Five things to Keep in Mind for IPOs

Overview

Capital is the fuel that drives the economic engine of any company. Capital is also one of the prime requirements to initiate any business. Initial Public Offering is one of the ways through which companies access public capital, which could be used for numerous prospects for the growth of the company, among its various other uses.

Apart from capital, there could be several reasons for a company to go public. Some of the other reasons include a company’s strong performance, seed capital exit, industry disrupting attributes of the company and IPO of competitors.

Besides, IPOs benefit the organisations through strong equity, new growth & valuation potential, increased brand awareness, partial exit for owners and improved appeal as an employer. At the same time, IPOs are associated with significant costs and time-consuming process.

In this article, we would talk about some factors that influence an IPO:

Profitability

Profit-making ability or profitability is the attribute of any company, which impacts investor sentiments. Increasing share of zombie companies in the listed world may have led the investors to question the profitability of the companies.

In a research conducted by Bank for International Settlements, zombie companies were defined as companies with relatively lower profitability, that were not able to cover interest payments on debts of the company from the current profits over an extended period of time.

Profitability of a company depends on a range of factors, including the industry, competition, product offering, competitive advantages, business models and much more. Besides, the management of the company has a vital role to play to achieve a profitable business in the light of numerous risks posed by any company.

Industry

Each company is tied to an industry, which is an ecosystem of its business. An industry is associated with numerous companies with similar revenue generating activities. A large pool of industries is often said to be a sector, and a sector may host several industries as well.

An industry becomes an important part of our consideration because it impacts the business model of any company directly or indirectly. While analysing the industry of a company, an investor should consider familiarising with the state of competition in the industry, size of competitors, and attributes that distinguish the company from the rest.

In addition, the demand-supply mechanism of the industry should be analysed for potential growth opportunities. Current scenario of an industry should be kept in mind, and emphasis should be laid on the rationale behind the company’s intention to enter a particular industry or creating a foothold in the same industry.

Experience/Firm’s Age

At the time, when the companies are about to enter the public markets, it is mostly idiosyncratic in nature for the companies. In general, companies may apply for the initial public offering after fulfilling the minimum requirements, as directed by a particular jurisdiction.

Reliance Worldwide Corporation Limited (ASX: RWC) was listed in the year 2016, and the origin of the company dates back to 1912, with formal commencement under the name of Reliance stated in the 1980s. Meanwhile, Prospa Group Limited (ASX: PGL) was listed this year, and the company was found in the year 2011.

Being a relatively new company provides opportunities to grow in various segments. Also, as a growing company, the business is flexible enough to onboard changes much faster than an older company with comparatively broader business. This allows relatively new companies to efficiently improve the models, adopting new models or maybe optimising the existing business models.

Apart from being a relatively new company, the prowess to launch new and promising products simultaneously might provide substantial opportunities for revenue growth as well. Some companies enter public markets early to capitalise on the disruptive business they are operating.

There could be numerous reasons for a company to enter market at a particular time. However, relatively new companies in the market may have a better pipeline for growth, compared to any existing mature company.

Valuation

Companies issue a prospectus while applying for an Initial Public Offering. The prospectus is an exhaustive document about the company, which hosts a plethora of information about the company. Besides, it includes an offer price, which is the price an investor pays to own a number of new shares in the company.

Now the question arises, whether the offer price of the stock is reasonable or not. At times, valuation remains consistent with market medians. However, the valuations related to the IPOs have become a debated topic lately.

Markets and participants have voiced their concerns related to the valuation of IPOs. For companies, it is favourable to get a hefty valuation, as it would only increase the level of money being raised from the IPO.

An investor could use a relative valuation model to predict the viability of the said valuation. However, the valuation provided for a company going public should be compared to a company having a similar business, similar revenue streams and so forth.

Sales/Revenue Growth

Being a new company has its own advantages, and sometimes new businesses are often complemented with large addressable markets. This directly impacts the revenue of the company, and in part, the selling and distributing capabilities of the company also play an important role.

Also, board of the companies hosts a number of people with concerned expertise in each area. The results depict the efficiency of any board. Further, companies tend to invest in selling and distribution, which may include advertisements, marketing etc.

Besides, the companies look for strategic partnerships to sell their respective products, mostly while launching the product in an overseas market. Such initiatives not only improve the sales but also increase brand presence, diversified revenue stream, and maybe a foreign exchange benefit (loss as well).

Innovation and new product launches could have far-reaching impacts on the revenue of a company. New product launches incur significant costs, but the decision by the companies should weigh in all risks associated with it, and the expected return on the investment.

As businesses move to a more customer-centric environment, the role of the customer is increasing, and some of the companies take ample feedback before launching any product from the customers. At the same time, the quality of the product or services plays an important role as well.

Disclaimer

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