Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 161

Opportunities in new company floats

We continue to see a steady stream of company floats or Initial Public Offers (IPOs) coming to market, although the current IPO cycle appears quite mature. Unlike previous cycles this far advanced, this one is still offering some attractive opportunities for investors.

The typical IPO cycle

The IPO cycle typically starts with the listing of higher quality companies. To overcome investor apprehension, they are often priced quite attractively and accordingly they generally deliver good returns for investors. The success of these IPOs then allows lesser quality companies to come to market, with the quality falling away over the course of the cycle. The IPO cycle will continue for so long as the market remains receptive. Sometimes, it will be a market correction that ends the cycle. This was the case with the GFC, when IPOs stopped dead.

Other times the end comes about as a result of a run of poor performing IPOs or a high profile failure. For example, the last IPO cycle ended with Myer, which floated in late 2009, and whose share price halved within two years (it has halved again since). The IPO cycle lay dormant until around 2013 despite the fact that the market was strong until then. It was at this point that the current IPO upcycle began.

This IPO cycle

True to form, the current IPO cycle came with some early successes, including IPH, Mantra Group, Aconex, and Burson Group. All of these stocks have doubled or tripled since their IPO at the start of the cycle. What has perhaps been different this time is that there has not been the same obvious deterioration in quality over time. Both successes and failures have been spread quite evenly across this IPO cycle. Early in 2013 we had the IPOs of Vocation and Dick Smith, both of which found their fate in administration. And more recently we have had some high quality IPOs that have already delivered decent returns.

One recent example is BWX Limited, which owns the Sukin range of natural skincare creams. It is a quality company, with a strong brand, an astute CEO, and bright growth prospects. The company floated in November 2015 at a share price of $1.50. Since then, it announced strong first half year financial results in February 2016, and it is further down the track in its offshore expansion plans. It’s share price has already tripled since its IPO.

There have been a number of other decent companies that have undertaken IPOs recently with decent success. For example, in April we had the IPOs of Motorcycle Holdings (+38% since listing), Reliance Worldwide Corporation (+22%), and WiseTech Global (+32%). Recent successes like these are allowing this IPO cycle to continue, and while we are conscious that quality may well in fact deteriorate, we are still seeing some attractive opportunities coming our way.

A focus on quality, but IPOs have specific issues

At Bennelong (BAEP), we analyse all new companies coming to market just as we would those already listed. For us, that means focusing on the fundamentals and looking out for high quality, strongly-growing companies that are reasonably priced. However, in our analysis, there are a few peculiarities in the specific case of an IPO:

1. Research timeframe

The research effort for an IPO must be completed in a compressed timeframe and before the drop-dead date to bid for stock. Investors often have less than two weeks to put in bids once a prospectus is released. Fund managers will usually have longer, with broker research released a few weeks prior, and often with the benefit of meetings with management in the previous 6-12 months as part of so-called ‘non-deal roadshows’ (brokers use these to gauge interest for an IPO).

2. Track record

IPOs have limited financials and other important information. The typical prospectus will provide just two to three years of historical financials. Investors generally have little familiarity with the business, including its performance in various business conditions, and little exposure to management and their capabilities.

New investors thus start at a considerable disadvantage vis-à-vis the vendors of the business, who have normally been intimately involved with the company and management for far longer. Vendors have the luxury of choosing the timing of their exit, and this is likely to coincide with when the business is performing well. New investors must assess the sustainability of current earnings and whether forecasts are achievable.

On the other hand, the disclosure of a longer track record will often signify a strong business, not least because the disclosure probably comes because the record is attractive. A recent example is Reliance Worldwide, which is a well-run manufacturer of plumbing supplies and provided 10 years’ history of sales revenue, which had grown at 13% per annum. Of course, even in these cases, it is necessary to consider whether the future will be as bright as it has been in the past. For us at BAEP, this included undertaking a large number of meetings with customers and other industry contacts in the short timeframe we had.

Investors may be familiar with the business because it has been listed before in one form or another. Have things changed for the better? Generally, they have not, with Dick Smith a case in point. This business struggled for decades under Woolworths’ control, with numerous CEOs and strategic reviews before being sold in 2012. The private equity buyers relisted the business the following year at a materially higher valuation, after a very quick ‘turnaround’ that more than doubled profits and supposedly set the company on a more prosperous course. As it turned out, the troubled track record was indicative of the company’s ultimate outcome.

3. Vendor’s motivations

Understanding the vendor’s motivations allows investors to understand the opportunity. An important distinction should be drawn between two scenarios:

a) Existing shareholders selling their shares as part of the IPO, leaving them with no or little remaining interest in the company. Such vendors are effectively cashing out, and are likely to be motivated purely towards maximising the proceeds, with little regard for the company’s success once listed. Extra care is required here, with private equity exits such as Dick Smith and Myer serving up cautionary tales.

b) The company itself raising the money through the issue of new shares. Existing shareholders do not sell shares and remain in. Here, the capital raised goes to the company itself, to be used for its benefit to invest in growing the business. Existing shareholders retain their shares and price maximisation is not the sole motivating factor in setting the IPO price.

Special situations

There are a two types of floats that are particularly attractive: privatisations and demergers.

a) Privatisations involve an IPO in which a government is the vendor and it sells a public asset. Governments are minded to give incoming investors, who happen to also be voters, a positive experience, and this often means pricing at a reasonably attractive level. Commonwealth Bank, CSL, Telstra, Aurizon and more recently Medibank are typical examples in which investors have done well.

b) Demergers involve the distribution of shares of a subsidiary company to the shareholders of the parent company. The new demerged company is let free to chart its own course, with management often more focused and incentivised. Except in the unusual case, demergers do not also involve raising new capital. Consequently, there is no need to sell the IPO to any new investors, and unlike most IPOs, there is no special sales effort behind the listing. A recent example of a successful demerger is Clydesdale Bank, which separated from National Australia Bank, and floated in February 2016. The demerger was undertaken because the business was considered non-core, but left alone, it has already prospered and its share price has risen accordingly.

Conclusion

Gaining comfort in a soon-to-be-listed company and its prospects as an investment is generally more difficult than those we’ve been researching for some time. However, the research effort is always worth it, even if only to become familiar with the company with the potential of investing further down the track. Keep an open mind, recognise that IPOs can be attractive, and remember that every company of course was once an IPO.

 

Mark East is Chief Investment Officer of Bennelong Australian Equity Partners (BAEP). This article is general information and does not consider the circumstances of any individual.


 

Leave a Comment:

     

RELATED ARTICLES

Bounce back delivers super second-half for IPOs

IPO a-go-go: the who, why, when and how much of IPO investing

The future has arrived in Australia

banner

Most viewed in recent weeks

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Two strong themes and companies that will benefit

There are reasons to believe inflation will stay under control, and although we may see a slowing in the global economy, two companies should benefit from the themes of 'Stable Compounders' and 'Structural Winners'.

Latest Updates

Retirement

Stop treating the family home as a retirement sacred cow

The way home ownership relates to retirement income is rated a 'D', as in Distortion, Decumulation and Denial. For many, their home is their largest asset but it's least likely to be used for retirement income.

Property

Hey boomer, first home buyers and all the fuss

What is APRA worried about? Most mortgagees can easily absorb increases in interest rates without posing a systemic threat to the banking system. Housing lending is a relatively risk-free activity for banks.

Property

Residential Property Survey Q3 2021

Housing market sentiment has eased from record highs and confidence has ticked down as house price rises slow. Construction costs overtook lack of development sites as the biggest impediment for new housing.

Investment strategies

Personal finance is 80% personal and 20% finance

Understanding your own biases and behaviours is even more important than learning about markets. Overcome four major cognitive biases that may be sabotaging your investing and recognise them in others.

Where do stockmarket returns come from over time?

Cash flow statements differ from income statements and balance sheets, and every company must balance payments to investors versus investing into the business. Cash flows drive the value of the business.

Fixed interest

How to invest in the ‘reopening of Australia’ in bonds

As Sydney and Melbourne emerge from lockdown, there are some reopening trades in the Australian credit market which 'sophisticated' investors should consider as part of their fixed income portfolios.

Shares

10 trends reshaping the future of emerging markets

Demand for air travel, China’s growing middle-class population, Brazil’s digital payments take-up, Indian IPOs, and increased urbanisation are just some of the trends being seen in emerging economies.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.