Livewire | Your one IPO playbook for 2021

Your one IPO playbook for 2021

Angus Kennedy (featuring Robert Miller)

Who hasn't daydreamed about nailing that one great IPO? More to the point, who hasn't felt their heart grow gangrenous about missing out on Afterpay when it listed at $1 per share in 2016. Maybe I speak for myself - some of you must have nailed that one. But then the question for you is how to go about doing it again? What is the trick to picking your next big winner?

While no-one can promise a flawless method for identifying winners, certain steps can be taken to put yourself in the best position to separate the quality from the busts. Accordingly, in the third edition of this collection (part one looked at the record year for IPOs in 2020 and part two at IPOs going into 2021) we reached out to three experts (plus a bonus resource) for their IPO playbooks. 

Responses from:

• Robert Miller, NAOS Asset Management
• Martin Pretty, Equitable Investors
• Dean Fergie, Cyan Asset Management
• Bonus: Ophir Asset Management

IPO-ing for the sake of IPO-ing is a major red flag

Robert Miller, NAOS Asset Management

At NAOS we are particularly cautious when it comes to any IPO - It is rare for us to participate in any.

Our general view is that new shareholders are investing from a position of weakness vs existing shareholders in the sense that you can only learn so much about an IPO from reading a prospectus. For example, it is hard to gain an understanding of company culture, or a company’s ability to consistently deliver results or a track record of capital management.

“An IPO is like a negotiated transaction – the seller chooses when to come public – and it’s unlikely to be a time that’s favourable to you” - Warren Buffett

With the above in mind, when looking at an IPO the first factor we scrutinise in detail is the use of funds as this will likely provide the best insight into the motivations behind the IPO. Is capital being raised to reinvest in the business to improve its competitive advantage? What is the shareholder composition? Is there going to be an insider selldown? If so, why?

In our opinion, regardless of other factors, if we do not believe there is a sound justification for the use of funds in the IPO, we will not participate.

Our investment process remains consistent regardless of whether we are looking at an IPO or a business that has been listed for 50 years. A relative valuation sense check to comparable listed companies is simply not enough to provide a sense of the true value of an IPO company. 

On the rare occasions that we would participate in an IPO, we consider it through the lens of being a long-term investment in our portfolio and conduct our analysis accordingly. 

Being critical is key

Martin Pretty, Equitable Investors

We did not participate in a single IPO in calendar 2020, an outcome we would not have predicted at the beginning of the year (we have invested in one Reverse Takeover). We found great opportunities were presented to provide new capital to companies we already knew well and we prioritised these opportunities over new listings. Key considerations for any raising include:

• Parameters: We don't look at the mining sector or drug developers. We need to understand how far the company can go in progressing its strategy with the IPO proceeds, being cognisant that we aren't large enough to take a view that we can fund any future needs ourselves.
• Motivations: It is extremely important to understand the motivations of the company for listing. If it is about vendors taking money off the table, then more caution is appropriate. The sellers know exactly what it is they are selling and have had time to package it up to look as attractive as possible. The prospectus and pitch deck are part of that packaging.
• Pricing: In general, given the knowledge imbalance between the pre-IPO owners and IPO participants, we expect an IPO to be priced at a discount to its listed peers. This doesn't mean it has to be priced like a deep value play. A fast-growing company with market power or strategic value should be priced against other companies with those characteristics.
• Structuring: We've touched on setups where investors who came in before the IPO are guaranteed a significant discount to the IPO price and how that can undermine the price of the stock once it lists. But there are a number of other things to watch out for. A classic is the provision of a significant "free carry" where the promoters are issued with free shares and claim that this creates alignment - the truth is that the stock price can halve and the promoters may have done very well for themselves. Sometimes you see IPOs where the intellectual property or other important components of the business are ring-fenced in an entity that will remain private and won't be owned by the listed entity. The bottom line is that you need to read the prospectus, including its footnotes, with eyes wide open.
• Ownership: Who your fellow shareholders are is also relevant. We want to see founders, board and management holding reasonable investments. We do think about whether an IPO is attracting flighty day traders or patient capital. It does worry us whether fellow owners understand what they are holding.
• Potential: Ultimately we are looking for a business that we expect in the future, based on our understanding of its economics, can generate future earnings that will drive a valuation that makes the issue price look like a bargain today. Revenue multiples have become increasingly popular in comparing IPOs with their peers. We think this can be a valid approach but, as is the case with other valuation benchmarks, you need to have an understanding of what the scale of the opportunity, margins, growth, cost structure and risks in the business are like or could look like in time. 

The first stop of on any prospectus deep dive

Dean Fergie, Cyan Asset Management

It’s a very broad question, but beyond the myriad of characteristics we would look for in any investment (our ability to understand the company and industry, its financial history, scalability, valuation, management capability... the list goes on and on) the main question we ask ourselves is, “Why is this business looking to list and what are they doing with the funds they are raising?”

So my advice is go straight to the “Sources and use of funds” section of the prospectus. If a significant proportion of the funds are being used to pay existing shareholders or pay down debt then we don’t think that’s a great look. 

We like to see funds staying in the business and being used to expand the business either organically or through a proposed acquisition. That’s a good start.

6 questions: The perfect IPO speed date

Ophir Asset Management

Our friends at Ophir recently published an extensive guide to approaching an IPO listing. We have summarised the key questions to ask yourself, and we highly encourage you to check out their whole report.

1. Who is the Vendor? Look at the track record of the sellers to ensure this is not just an opportunity to cash out.
2. Who is the broker? Pay attention to how skin in the gamer these agents have. If they aren't willing to underwrite a significant portion, why should you be willing to buy in?
3. Who are the buyers? Alarm bells can ring if it looks like directors are desperately seeking buyers. Strong demand could be a positive sign that the shares will not be dumped after a quick profit.
4. Why is the IPO happening? Is management trying to cash out their positions or looking to raise money for sincere reasons?
5. When is the IPO? Be wary of companies simply trying to capitalise on market FOMO. Peak IPO seasons occur during cyclical highs, however, these valuations can be caught out swiftly during corrections. 
6. How much? As with any investment, be wary that overpaying is a recipe for disaster no matter how good the company is. Take a good look at the financial information included in the prospectus when making your decision. 

Conclusion 

It is a good reminder that every listed company was once at the IPO stage. Whilst it may be a dangerous game trying to find the next Google/Apple/CSL/Amazon/Alibaba from inception, it is important to keep an open mind to companies that are positioned to shake up the current market landscape. There will no doubt be new opportunities to come. 

Although valuations continue to get steeper - and not even initial listings are safe from this - following a process to filter out those companies simply looking to cash-out can go a long way to finding your next big winner. Each of our experts follow varying processes, but ultimately IPO-ing for the right reasons and having coherent growth plans for the future should be at the heart of any decision. 

This concludes our 3-part IPO collection. Click record year for IPOs in 2020 for part one, and IPOs going into 2021 for part two.

Livewire: Published 29 January 2021