Before you invest in an IPO….


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Do your sums right! (Photo credit: Wikipedia)


As not all IPOs perform the same way in the long and short term, it behooves investors in paying attention to a number of important issues when considering whether to invest or not. They include:



A) identity of people involved. Profile of underwriters as usually top quality sponsors bring good companies to the market (reputation at stake). Profile of senior management, as high profile directors continue to work in interests of new shareholders. Where is the power concentrated? Security is reduced once power is concentrated on one person – the CEO who is also chairman.



B) financial accounts (provide first-hand information on performance of the company). Things to look out for in the accounts include:



Indebtedness – high levels of debt increases risk. Also, if a firm is VC-backed, its IPO is usually not very much in demand because it is perceived that VCs will pile the firms with large debt before selling off their stakes at the time of IPO.



Profit figures – when the figures are good, it is important to find a reason for the high profit. Could it be a strong brand name operating in a niche market (World Scientific in the scientific, technical and medical publishing market) , a patent that protects it from competition (for e.g, in 2008, Creative Technologies sued Apple for infringement of patent rights of its menuing structures of its mp3 player and won $100 million), market expansion (for e.g., Zara’s and H&Ms staggered expansion into several overseas markets, usually when one opens in a certain country, the other follows suit a few years later). Consistency is also very important – erratic or declining financial performance usually signals riskiness of firm. Profit forecasts signal confidence in firm meeting targets.



Inventories on the balance sheet – if the inventory is growing faster than sales, it may mean that demand is falling.



Cash flow statements – a healthy company generates excess cash from its operations and should typically show negative cash balances in its cash used in investing activities and cash generated from financing activities. A self-sustaining business is able to pay off its debt and finance new investments internally.



C) terms and conditions of offer – number of shares, the price of the share – it determines what an investor is paying for and what he can expect in return.



D) reason for the IPO – the firm will usually discuss why it is going IPO and how it intends to use its proceeds. Reasons include for e.g. Portions used to help loan note holders realise part of their investment, growth purposes, retire debts, etc.



E) Lock up agreements – it is a signal of the insiders’ commitment to work in the interests of outside shareholders after the firm has conducted its IPO. These agreements reduce information asymmetry as it gives investors time to collect information about the newly listed firm. Investors have to find out who is locked up, for how long and escape clauses buried in the footnote. By virtue of the fact that the directors and senior management do not sell their shares is a strong signal of commitment to the company.



F) risk factors – there are a large number of risks that are common between IPOs for e.g, failure in recruitment and retention of key management, exchange rate fluctuations, global economic downturn,etc. Investors have to be mindful that forthcoming companies regarding their risks do not necessarily mean that they are likely to succumb to them as compared to those who are less forthcoming.



G) future plans – whether plans for the future are backed by credible projections of sales and costs. Sufficient working capital required.



H) market conditions at the time of the planned IPO as the IPO may fail to float if market conditions are poor.









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2 thoughts on “Before you invest in an IPO….

  1. Thanks for finally writing about >Before you invest in an IPO….
    | Musings from an Executive – Business-Leadership-Management-Self Percolations <Loved it!

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