HOW TO: Analyse an IPO

The year 2008 was one of drought as far as Initial Public Offers (IPO) goes. But with a revival of sorts in the markets, quite a few of these are lined up, with one — that of Mahindra Holiday and Resorts — already through. Investing in an IPO is a shade trickier than an existing company since not much information about it — financial or otherwise — will be publicly available. This is where, as a rule, the prospectus comes in as the best possible source of comprehensive information on the company.

Since the bulky document may appear a tad intimidating to the new investor, here are a few guidelines on how to pick relevant information, and what to base your investment decision on.

Any issue prospectus will be divided into seven sections — risk factors, an introduction to and detailed information about the company, financial information, details on the issue, legal and other regulatory information. Of these, the company background and business model, the industry it operates in, purpose of the issue, financial performance and risk factors are areas you should concentrate on.
Business

The section ‘About the Company’ gives a detailed description of the nature of the company and its business models; understand how and where the company accrues revenue, and if it is sustainable.

This includes going back to the history of the company, since it explains how the company has developed over the years, acquisitions made, milestones crossed, subsidiary activity, all of which are indicators of the consistency of performance and sustainability.

If possible, compare revenue models with those of existing peer companies to identify if, and where, the company has an advantage. If any competitor is already listed, use it as a comparison for performance, valuations, financials, and strategies.

Also included in the business section is an overview of the industry. Scrutinise it thoroughly to get a grip on the future of the industry and the company’s own prospects within it. As far as financials go, analyse these as you would for any other company.
Strengths

The company will list its ‘strengths’ — what it considers as an edge over peers — again in the business section. Give these a once-over, paying attention to the details only if the said strength stands out — for example, Gitanjali Gems has a diamond sourcing agreement with Diamond Trading Corp, a key strength since the company is ensured of access to good quality rough diamonds which most peers do not enjoy. Sizeable market share (check source of data here), backward integration, and so on, are other factors favouring the company.

Take the strengths with a pinch of salt, since companies sometimes tend to paint a brighter picture than what they actually are. Conclude yourself if the point given in reality works in the company’s favour significantly.
Risks

Risks detailed are wide-ranging, from an economic scenario to company-specific, which must be noted to understand potential downside to your investment. Risks are explained at the start of the prospectus.

Some risks given are general in nature and can be ignored, such as political instability, natural calamities, competition from peers and such, which are usually applicable to all companies, regardless of industry.

Legal issues that have a significant bearing on the functioning of the company, are also given here — for example, Mahindra Holidays has a resort in Munnar, where the land is under legal proceedings since it was said to be agricultural.

Now if the case goes against Mahindra, it will mean closure of a flagship resort and loss of revenue from it.

Understanding such material legal proceedings allows you to skip most of the section on legal issues that appears later in the prospectus. For example, legal issues regarding taxes, labour and such need not be combed through.
Objects

The purpose of the issue is explained in depth, and companies are required to explain the utilisation of funds raised in subsequent annual reports.

Proceeds from the issue can go towards any number of purposes, from repayment of debt to working capital, from capacity expansion to company acquisitions besides covering issue expenses.

Fund utilisation should, as far as possible, contribute to revenue generation and earnings expansion.

For example, companies may raise funds to either ramp up production capacity which may lead to increased sales, or to pay back high-cost debt resulting in lower interest costs and more leveraging capability; or for acquisitions that may add to revenues. However, the time taken to accomplish the stated objectives needs to be gauged.

Check the amount of funds set aside for issue expenses, which include advertising and promotion, printing of the prospectus and so on. Check also whether the proceeds of the IPO go entirely to the company; some IPOs involve a stake sale by the promoters in which case funds raised would not accrue to the company.

Other sections you can glance through are the regulations and policies the company is subject to, the management team and the relevant experience they hold and the instructions to bidders in the section detailing the issue — just to make sure you don’t inadvertently mess up your application.

via Business Line