Case study of Winchester Resources Ltd prospectus

Winchester

A prospectus is an invitation to the public to subscribe to a securities issue. The prospectus should contain all of the information relevant to the decision of whether or not to subscribe to the issue. This includes information about the company and its business, as well as the company's historic financial data. There should be information about the firm's customers, supply chains and distribution channels. There may be details with regards to estimated future financial information.

There should also be information regarding the management, including biographies of key executives, information regarding the people and companies that are promoting the IPO. The company's risk factors should also be outlined, to the best of management's ability. These should include both company-specific risks and general risks (Suruhanjaya Sekuriti, no date). In addition, the prospectus needs to outline for the benefit of potential future shareholders the rights that are attached to the security that is being issued (ASX, 2009).

Every firm that issues a public offering must publish a prospectus. According to the ASK website (2009), in Australia, that prospectus must be filed with both the Australia Securities Exchange (ASX) and the Australia Securities and Investments Commission (ASIC). The prospectus then needs to be approved in order for the company to have its shares listed on the ASX. At that point, the issue can go through, the IPO can take place and the company's shares can begin to trade on the open market.

2. There are many listing requirements for the ASX. The ASX website (2009) outlines these as follows. "The entity's structure and operations must be appropriate for a listed entity"; the "entity must have a constitution" and this "must be consistent with the listing rules." The firm must have a prospectus and this must be lodged with the ASIC and ASX. The entity must also "apply for and be granted permission for quotation of all the securities in its main class of securities." Additionally, there must be 500 holders, each having over $2,000 worth of the main security or an alternate set of criteria relating to ownership. The entity must pass a profit test rule. There are a number of more minor rules as well, each of which must be addressed in the prospectus in order for the security to be cleared for listing.

In addition, there are supplementary rules for different types of entities. If the entity is foreign, there are three other criteria that must be met, including becoming registered as a foreign company under the Corporations Act. Trusts must be registered managed investment schemes.

If Winchester Resources is to obtain a listing on the ASX, it would be categorized as a Resources company, with the subcategory of "Minerals." This categorization covers all firms that derive their investment risk from the exploitation of resources found under the earth's surface.

3. In the Australian finance system, the term no-liability is reserved exclusively for mining companies. This structure reflects the increased risk, in particular of mining firms that are engaged strictly in the exploration phase at the time of their incorporation and/or initial public offering. No-liability companies must therefore have a constitution lodged with their prospectus that limits their operations to mining activities only (ASIC, 2009).

A no-liability company is one in which the "shareholders are not bound to pay calls on their shares" (ASIC, 2009). A limited liability company, by contrast, is one in which the shareholders have a limited degree to which they are bound to pay calls on their shares (Carew, 2009). Winchester Resources is being organized as a no-liability company (Winchester Resources Prospectus, 2009).

4. The underwriter is the organization that is responsible for the pricing, selling and organizing of the public offering. The underwriter prepares all of the documentation for the issue and works to promote the offering. All underwriters are expected to perform due diligence for the issues that they promote. Underwriters typically buy some or all of the issue, depending on the terms of the agreement (Berman, 2009). Post-offering, the underwriter may continue to work for the stock, making a market for it, ensuring liquidity for it and continuing to promote the stock.

According to its prospectus, Winchester Resources does not have an underwriter for its issue (p. 9). This is common for firms with small issues. Underwriters base much of their business on the quality of their issues, and are therefore likely to support only firms whose issues they can count on to be popular. Alternately, the firm may be unwilling to make an issue with an underwriter, in order to avoid the high cost of underwriting. If the firm is confident it can subscribe most of the issue without the marketing help of an underwriter -- something that is possible in Australia's savvy mining securities industry -- then it may choose to forgo the services of an underwriter. In the case of Winchester, this appears to be the situation.

5. There are two key costs associated with the issuance of new securities. Direct costs are the first type, and consist primarily of fees paid to the underwriter and/or securities regulators for the listing. Indirect costs are the other type, and primarily include underpricing (Handley, 2009). The exact dollar values associated with direct costs are highly variable, depending on the types of services that the underwriter performs in the course of the issue.

The indirect costs are even more difficult to pin down because each firm is going to take a different approach to pricing its issue. Some firms may choose to overprice the issue, in which case there are no indirect costs. However, most firms choose to underprice new issues, largely to attract a sufficient amount of new investors. Because of these unknowns, it is impossible to predict the cost of raising share capital; each issue will have a substantial amount of firm- and issue-specific costs.

6. The prospectus for Winchester Resources does not give any indication of a dividend that it intends to pay. This makes sense for a couple of reasons. The first is that the company's shares are being issued at $0.20. This leaves little room for a dividend of any type. The second reason is that a dividend is unlikely to be paid by the type of company that Winchester is. The firm is an exploratory mining company. As of yet, it does not have active properties -- the issue is simply to raise money for further exploratory and geological work. The issue is being conducted with the expectation of future revenue streams developing. However, until those streams are developed, Winchester is not in a good position to pay a dividend.

There is also no indication in the prospectus of any future dividend expectations. Such predictions are unwise at the best of times, but are also not appropriate for the type of business in which Winchester is engaged.

7. Equity capital refers to the capital that derives from the shareholders -- the owners. This capital comes from investors but does not have a liability obligation attached to it. Instead, the shareholders get a piece of future profits. Equity capital is the opposite of debt capital, in which the investor takes no ownership stake, but has a guaranteed payback from the company.

Winchester Resources seeks to raise $2,000,000. They intend to do this by issuing 10,000,000 shares at $0.20 apiece. According to the prospectus, the company intends to use the funds raised by the issue "to firstly begin a detailed work programme on the Tenements, and secondly to consider and evaluate potential new mineral resource-based projects." These projects are comprised of three small patches of land (23.2 square km) in the area to the northwest of Kalgoorlie in Western Australia. The land is in a historic gold-mining region.

The Tenements projects include buying into the Ora Banda project, which includes 14 prospecting licenses, in particular for gold and nickel. The company will also use some of the funds to identify other potential projects in which to become involved. The search will include both sites in Australia and sites abroad.

8. The minimum number of shares that an initial investor can purchase is 10,000, according to the prospectus. The closing date for the prospectus was November 6, 2009 at 5:00 PM WST.

To subscribe to this offer, there is an application form contained within the prospectus. This application form must be filled out, and then submitted to the transfer agent (Security Transfer Registrars) before the closing date. Enclosed with the application form must be a cheque made out to Winchester Resources Limited -- Share Offer Account. The application and cheque must arrive before the closing date.

If this offer was missed, the acquisition of Winchester shares would need to be conducted on the secondary market. The company expected the shares to trade on the ASX shortly after the issue closed. An investor, at that point, seeking to own some of Winchester Resources, would have to buy them on the open market.

9. In terms of an IPO, underpricing refers to pricing the offering below the book or reasonable market value of the shares. This is done primarily to attract buyers to the offering. By selling the shares below value, it is believed that any rational investor would be enticed. Rational investors would know that when full information about the company comes to light, the market price of the shares will move to the true, rational value point. Thus, their investment during the IPO process would virtually guarantee them a profit.

An overpriced offering is one in which the shares are priced above the book or reasonable market value. Typically, a firm that overprices an offering understands that the offering will not sell out but is willing to accept this is return for a higher price. Alternatively, an issue may be overpriced if the issuing company believes that the market is irrational (such as during the dot-com boom, for example). In that scenario, the issuer would know that the market price is not the real equilibrium value of the firm but would also know that they can extract higher than normal value from their IPO simply because of the irrational behavior on the part of investors. Should the stock return to its equilibrium value later, the company is unaffected, and will have gained unusual profit from its initial public offering.