What makes a good initial public offering (IPO)?

The key function of any capital market is to raise capital.

That is not necessarily well understood by most shareholders as the primary purpose. Indeed, many investors believe that the purpose of a stock market is to facilitate trading and serve the needs of investors. In truth, they are merely ancillary functions that provide credibility and liquidity to the primary purpose of raising capital for limited liability companies.

To quote from well-known Australian investment commentator Marcus Padley, when it comes to investment – investors are the ‘bunny’. Stock markets, brokers, wealth managers…their motivations and key purpose lie elsewhere.

Of course, that is why NZSA exists – to make sure that there is at least someone looking out for the interests of investors.

Over the last couple of months, we learnt the views of the DGL Group CEO, Simon Henry, in relation to what made a good IPO. The gist of his advice appeared to be that a bit of cleavage goes a long way in convincing investors as to the quality of an IPO investment. Indeed, many of us will recall the somewhat blatant positioning of the Moa Brewing IPO way back in 2012. Simon Henry would have been better to (rightly) call that out as an egregious use of the old ‘sex sells’ technique in jazzing up an IPO offer document.

Nonetheless, there is no doubt that a consumer brand launching an IPO (such as My Food Bag) has the ability to utilise a different set of tools and techniques to raise awareness of its impending listing, as compared with a business-to-business brand (such as DGL Group). In both cases, however, that’s all down to marketing.

Back to Moa Brewing. The sad fact is that, in the short-term at least, the company’s provocative and blatantly sexist offer document worked. The original MOA offer was oversubscribed. Longer-term, however, the company was in trouble. The sexist theme extended into its marketing, which quickly became outdated and limited its ability to expand to new consumers.

So of course, behind the media furore that followed Simon Henry’s comment – there is a valuable insight to take away.

#1: Look beyond the marketing hype

Strip away your own conscious and unconscious biases

It would have been so much better if he’d said it like that.

So, with the ‘message puffery’ removed from assessment, exactly what components should investors be looking for when considering an IPO?

One key factor is the extent of capital raised is actually going to the company, versus that used to ‘pay out’ stakeholders (such as existing investors). This was a clear factor in the My Food Bag (MFB) float, with only 12% of funds raised going to support MFB’s operations. The remainder of the funds raised were paid to the existign owners of MFB.

The reason this is important to consider is related to the ‘binary’ nature of a market transaction. In a situation where existing owners are selling down most or all of their holding, it’s worth asking why exactly they are doing that. A good transaction for the seller is likely to be a less-good transaction for the buyer, as their interests are not aligned. On the other hand, if the vendor retains a significant portion of their shares, that’s more likely to lead to a greater alignment of interest.

Remember, as an investor – and to quoute Marcus Padley – you are the bunny!

#2: Alignment Matters!

What are the motivations of the stakeholders in the IPO?

All that, and we haven’t even started to think about the actual company yet.

The assessment of future value is the future arbiter of a what constitutes a ‘fair price’ for an IPO. Of course, this is the land of analysts and their assessments – but that should only be a start point for your own evaluation. Information provided by the company has its own motivation – again, I refer to the 4-legged animal oft-referred to so far.

Never fear – even as a DIY investor, there should be enough disclosure for you to understand the company and its market well enough to make a qualitative assessment.

• What does the company actually do?
• What competitive advantage does it maintain in its market?
• Is the market in which it operates attractive?
• What is its compelling offer for investors (eg, growth, dividend stream, other)?
• Does it have an effective management team that can support its transition to a listed entity?

#3: Look at the market the company operates in

In this aspect the premise of a good IPO is the same as that for any investment – in other words, what global trends provide a ‘tailwind’ to the company’s performance and does the new company provide a positive exposure from which shareholders can benefit in the longer term?

Ultimately, of course, the value of an IPO is ultimately dependent on operating results. Operating cashflow is your friend – or perhaps not as the case may be. Doing some basic research on the financial information provided by the company is critical, as that will ultimately determine the fair value of the IPO offer price,a dn the subsequent performance of the share price post-listing.

#4: Is the IPO offer price fair?

There’s a bunch of metrics to look at here. Just what will happen to future operating cashflow? How will the company utilise the new capital it is raising to support cashflow growth? What is the implied “return” of earnings per share as compared with the offer price? What is the nature if the company’s current financial performance?

In summary, maintain a healthy scepticism around the motivations for bringing the company to market. Seek out all the information you can – and seek further independent advice where you need to.

And above all else – remember that you are the bunny.

Oliver Mander