What do I need to know about IPOs?

August 23 2016
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With IPOs, by and large, posting strong performances over the first half of 2016, they might be a good option for investors on the hunt for yield. Here’s what you should know.

In the first half of the year, new floats were flying and large caps were struggling. New company floats in Australia enjoyed an average price increase of almost 34 per cent in the second quarter of 2016, according to our research.

The 33.5 per cent gain in IPO securities compares with a mere 3.0 per cent rise in Australia‘s main share market barometer, the S&P/ASX 200 Index.

The IPO performance numbers also represent a sharp jump from the first quarter, which saw IPOs up 1.3 per cent over a period when the overall market index was down by 5.4 per cent.

Shares are trading sideways in the wake of the high degree of global uncertainty, especially following the Brexit vote and a wave of global terrorism. As such, backing new high-growth players may be your best bet.

What’s the secret?

While not every IPO goes up on day one (for instance, Kogan dropped 15 per cent on the first day because it coincided with worries about Brexit and the Australian federal election), there are at least two elements of a new float’s pricing that are positive.

One, in order to attract investors, the vendors and their agents have to make sure the offering is priced at a level where informed investors will see more upside than downside.

Two, listing shares means they become liquid, going from being untradeable to tradeable. That inevitably makes them more attractive to investors.

Other factors? It could be that there’s a turbo effect on the upside insofar as investors are chasing new floats because previous ones have gone well.

And there’s a bias to IT floats. Over the first half of this year, the IT sector accounted for 12 IPOs, easily the most active sector accounting for company floats, with returns at 3.3 per cent, outperforming the broader share market.

There’s a positive nuance in the fact that people who buy into new floats at the moment and who hold onto their shares do better than “stags” who flip their share allocation on listing day. In this case, it’s 33.5 per cent over the second quarter against 24.5 per cent first-day gains.

Moreover, contrary to recent criticisms that many companies coming to the market are not developed enough to stand the listing process, the current crop of offers are tending to list at a premium, and rising from there.

What are the probabilities of getting ahead?

Of the 21 companies that came onto the boards in the second quarter of 2016, only five came on below their issue price. These are good odds.

Among larger IPOs, software company WiseTech jumped 32.2 per cent by June 30 after listing on April 11, and plumbing manufacturer Reliance Worldwide Corporation was up 23.6 per cent by June 30 following an April 29 listing. Meanwhile, there were a few bolters on the upside.

Abundant Produce, which produces vegetable seeds bred specially to survive in hostile environments, had a subscription price of 20 cents, came on at almost 60 cents and at last glance was at 90 cents. That’s a 350 per cent lift for original buyers.

That’s not to say your next investment will net you 350 per cent. But the so-called “window” for IPOs, the period when it makes economic sense for vendors to come to the market, shows no sign of closing any time soon.

What’s perhaps best about the crop of figures from this year is that there haven’t been any whopping big IPOs to skew the results and dominate the headlines.

That’s the problem with the perception of IPOs: one bad big one such as Myer or Dick Smith gets a massive amount of negative publicity, leaving investors wondering why they should go near a new float even though the actual returns are far more inviting, if less sensational.

Unless there’s a dramatic change in the market mood, there will be worthwhile profits coming the way of both institutional and retail investors prepared to put their money to work.

Tim Eisenhauer, MD, OnMarket BookBuilds

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