Latest crop of IPOs call for a sceptical eye
Is it just us, or is there a discernible lack of quality in the companies seeking to come to market with an initial public offering?
In the past, when we have seen this — along with little value in evidence among incumbent listed quality companies — we have observed it is generally not a great time to be loading up on equities.
There has been enormous interest this week in the pending IPO of music streaming service Guvera. The negative commentary around this float has been so intense it has prompted the ASX to take the unusual step of extending its review of the offer, while the Australian Shareholders Association has put out a de facto warning note.
But there are many more IPOs deserving of a sceptical eye.
One reported forthcoming float is Booktopia. Our comments here do not relate specifically to Booktopia. Instead the online space invites investors to dig a little deeper to understand the risks and opportunities available in the fast changing sector.
Putting aside the question of whether a leading online book retailer can be Australian-based, it is worth considering the present economics of online book retailing generally, the competitive landscape in which this business resides, and its prospects.
If a company has been loss-making recently, investors must first ask; why? One redeeming possibility is if losses are due to reinvestment in the business. We actively seek businesses that are able to profitably redeploy capital.
The problem however is the amount of the reinvestment. When playing a competitive game, it is not relevant whether your reinvestment is large relative to the size of your business, it is the investment required to be competitive overall. The investment has to be appropriate relative to the size of your rivals. In the book retailing business your competitors include Amazon, Apple’s iTunes, BBC Shop, the Amazon-owned The Book Depository and Google, so the owners of the business will need very deep pockets indeed.
According to the Smart Company Awards website, Booktopia generated revenue of $40 million in 2014 with 98 staff. In 2015, revenue grew nearly 30 per cent to $51.9m with 103 staff. If growth continues at that pace, revenue could be $70m in 2016.
So if the rumours of a $150m float are correct, the company will list on roughly two times revenue. That doesn’t sound like a roadblock to a successful IPO.
One might assume that the promoters of any IPO will address the iTune, Amazon threat by pointing to the strong “growth” of revenue amid the existing competition. We can’t criticise that.
But shareholders cannot take revenue to the grocery store. As an old friend and restaurant owner once told me: “Revenue is vanity, profit is sanity.”
When it comes to online retailer IPOs, investors should dig deeper to see if if any acquisition has been made in the recent years prior to the IPO. PreIPO acquisitions are a red flag to us and we need to do more work isolating the legacy business from the acquired business to understand the drivers of future returns.
If investigation reveals that a business was unable to grow organically to be the dominant player in its industry, or alternatively to the scale that would permit an exit through an IPO, we become circumspect about the future prospects for organic growth – which is our preferred form of growth. If an acquisition has occurred, be sure to adjust the numbers to exclude the revenue and profit of the acquisition.
And be cautious if debt was used to fund the acquisition because if funds raised through the IPO are being used to pay down that debt, you are effectively paying for the acquisition as well as any selldown by the owners, who otherwise may not have built the business to a scale in order to exit.
One must also ask the leader managers of the float if they considered or explored a trade sale. If they did but have chosen the IPO route to selling, it could suggest that either trade buyers weren’t interested in the business or the price — or both.
Returning to bookselling generally, it is a tough gig.
In 2011, Australia’s largest book retailer, REDgroup, went into voluntary administration with reported debts of $170m. By midyear, 2000 staff had lost their jobs as 114 Angus & Robertson and 26 Borders stores were shut down — and don’t forget these two chains represented more than 20 per cent of the nation’s retail book sales. That year, Australian Publishers Association chief executive Maree McCaskill reportedly warned “the book industry is in the midst of a prolonged, retail slump”.
Analysts and promoters often put rational-sounding “valuations” on the business they are floating by looking at the average multiple of other sometimes much larger operators. In the case of bookselling that might reasonably be Amazon and TradeMe, or even REA Group or Carsales.
If the IPO company is a smaller competitor, a discount might applied to the multiple of these “winners”. Again, this is all quite reasonable in terms of arriving at a valuation. If however you don’t believe a business has a long term future that you are certain about there is only one rational valuation: its the valuation you apply to something you don’t want to invest in.
Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery, find out more.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
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.
Aussie Shepherd
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This is my personal opinion and not advice of any kind….
Booktopia’s FY15 accounts are on ASIC. Yes they are historical looking but they can be informative. Unless I am mistaken, the accounts appear to show increasing losses, negative equity, meaningful working capital deficits, and acquisitions funded in part by deferred consideration which is coming due relatively soon. If I was an auditor I might ask if Booktopia was a going concern.
If any prospective vendor wants a massive pre-money equity valuation price to fix all this up…No thank you. I wouldn’t even be able to say what equity value was – if any. What happens if Booktopia cannot raise capital – does it have sufficient cash from operations to pay deferred consideration and meet its bank obligations? If not – doesn’t that answer what pre-money equity value is? Why does this business even have debt? Shouldn’t Booktopia be keeping cash from sales to offset its creditors given its negative working capital position? – if asked, and generally speaking, I wouldn’t want to be a director of any company with metrics like these.
Australia’s tech and IPO market appears to be out of control. Bad tech investment after bad tech investment. And this isn’t even tech. It’s pure bookselling. When will our market learn?