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Not drowning, saving: how to survive a float

Investors all dream about buying shares in the next Apple or Westfield when it makes its market debut. But for every shooting star there are plenty of floats that sink into oblivion.

To date in 2017, the returns from initial public offerings (IPOs) range from a high of 700 per cent to a disappointing minus 65 per cent, with almost equal numbers in the red as in the black1. Of course, these are short-term returns and performance figures could look very different in the long run, but it highlights the risks involved.

So, how do you pick a winner?

The short answer is by doing your homework, although this is easier said than done. Most research on companies in the lead-up to a public float is done by the company being floated and the institutions involved in the listing, so you need to approach with caution.

“IPOs are not for the faint-hearted; you can’t simply rely on the opinion of others”, says Nick Bugryn, CommSec Adviser Services Investment Manager. “If you decide to go into that space, choose companies you understand and have an opinion on whether they will do well,” he says.

The IPO cycle

IPOs typically follow the sharemarket cycle. When shares are booming, companies rush to list and investors are more willing to invest in riskier IPOs. But when markets fall, such as during the GFC, the money pool for new listings dries up.

“This year we’ve seen almost Goldilocks conditions for IPOs,” says Bugryn. The local economy is performing solidly and there have been none of the global shocks we’ve weathered less recently such as the Eurozone debt crisis, Brexit or the US debt-ceiling impasse.

In times of economic uncertainty, companies tend to postpone plans for a public listing and wait for better conditions. There were 133 new listings on the Australian Securities Exchange (ASX) in 2016, and Bugryn expects 2017 will exceed that.

The current IPO cycle has already thrown up some successes, such as Afterpay Touch Holdings (up 317%), Kogan (up 131%), Medibank Private (up 48%), Steadfast (up 144%) and Bega Cheese (up 420%).2  Others showed early promise but have since drifted below their listing price, such as Freelancer, Virtus Health and Oz Forex.

Speaking at the ASX Annual General Meeting, Chief Executive Dominic Stevens said the Australian exchange was developing as a global ‘sweet spot’ for listing technology firms and offshore companies in the $50 million to $500 million market capitalisation range.

Track record

Part of the attraction of an ASX listing is the market’s liquidity and the quality of our governance standards. All companies preparing to float are required to release a prospectus, which is a good place to start your research. This typically provides two or three years of historical financial information, although quality companies with a long track record may provide more.

Bugryn suggests looking at fundamentals such as the price-earnings valuation and comparing this with other companies operating in the same sector. Also look for management with a strong track record, sustainable earnings and a convincing business strategy.

And don’t be rushed. If an IPO catches your eye but you need more time or information, Bugryn suggests waiting until after it lists. There is often a flurry of speculative trading immediately after a listing but further information generally comes to market later, as more research houses begin to cover the company.

Scrutinise the motive for listing

Some types of IPOs inspire a higher level of confidence than others. When a government decides to sell a public asset via an IPO, they have a vested interest in selling at an attractive price to keep investors (who are also voters) happy. Medibank, CSL, Commonwealth Bank and Telstra are all examples of successful privatisations.

More caution is advised when companies are brought to market by private equity firms. In some cases, Bugryn says, the numbers can be skewed to look good for listing. They may reduce staff or take other measures to cut costs and improve earnings in the short-term, but these moves can sometimes harm longer-term prospects.

Take Dick Smith. After performing badly for years under Woolworths’ control, a private equity group bought the consumer electronics chain and floated it a year later after a quick turnaround that doubled profits. After listing in December 2013 at $2.20 it stopped trading two years later at 36c before going into liquidation.

Watch the exits

Also watch out for existing shareholders using an IPO to make a profitable exit. Sometimes there are escrow periods where the management team and institutional shareholders are given a share allotment and not allowed to sell for a certain period. When that time comes, they may sell and trigger a loss of investor confidence in the stock.

Prospective investors should look for companies where existing shareholders and management retain their shares and are committed to using the capital raised to grow the business.

As the saying goes, hope floats, but you need more than hope before you part with your cash. IPOs can be attractive but only if the decision to invest is based on evidence and not wishful thinking. If you’re considering in investing in an IPO, it can help to talk to a financial adviser. Find one here.

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