In our earlier article, we talk about some brief things you should know before going to apply for an IPO. We know Initial Public Offerings (IPO) can spark excitement, especially if the listing firm is a familiar name or has famous anchor investors.
However, before you rush to apply for the IPO, take a few minutes to read through this article. A company’s IPO prospectus can be as thick as my childhood day’s encyclopedia. It has almost all the information you need to know about the business. However, I don’t think anyone would have the time or the patience to read every word of an IPO prospectus. Hence, we decided to highlight the key parts of the IPO to read.
Understand the business
First and foremost, we have to understand what a soon-to-IPO company is about. To do this, you should look at how the company derives revenues, what the business segments are, the main investment highlights of the company, its future plans, and its industry prospects. Some IPO prospectuses have the above information lined out in colorful pages at the start.
Next, we have to understand the total number of shares on offer. Most IPOs will have a public tranche that are offered to retail investors like you and me, as well as a placement tranche. A placement tranche is only offered to certain investors such as institutional investors, banks, insurance companies, and wealthy individuals. Some IPOs do not have a public tranche at all.
Take note of the IPO price, the price investors have to pay to subscribe for a share. The total number of shares in offer multiplied by the share price will give the gross amount of proceeds the IPO will raise.
The IPO prospectus will outline how the company plans to use these proceeds. The money is usually used to pay listing expenses, fund business expansion, and for general working capital. After all these expenses, you will get to the net proceeds, which the company can deploy for plans in the near future.
The prospectus will also state the company’s dividend policy, which shows the percentage of earnings that the company wishes to pay as dividends. Some companies do not pay dividends, and this will be stated in the IPO prospectus too.
All businesses come with risks. The section on “Risk Factors” outlines the risks related to the industry and business, and risks associated with investing in the shares. All investors should note the risks involved before investing in any IPO.
Another thing to look out for is whether the company is reliant on a few key customers or suppliers to sustain its business. If so, it is a significant risk for the company as it could be in tatters if the relationship with any of the key customers or suppliers sours.
We should always invest in companies based on their business fundamentals. One thing to look out for is whether the company is making consistent revenue, net profit, and cash flow. It also not have too much debt, which could harm the company when an economic crisis strikes.
The first few pages of the IPO prospectus usually lays out the financial highlights such as the revenue and net profit trend in the most recent years. For a more in-depth look, you can turn to the income statement, balance sheet and cash flow statement (collectively known as financial statements) given in the later pages of the prospectus.
Warren Buffett once said that price is what you pay and value is what you get. The price of a stock tells us nothing about its value. IPOs are usually priced at overvalued prices to get the maximum returns for the key stakeholders of the soon-to-IPO company. Therefore, we should only invest in IPOs that are valued fairly at the most.
Usually, the valuation of the IPO will be under the section called “Offering Statistics”. Most of the valuation will be based on the pre-offering share count. Investors have to adjust the valuation for the post-offering share count to get a more accurate picture.
Management and key shareholders
On top of knowing what you are investing in, you should also know whom you are investing in. The management team of a company makes the day-to-day decisions of the business, and thus, they must be competent and have integrity.
We also want to know if management has significant skin in the game so that their interests may be better aligned with those of the company’s shareholders.
Knowing who the firm’s competitors are, allows investors to size up the business’ competitive landscape. If the industry is too competitive and the company has razor-thin margins, it may mean that the company lacks competitive advantages.
Bonus: Sign Up For Independent IPO research report
There are research reports produced by the lead managers or underwriters of the IPO. These reports, which can provide insights into near-term financial forecasts, can be somewhat biased to the positive side, because the parties usually have the interest to make sure the shares of these companies continue to do well near-term after listing. Hence, it is important to gain some independent insights into the real deal, before jumping in to apply.