Underperforming IPOs: 4 steps to avoid them

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Stock research application house Skaffold has warned investors to be cautious and focus on value when considering initial public offerings.
 
According to Skaffold, investors who believed the 2013 resurgence of IPOs would deliver them above-average returns for their portfolios will have a rude awakening.
 
Skaffold had looked over 29 of the new listings in 2013 and there are only four standouts, CEO Chris Batchelor said.
 
These are Nine Entertainment, the online foreign exchange group Ozforex, Sino Australia, providing oil recovery services for companies operating in China, and the listed law firm Shine Corporate.
 
“Although 2014 is shaping up to be another huge year for IPOs, investor appetite for them has been given an overdue reality check. Many of 2013’s IPO stocks have underperformed for various reasons, none the least being they were overpriced and over spruiked companies in uninspiring sectors. Our opinion is that most IPOs have been best left alone,” Batchelor said.
 
ASIC has recently warned invesors over the quality of some offerings. The regulator found around a third of float prospectuses misled investors.
 
Batchelor said of the four stocks that get the Skaffold tick of approval, Oxforex and Nine are trading well above value at around 50%, and Shine is trading at an 8% premium.
 
“Although Sino is trading at a discount, there aren’t any analysts providing forecasts so its value is based upon past performance. All four companies will release their latest results in February.”
 
Batchelor said that Lifehealthcare Group, a distributor of medical devices that listed in early December, was an interesting stock.
 
“Like many IPOs this is a new, largely unresearched stock and, therefore, difficult to measure accurately.  However, by our methodology it is rated B2 and its value is forecast to rise around 30% a year over the next two years. Although the company does have a large amount of debt, at its last report there was enough cash in the bank to cover its interest bill three times.”
  
Although there had been some good success stories in 2013, Bloomberg data reveals that just under half of the 40-odd companies that listed on the ASX in 2013 are trading at share prices lower than their float price.
 
“This should warn value investors, and newcomers to shares alike, that buying into floats for ‘stag’ profits is a risky strategy,” Batchelor said.
 
 “Unsurprisingly, with institutional investor appetite for floats also becoming a little jaded, several IPOs have been cancelled. Mine-site logistics business, Bis Industries, recently pulled its $1 billion-plus float amid unfavourable sentiment over new project numbers at decade lows.”
 
Four steps for reviewing IPOs and prospectus documents:
 
1. Stick to your value investing principals
Look for companies with consistently above-average return on equity (ROE), with little debt and not too much goodwill on the balance sheet. On the flipside, steer clear of buying into floats where the net tangible assets (NTA) or net worth (pre-IPO) is negative.
 
2. In whose best interests?
Think carefully about buying into a float where the people responsible for turning the company around are planning to exit relatively quickly.
 
3. Focus on the fundamentals
As a value investor, you should be more interested in investing in an IPO for the long term than selling immediately for a quick profit.
 
4. Do your homework
It’s equally important to investigate previous financial statements of companies planning to float and find out whether the money raised is being earmarked to fund expansion or repay debt, and the amount to be paid to existing owners.

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