What is the IPO market telling us?
For obvious reasons, much of 2020 was a quiet time for ASX IPOs: the uncertainty caused by the COVID-19 pandemic made for a challenging investment environment – one that only a brave business owner would want to list into.
As we approach Christmas, however, the IPO market is running hot, particularly in terms of smaller company listings. The ASX website shows 20 separate IPOs hitting the boards in October and November, before the window closes into Christmas. Reflecting this, Montgomery’s small caps team can currently be seen with bags under their eyes, having worked through a large number of prospectuses, often with compressed timeframes between documents being released and books closing.
To some extent, this may reflect pent-up demand, as businesses that would have listed earlier in the year have had to wait for the window to open and volume is now catching up. However, it is important to remember that there are different reasons a business owner may pursue an IPO.
One (relatively wholesome) reason is to access additional capital for growth, and there are certainly some small businesses with the ability to create significant shareholder value by investing additional capital at attractive rates of return.
However, another reason may be that the business owner perceives an opportunity to exit at a higher price than might normally be available, and with the market currently paying up for growth stories, this is likely to be a significant factor driving the steady flow of IPO documents currently flowing out of broking houses.
As well as questions around multiples and valuation then, some good questions to ask of an IPO include:
- How is the offer split between new capital into the business, as opposed to exit for current owners?
- To what end will the new capital be applied, and how compelling is the potential return on that investment?
- What is the likely extent of long-term commitment from the current owners?
While some IPOs are less wholesome than others, it is still the case that an IPO can present an opportunity to buy an excellent business before the market has fully appreciated its potential. Accordingly, it pays investors to keep an eye on the stream of opportunities presented.
A gimlet eye.An IPO can present an opportunity to buy an excellent business before the market has fully appreciated its potential. Tim shares key questions when evaluating an IPO. Click To Tweet