This article was written for SMSF Adviser online magazine.
With the avalanche of new listings coming to market, we consider the issue should investors participate in IPO’s (Initial Public Offers)?
When it comes to investing we all aspire to Warren Buffett, and yet at times investors act more like Gordon Ghecko, the fictional character portrayed by Michael Douglas in the 1987 film “Wall Street”. This is how it seems with the love affair investors have with IPO’s.
Every investors dream of course is to buy into a float, and then sell day one for a handsome profit, otherwise known as a ‘stag’.
We acknowledge how easy it is to fall in love with a new IPO, after all the prospectuses produced usually come complete with stunning pictures of celebrities such as Jennifer Hawkins who made the Myer prospectus worth flicking through. When Pacific Brands pitched to investors the images of Pat Rafter and others in their underwear may have been visually appealing, but certainly not instructive.
Aside from the pictures though, the prospectus almost always outlines a rosy outlook for the business.
The first question we would suggest investors ask themselves is – would they want to have this in their portfolio in 5 years time? If the answer is a clear no – then we suggest extreme caution.
Other than the normal set of investment considerations that investors think about when investing, such as price, management, gearing etc here are a series of additional points when thinking about investing in an IPO.
- Investors need to understand who is the vendor of the IPO. Private Equity funds have established a poor reputation for taking over businesses, loading them up with debt after stripping the company of other assets before selling back to unsuspecting investors via an IPO. Dick Smith comes to mind as a perfect example. We are not opposed to buying from Private Equity funds as such, but investors must understand that the vendors in an IPO have a far greater understanding of the business than the investor can gather from reading the prospectus, which puts the vendor at a significant advantage. Conversely the history of Government IPO’s has been a little friendlier for investors, other than of course Telstra II, which is still significantly underwater from its $7 plus offer price.
- Once investors have established who is the vendor, it is important to also understand whether the vendor is retaining any part of the company or if it is a full sale. If the vendor is retaining part of the business, investors need to understand if there are any time limitations around this ownership. We also believe that it is also crucial to understand what the IPO proceeds are being used for. Is the IPO simply to reduce debt, or for the vendor to sell out? Or are the proceeds being used to grow the business?
- Brokers are remunerated for selling the IPO. While this may sound obvious, it reminds us of the phrase “never ask a barber whether you need a haircut”. Brokers have to sell their services to the IPO vendor, which results in a research blackout on the IPO company. This simply means that it is virtually impossible to obtain unbiased investment research from the broking firm that is handling the IPO. And of course as the experienced brokers will tell you – “the best IPO’s you can never get enough of, and the IPO that you receive your full allocation for is generally the one you don’t want”
- One of the best pages of the prospectus is the “Investment Risks” section. In our experience, very few investors read much in a prospectus at all, and in particular do not read or understand the investment risks section. If it is one section of a prospectus that investors read, it should be this section.
So, should you invest in IPO’s? Our view is that while some IPO’s offer good opportunity, greater caution should be exercised by investors when considering IPO’s due to the lower level of information usually available.