Thursday, October 15, 2009

The Revival in IPOs

It’s been quite some time since I’ve blogged about Initial Public Offerings (i.e. IPO), with my last post on this being dated April 2009 and the previous one was more than 2 years ago in August 2007! Over this time, I have learnt a lot more about the nature of IPO and also how their appearance (and disappearance) tends to coincide with economic cycles. Let me elaborate further.

It has been noticed by me that when markets crash and valuations hit extreme rock bottom, no companies out there will be willing to list. This is because they will be unable to raise much money are the valuation multiples used would be rock-bottom, and also since they are one of the few who may choose to list, they may also be subject to greater scrutiny by the investing public. The rationale for listing will always be to raise funds, and of course the more funds raised with the same number of additional issued shares, the better, as there will be less dilution to the founding shareholders.

Conversely, if we look at the situation at the height of the bull market in 2007, IPO were being churned out like clockwork and all sorts of kachang-puteh companies (i.e. companies without much substance) could list without much problem. All one needed was to spin an attractive growth story, fill in some nice-looking numbers and come up with glossy marketing material and everyone would pile in to catch a piece of the action. I remember it being so bad that forums were filled with punters (they call them “stags”) who bet on the closing price on the first day of IPO and how many % they would be above their offer price. Sadly, I must admit that I was also one of the uninformed who tried my hand at applying for one of these “hot issues” , till I realized better some time later and stopped altogether. All sorts of companies, whether good, bad or ugly, will be able to list at lofty valuations during a bull market, and the onus is up to the investor to ensure he does his due diligence so as to avoid massive losses when such promises of growth do not come true.

Taking a glance back at our local bourse over the past 1.5 years, I noted a still healthy pipeline of IPOs all the way till September 2008 (the month of the Lehman Brothers collapse). In October 2008 there was just 1 IPO (China Kunda) and another in November 2008 (Otto Marine), after which the IPO pipeline totally and completely dried up until January 2009 (Westminster – Catalist) and February 2009 (Japan Foods – also Catalist). From this simple observation, it can be concluded that the sharp plunge in valuations from the October 2008 to March 2009 period caused the IPO tide to recede, such that no companies wanted to list at all for fear of getting very poor valuations. Ironically, if a company were to choose to list at such low valuations, and if its business model was a sound one, one would actually be able to get a very good price at IPO to be able to hold long-term, as one would be buying into a company at depressed valuations (similar to buying a company already trading on SGX at low valuations).

Once March 2009 passed, and valuations took a sharp upward swing in May 2009, the IPOs started trickling back. It began with Teho in June 2009, then followed up with 3 companies each in July, August and September 2009, making it a total of 10 companies in just 4 months, compared to just 2 companies in the first 5 months of 2009. Now the trickle is becoming somewhat of a torrent, with 3 IPO aspirants planning to list at about the same time (Ziwo on Oct 8, Goodland Group also on Oct 8 and Hengyang Petrochemical Logistics on Oct 9). Judging from the response to the new IPOs (all closed “above water”) and also the recent news about the IPO market “hotting” up in Hong Kong and China, I have no doubt that sentiment and valuations are indeed on the rise, allowing many firms to realize their “dream” of listing and gaining recognition. As I write this, another IPO aspirant called Jason Marine is trying to list on Catalist by selling shares at S$0.21 apiece. The shares will be traded on October 21, 2009.

The discerning investor would have to plough through thick wads of prospectus to be able to differentiate the wheat from the chaff, but I feel this is unnecessary; for IPOs are generally “priced to perform” and are usually using low or moderate historical PERs to justify their pricing. Moving forward, whether these PERs appear low or not would be judged based on the future performance of the businesses which these companies are involved in. I can safely say that only 1 out of 10 IPO companies has characteristics which make it investment-worthy; but even then my track record with IPO companies has been less than stellar. Ultimately, it would still be more prudent for the investor to look for companies which have track records and have been listed for a good number of years, as they offer more information on whether they had delivered on earlier promises and whether they can successfully weather economic storms. With the stock market hitting new year-to-date highs, one must be even more cautious and discerning when ploughing through newly-listed companies looking for bargains.


Lemizeraq said...

Hi Musicwhiz,

Great post. When I first started to buy shares, I was a bit IPO mad as I was right in the financial industry in a brokerage. So infected by the IPO fever.

But it was a good time to be in because one IPO I got was from a pretty good company- SGX :)

Since then, I have steered clear of IPOs especially since one rather haughty customer asked me if an IPO listing the next day was a stag and I went huh?

He gave me a good tongue lashing saying that I shouldn't be there if I didn't even know such simple terms.

I hoped that I have progressed since then and if I meet such people, i will still go huh?

Even though I know the meaning of stag now, I wouldn't know how the IPO will do the next day. So it was a question that was basically unanswerable.

In case some person comes along and ask you for a tip :)

I hope I have saved you some trouble of answering such posts. At least for this post.

Musicwhiz said...

Hi Lemizeraq,

Haha well usually I will reply nonetheless. :P

Well IPOs are generally risky, and its best to have some track record before investing in them. Companies which list on Catalist are valued much lower (e.g. Jason Marine at just 3x historical PER), but then they are also smaller players and command less market share, so the lower valuation is "justified". I guess there's a right price to pay for everything; it's just that one has to have some methods for determining this.

Thanks and Regards,