Doing an IPO? DAVID PERRY tells how to avoid being crucified by the market.
“I am thinking of listing on the Australian Stock Exchange but I worry when I hear stories of successful companies bombing once they list. How many companies “bomb” on listing and why?”
David Perry answers: Typically, more than half of small company initial public offerings (IPOs) “bomb” in the first year after listing. By “bomb” I mean that their share price falls, often quite dramatically, against a background where new investors are expecting a decent gain. Not even a buoyant sharemarket such as the current one, with rising share prices, seems to alter the balance: fewer than half of all small company IPOs make it through their first year with anything like success. This has negative consequences in both the short and medium term, both for the companies involved as well as for confidence in small company start-ups generally.
Here are my 10 reasons why so many companies “bomb” in the first year of listing:
1. It is too easy for small companies to float when the market is rising.
There is plenty of evidence to indicate that as the sharemarket rises, the number of small company IPOs increases. Company owners find it easier to float and investor demand and risk tolerance rises. But this can all change quickly and investors can turn on a company, particularly if their expectations of performance are dashed.
2. IPOs are not a sprint race.
There is a tendency for many companies to see an IPO as the pot of gold at the end of a short sprint. The IPO is really the warm-up to the start of a professional long-distance race. So many company owners think a trade sale will get them four to five times earnings, but listing will reap 10 times earnings, which will make them twice as rich. Investors want to know you are listing for growth reasons, not for the fancy house.
3. You’re just one of many…and professional investors see every flaw!
Institutional investors have seen hundreds of companies and heard hundreds of stories. So weaknesses in a particular company’s story will be readily apparent to them. Also, very few institutional investors and analysts are going to bother with you unless you are a certain size and liquidity. It might take the average institutional investor a week to research your company, and time is money. Also investors usually want to own a small share of a large company not a large share of a small company. The larger the company, the more liquid the share register (that is, it is easier to buy in and sell out of it). This means a company really should have a market valuation of more than $100 million or there is not much point being listed as the company will struggle to attract interest from analysts or investors.
4. Punishments are more severe in the market.
Companies list when the business is doing well. Management budgets and projections are often on the over-optimistic side and don’t allow for contingencies. Conditions change and failure to meet projections are met with penalties. Small companies learn a harsh lesson: the penalties for under-performance are magnified in a listed environment. And investors have long memories. 5. If you can’t hack the pace at the beginning of the race…
In the first year of listing, your credibility is on the line. The investment markets see your first year of listing as a real barometer of a company’s strategy and managements’ credentials. So the first year is more about the future than it is about the company’s performance to date. If you can’t hack the pace at the beginning of the race, your reputation — and share price — will be damaged.
6. Contrary to popular belief, the IPO process distracts from the business!
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Most private companies significantly underestimate the amount of effort required by management to get to the IPO. One will often hear management say at the time that they have not been too diverted by the IPO process from focusing on the business, then admitting six to 12 months later that in reality they had taken their eyes off the business — and risked the market penalty for underperforming as they regained their momentum after the IPO. 7. Underestimating a public company’s very demanding investor obligations. Most private companies significantly underestimate what it takes to be a successful public company. There are major issues to do with (a) the culture of disclosure — revealing the bad and good, in a continuous disclosure regime, and (b) professional investor relations and communications. For example, do you know what you can say and what you can’t? Can you answer in a confident fashion when you can’t? Or would you give the impression
8. “Talking the talk”: being able to speak the language of the market.
Companies need to understand the language of the market to communicate with it. Do you really know the meaning and significance of various terms such as EPS, ROE, free-cash flow, DCF, Capex, earnings targets, dividend and gearing policies, etc — and how these all interrelate? New companies who can’t ‘talk the talk’ will not get their message across and/or send the wrong messages.
9. Keeping your balance…in favor of investors!
The reasons for an IPO have to do with (a) growth and better access to the capital markets — which is the focus of investors — and (b) providing liquidity and an exit point for some existing shareholders. Investors expect the balance should be much more in favour of the former. There may well be problems if that balance is lost.
10. “We know better”: the biggest pitfall of all!
The market is much, much bigger than any individual company and there is an important investment law that companies misunderstand at their peril — “the market is always right”.
There is no use criticising the market. Demonstrate your performance instead.
David Perry is director of research at Value Enhancement Management, a stakeholder strategy and investor relations advisory firm. Perry has more than 20 years experience in sharemarket advice and research — including 10 years as head of research for stockbroking investment group Austock, and head of capital markets and futures research for ANZ McCaughan.
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Disclaimer: The opinions given are personal opinion of the author only. As all situations are different and subject to different facts, you must seek your own independent advice prior to acting on any opinions written here.