Saturday, August 04, 2007

Initial Public Offerings – To Invest or Not To Invest ?

Firstly, a brief introduction and summary: Initial Public Offerings or IPOs are companies which wish to go public in order to raise more funds through an equity offering to institutional investors and the public (also called retail investors). A company can either list on the Main Board of SGX or the second board called SESDAQ which has less stringent requirements. I do not exactly know what the requirements are (you can check this out on SGX) but I do know you need a three-year profit record for Main Board listings.

Everyone seems to be jumping on the IPO bandwagon these days. In a bull market (as is the case now, notwithstanding the corrections), all the newly listed companies’ valuations can go pretty crazy. If one actually follows and tracks the balloting ratios for the more recent IPOs (in the last 6 months), you will see that the retail float is usually very small (about 2-3 million shares) and the chances for allotment can get as low as 1/99 for one lot ! To me, this is hardly worth the effort to apply as you will use up your S$2 application fee and get a 1% chance to get 1,000 shares ! If you factor in the brokerage from the sale of the IPO (assuming you stag it), it can barely give you a decent profit ! Thus, I would advise readers to concentrate on companies which have a track record or earnings visibility, in order to have a greater margin of safety.

Another point I would like to mention is that most companies tend to list at the peak of their “cycle”, meaning that they choose the most opportune time to go public (when sales or profits have hit a peak). I have seen this for several companies as I read their prospectuses; profit seems to just leap up suddenly for FY 2006 seemingly for no reason at all. The question a discerning investor should ask is whether the continued good performance is sustainable. Most IPOs are marketed with glossy front covers, full pages photos and marketing jargon drumming up the merits of the company while playing down the risks. Large bar charts are used to trumpet high CAGRs for revenues and earnings, but again one should ask if this is sustainable and whether the industry is a cyclical one. Also, remember to apply a simple Porter’s 5-Forces analysis on the company’s industry to see if it is a market leader, or whether it has prospects.

One crucial thing most investors may miss are the margins for the 3 preceding years, as well as the risk factors mentioned within the prospectus. In the first place, the prospectus is one huge, thick stack of paper which is heavy enough to kill a small mammal ! There was an article some time back in the Business Times which suggested that companies drastically reduced the amount of information in the prospectus and just summarize the key points which are relevant to retail investors. This would save lots of paper and make people less averse to reading these thick manuals ! On the issue of margins, an investor should note that for some of the recent IPOs, the company actually had declining gross profit margins which were not captured in the “marketing” section of the prospectus. Such details are conveniently “hidden” right smack in the centre of the prospectus and investors (most of whom may be laymen to accounting jargon) have to dig through a pile of information just to find something relevant. I sincerely hope that the authorities at MAS will streamline the whole IPO process and make it less tedious and cumbersome both for the company and for retail investors.

My final point to make is that most companies, even if they have sound fundamentals and are in a growth industry, may not have an adequate track record to make it a worthwhile investment. Not much is usually known about newly listed companies, they may not have websites and analysts may hesitate to write reports because they are waiting for either a results announcement or some significant event. Thus, investing in IPOs on the first day of listing can be considered almost a gamble as the company’s intrinsic value cannot be calculated or estimated with reasonable certainty. Just to give an example, I hesitated on investing in Swiber because it was a new IPO. Only after it released its 4Q 2006 results and after it clinched the Brunei Shell’s US$146.6 million contract did I decide to buy part of the company. Even then, it was after much tracking of its announcements, reading up on the industry and the business and the usual homework to be done before an investment is made.

My Conclusion: Do NOT be an eager beaver to invest in newly-listed companies. Most have non-existent track records and may list at the peak of their business cycle. Plus, in the current bull market, most IPOs are opening at super inflated prices versus their offer price, and are thus extremely risky to invest in. My advice is to do your homework and exercise patience in order to sift out the outstanding companies from the weak/mediocre ones. Once enough information has been obtained to make an informed decision, one can then safely invest in an IPO.

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