large investors simply cannot come here: they are interested in liquidity."
Although the "right" level of free float depends on the size and needs of a particular investor, low liquidity definitely narrows the scope of investors that a company is able to attract.
"This is especially important for large, institutional investors who can't afford to buy securities that can be difficult to sell," said Michał Szymański, investment adviser with ING BSK Asset Management.
In BPH's case, Bayerische increased its holding in the bank to 77.85% on Aug. 9 and then through a capital increase two weeks ago to 81.46%. Given that the Treasury Ministry holds 5% of the bank and the European Bank for Reconstruction and Development (EBRD) another 4%, its free float is only about 10%.
Prior to Bayerische's share purchases, BPH had a free float of between 20-30%.
This has had negative consequences for the bank. On Aug. 16, partly due to the reduced free float and along with poor financial performance, Deutsche Bank Research changed its recommendation for BPH to "sell" from what had been a hold position.
But BPH isn't the only share on the WSE that presents such a liquidity problem for investors. Of the market's 20 largest companies, which are grouped together in the WIG 20 index, seven have a free float of less than 20%.
Of course, the ideal level of free float is different for every company and depends on its size. For example, Telekomunikacja Polska's (TPSA) free float is only 15%, but this is worth about $1.4 billion. (Of TPSA's free float, about 10.6% is represented by global depository receipts/ GDRs traded on London's Seaq market).
Other large companies with small free floats include Bank Pekao with 15% of shares freely tradeable and another 10% to come to market in November, and KGHM Polska MiedĽ with a 26% free float of 200 million shares of which 21.48% are traded as GDRs.
A small free float may not be as much of a problem for investors in terms of day-to-day liquidity of large caps. But it may have an adverse effect on trading through representation in various indices.
Many investors and fund managers model portfolios on certain indices. So if a company's weighting on an index goes down, funds may sell shares to reflect this, Szymański said.
For instance, if the presence of a company in a benchmark index was 10% and falls to 5%, while at the same time it accounted for 15% of a certain investment portfolio, the risk related to this company immediately increases by 100%, he added.
"So if the fund manager doesn't want to increase the risk, he will have to reduce his involvement in such a company," Szymański said. And that means sell the shares.
Since many WSE-oriented funds structure their portfolio based on the main market's all-share WIG or the blue-chip WIG 20, any changes in a company's contribution to these indices can result in immediate sell decisions.
To calculate the WIG or the WIRR index, which is the based on the WSE's parallel market, the WSE's index committee takes into account all publicly listed shares and whether they are effectively traded or not. If a company's free float is extremely small, the company's weighting in the index is reduced by half.
"And that's what has been done at the end of June with 10 companies," said Arkadiusz Szymanek, head of the WSE Index Committee. These companies were: Compensa, Gorażdże, Izolacja, Morliny, Nomi, TPSA and Żywiec in relation to the WIG index and Dom-Plast, Kopex and WKSM for the WIRR index.
"In terms of BPH, its contribution has not been cut yet, but surely it will be at the end of September, during the next WIG portfolio revision," Szymanek said.
In terms of the WIG 20, which is also used as a basis for derivative products, turnover and market capitalization are taken into account for a company's position in the index. Of these two factors, turnover, or trading volume, is 60% of the weighting, while capitalization is 40%.
As a result, BPH's free float would not affect its standing in the WIG 20. But if it and the company's reduction in importance in the WIG index result in lower trading volume, the company could have less of a presence or drop out of the WIG 20 altogether.
For many market watchers, though, the small free float of many WSE companies is also indicative of what may become a future problem: delisting. The question is for how long companies, which have one large investor who controls more than 75% of equity, will remain public.
Jan Stefanowicz, a securities lawyer and a specialist with the Adam Smith Research Centre, said this question is partially dealt with in the privatization process.
"But this is a total misunderstanding," he said. "Sooner or later, after certain obligations expire, the investor will try to pull the company out of the stock exchange."
"According to my calculations, about 25% of the WSE is in free float," said Marcin Materna, a broker with BIG Bank Gdański brokerage house. "It's very low."
Free float is the amount of a company's shares that can actually be traded, meaning they are not part of large blocks held by individual investors who are not looking to sell. The free float is especially important for large investors, who may find a stock less attractive if it has a small amount of freely tradeable shares and so is not very liquid. Without adequate liquidity, it is more difficult for an investor to buy or sell large blocks of shares without causing large price swings.
The importance of free float to fund managers and institutional investors was seen last week in an announcement by FTSE International, the manager for the main London Stock Exchange index. In a rules change that will take effect next year, weightings for individual stocks in the FTSE index will be restricted if a company has a free float of less than 25%. If a company's free float is less than 15% it will not be included in the FTSE index, according to Reuters.
Some WSE watchers have blamed government privatization policies for the lack of liquidity on the market and the small free floats of many important companies.
Lesław Paga, president of Deloitte&Touche and former chairman and founder of the Securities Commission (KPWiG), said that privatizations so far have resulted in large packages of shares either being sold to one, strategic investor or being left with the Treasury Ministry.
"Revenue to the budget mattered, not the capital market's development," he said of the decision to privatize in this way.
"Such a situation is not good for the market," Materna said. "(The market) develops slower because large investors simply cannot come here: they are interested in liquidity."
Although the "right" level of free float depends on the size and needs of a particular investor, low liquidity definitely narrows the scope of investors that a company is able to attract.
"This is especially important for large, institutional investors who can't afford to buy securities that can be difficult to sell," said Michał Szymański, investment adviser with ING BSK Asset Management.
In BPH's case, Bayerische increased its holding in the bank to 77.85% on Aug. 9 and then through a capital increase two weeks ago to 81.46%. Given that the Treasury Ministry holds 5% of the bank and the European Bank for Reconstruction and Development (EBRD) another 4%, its free float is only about 10%.
Prior to Bayerische's share purchases, BPH had a free float of between 20-30%.
This has had negative consequences for the bank. On Aug. 16, partly due to the reduced free float and along with poor financial performance, Deutsche Bank Research changed its recommendation for BPH to "sell" from what had been a hold position.
But BPH isn't the only share on the WSE that presents such a liquidity problem for investors. Of the market's 20 largest companies, which are grouped together in the WIG 20 index, seven have a free float of less than 20%.
Of course, the ideal level of free float is different for every company and depends on its size. For example, Telekomunikacja Polska's (TPSA) free float is only 15%, but this is worth about $1.4 billion. (Of TPSA's free float, about 10.6% is represented by global depository receipts/ GDRs traded on London's Seaq market).
Other large companies with small free floats include Bank Pekao with 15% of shares freely tradeable and another 10% to come to market in November, and KGHM Polska MiedĽ with a 26% free float of 200 million shares of which 21.48% are traded as GDRs.
A small free float may not be as much of a problem for investors in terms of day-to-day liquidity of large caps. But it may have an adverse effect on trading through representation in various indices.
Many investors and fund managers model portfolios on certain indices. So if a company's weighting on an index goes down, funds may sell shares to reflect this, Szymański said.
For instance, if the presence of a company in a benchmark index was 10% and falls to 5%, while at the same time it accounted for 15% of a certain investment portfolio, the risk related to this company immediately increases by 100%, he added.
"So if the fund manager doesn't want to increase the risk, he will have to reduce his involvement in such a company," Szymański said. And that means sell the shares.
Since many WSE-oriented funds structure their portfolio based on the main market's all-share WIG or the blue-chip WIG 20, any changes in a company's contribution to these indices can result in immediate sell decisions.
To calculate the WIG or the WIRR index, which is the based on the WSE's parallel market, the WSE's index committee takes into account all publicly listed shares and whether they are effectively traded or not. If a company's free float is extremely small, the company's weighting in the index is reduced by half.
"And that's what has been done at the end of June with 10 companies," said Arkadiusz Szymanek, head of the WSE Index Committee. These companies were: Compensa, Gorażdże, Izolacja, Morliny, Nomi, TPSA and Żywiec in relation to the WIG index and Dom-Plast, Kopex and WKSM for the WIRR index.
"In terms of BPH, its contribution has not been cut yet, but surely it will be at the end of September, during the next WIG portfolio revision," Szymanek said.
In terms of the WIG 20, which is also used as a basis for derivative products, turnover and market capitalization are taken into account for a company's position in the index. Of these two factors, turnover, or trading volume, is 60% of the weighting, while capitalization is 40%.
As a result, BPH's free float would not affect its standing in the WIG 20. But if it and the company's reduction in importance in the WIG index result in lower trading volume, the company could have less of a presence or drop out of the WIG 20 altogether.
For many market watchers, though, the small free float of many WSE companies is also indicative of what may become a future problem: delisting. The question is for how long companies, which have one large investor who controls more than 75% of equity, will remain public.
Jan Stefanowicz, a securities lawyer and a specialist with the Adam Smith Research Centre, said this question is partially dealt with in the privatization process.
"But this is a total misunderstanding," he said. "Sooner or later, after certain obligations expire, the investor will try to pull the company out of the stock exchange."
