IPO incentives
New listings have added some interest to the local equity market in recent times. There have been some outstanding successes, like Aconex and Veda, and some major disappointments like Dick Smith and Spotless. Most have been somewhere in between.
Getting IPO decisions right can make a big difference to investment manager performance, and unsurprisingly, managers focus a fair bit of attention on trying to gauge the merits of new issues as they emerge.
We’re no different. We see IPOs as an opportunity to appreciate the merits of a strong business before the broader market has fully priced it in, and so we tend to pay attention whenever potentially interesting businesses make their way to the boards.
Of course, the IPO market is also fraught with its share of peril, and we say “no” much more often than we say yes.
The problem is that the information gap that we are trying to exploit can also exploit us. When a vendor brings a company to the market, the vendor tends to know a lot more about the business than the investors buying in, and there is plenty of scope for the prospectus to provide a less than clear account of the prospects and risks. It is all too easy to omit relevant historical detail, to make creative pro-forma adjustments to the accounts, and otherwise paint things in a rosy light.
Business quality, industry structure, capital intensity, growth prospects etc. are all critical, of course, but where a public history is lacking, there is a credibility and trust dimension that becomes particularly important in an IPO.
One way to get a handle on this is to think carefully about the circumstances of the vendor and management, and the incentives that may be driving them. At one extreme, if a vendor has steadily built a good business and a good reputation over a long period of time, intends to remain involved with it well into the future, and is using the float proceeds to grow the business rather than exit, and has sensible remuneration arrangements in place, that could be grounds for confidence.
If on the other hand, the vendor has recently acquired the business, or assembled it from spare parts, is offering it at a price far in excess of what it cost them, paying management large one-off bonuses as part of the process, and intends to take the float proceeds and run…
Tim Kelley is Montgomery’s Head of Research and the Portfolio Manager of The Montgomery Fund. To invest with Montgomery domestically and globally, find out more.
Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
David Smith
:
Do you have a view on IDP Education
Tim Kelley
:
We bought it in the IPO, David. Value not as apparent at the current price.
david klumpp
:
Hello Tim: There are two recently floated businesses that I thought looked to have good quality and prospects: 3P learning (3PL) and Citadel (CGL). Would appreciate your opinion if you had looked at either of them.
Ian Hammond
:
Hi Tim,
I was wondering if the Montgomery team had a look at Mitula (MUA) which listed in July?
They are profitable and so far in the short history as a listed company still look to be on track to meeting the prospectus forecast.
Murray Wardle
:
Hi Tim,
Over the last few years there have been may IPO’s, and I know it’s not possible to comment on all of them. However, in December 2013, this article (http://rogermontgomery.com/will-it-float-or-sink/) was published and focused on 11 IPO’s. While there has been some followup commentary on some of these companies, I would like to know what you option is of these companies after they floated 2 years ago (in particular Lifehealthcare Group, Mcaleese, Freelancer Ltd & OzForex).
Thanks.
Tim Kelley
:
Not much to offer on those names I’m afraid, Murray. Of the four, only OzForex currently has the liquidity and profitability to qualify for consideration for our funds, and OFX is under takeover offer, so assessing it today with a quality and value framework would be of limited value.
Gav J
:
Hi Tim, any upcoming IPOs take your interest?
Tim Kelley
:
Not really, Gav. Might see some more activity on the other side of half year reporting season, but not much on the radar at the moment.
Andrew
:
Hi Tim,
I am intrigued by the new kid on the block in the food industry Beston Global Foods (BFC). They floated in July and just presented their first Annual report. Their cash flow statement worried me because it looked a little like the famous case study that Roger gives in his book about a certain chain of childcare centres. Their only inflows are from the float, everything else has brackets around it. But they are just starting up. One thing is for sure, they have great products, targeted to scratch exactly where the emerging market in Asia is itching. I work in the food industry & have done for 36 years. I have seen what is happening with Bellamys & Blackmores. Beston are going for the same market meme. I know the two dairy plants they have acquired. One used to be a supplier to our operation before it closed. I believe that clean green food into Asia will be the next big story for Australia but it will take some time to play out fully. Of course there’s execution risk, but with the tailwinds of currency & the movement in this direction in Asia what did the guys at Montgomery think when they looked at this one? Of course if it’s a question you would rather not answer I understand.
Tim Kelley
:
Not one we have looked at Andrew. We steer away from anything pre-profit, as too hard for us to value.