How to analyse an IPO?

Things to look for while applying for an IPO

Introduction

Recently there is a slew of IPOs hitting the markets. In the recent times, all the IPOs are listed at premium due to the overall euphoric sentiment in the equity markets. In this blog, let us understand how to analyse an IPO from a long term investment perspective.

How to analyse an IPO?

What to look in an IPO?

• The main thing to look at while analyzing an IPO is to look at the size of fresh issue and the size of offer for sale.
• Fresh issue is basically the capital used by the company for its business operations.
• Offer for Sale (OFS) is basically a promoter or private equity investor selling a part of their stake in company.
• Combining the size of fresh issue and offer for sale (OFS), we get the total size of IPO.
• Here, an investor should look at the proportions of fresh issue and offer for sale.
  • If Offer for Sale (OFS) > Fresh Issue , it means that the promoters are selling their stake. This can be a red flag.
  • If Offer for Sale (OFS) < Fresh Issue, it indicates that the promoters are not keen on reducing their stake in the company which indicates future growth visibility.
  • Usually the lower the offer for sale (OFS), the better it is because it indicates promoter’s faith in the business model.
  • Also, if the private equity investor is also not willing to exit through IPO, it is a very positive sign.

Fresh Issue in IPO

• The main thing to look for in Fresh Issue in IPO are the objectives for which company is planning to use the fresh capital issue like future business expansion, purchase of fixed assets, etc.
• Another objective that investors should take a look at primarily is, debt repayment. Investors should be cautious about what portion of the fresh capital issue is used for debt repayment and also take a look at how the company is in terms of interest coverage ratio, return ratios, etc.
• Fresh Issue from IPO can also be used to fulfill the working capital requirements of the company. In this case, investors should take a look at if the company is facing any cash-flow management issues. Working capital issues mainly arise when the company is not generating enough free cashflows. This is also a red flag.
• Companies can raise Fresh Issue of capital to tap into inorganic growth opportunities like mergers and acquisitions. Company can acquire new companies to take advantage of the synergies and gain market share. For example, capital requirement for future acquisitions was specified in Route Mobile IPO objectives.

Offer For Sale (OFS)

• Main thing to look for in offer for sale (OFS) is to take a note of who is selling the stake in the company.
• If promoter is undertaking a stake sale, it is important to take a look at the reason behind the stake sale.
• For example, if the promoter is undertaking a stake sale because he/she has pledged the shares, it is a red flag. Similarly if the promoter has unrelated businesses, there is a high chance that the capital from this offer for sale can be diverted to other businesses. This is also a red flag.
• Similarly it is important to know the reason behind the exit of private equity investors in offer for sale (OFS). If it is because of lack of opportunities for future growth, it is not a good sign

Conclusion

It is important to look at the IPO objectives and the reasons behind the stake sale by promoters and private equity investors. Investors should ideally subscribe for an IPO from a longer term perspectives instead for listing gains. This is because listing gains are mainly dependent on current market sentiment which can be gauged from grey market premium. . However, grey market premium is not an appropriate yardstick to measure how good the company is fundamentally.