It takes a brave business leader to list their company on a public stock exchange, and while the success of an IPO is largely based on the firm’s underlying fundamentals, it’s also a delicate act of timing.
This month, we’ve seen a string of British companies shelve their plans to float, including the likes of Arqiva, Bakkavor (although it later decided to float after all), and the UK’s largest debt collector, Cabot Credit. Last week, M7 Real Estate became the latest company to pull the plug on a planned float of its newest real estate investment trust.
Despite these cancelled plans, the IPO market has been relatively strong this year, so the question is: what’s causing these companies to abandon their multi-million pound floats?
“Companies looking to IPO are generally trying to list on a wave of optimism,” points out Rebecca O’Keeffe, head of investment at Interactive Investor. And while the market is still shifting upwards, there’s a reasonable amount of scepticism around current valuations.
It’s easy to view these cancelled plans as negative, but Darius McDermott from FundCalibre says it shouldn’t necessarily be seen in that light, because it could simply show that fund managers and other investors are unwilling to pay the high valuation on these companies that is being asked.
“It shows that they are picking and choosing the ones they think will succeed and add the most value – they aren’t just buying anything,” he says.
“The market isn’t broken,” McDermott adds, pointing to companies like Foot Asylum and Boku, which have been well received in their recent IPOs. But the other reason we shouldn’t think too negatively about these cancelled plans is that there has been a healthy amount of fundraising in the market already this year.
London’s IPO market has bounced back from a difficult 2016, when the uncertainty over the Brexit vote saw a slump in activity. In fact, in the third quarter of 2017, there were 27 IPOs, compared to just nine during the same period in 2016.
Fund managers will have already deployed most of their spare cash, meaning they would have to sell a current holding in order to buy an IPO, says McDermott.
“One reason cited for failed IPOs has been volatility, but this is nonsense as volatility is close to the lowest it has ever been.”
So given the landscape isn’t nearly as uncertain as some make out, if you do want to invest in an IPO, what should you look out for?
Investing in IPOs is a risky business, particularly because there is very little historic information to decide whether these companies are a good buy or not.
Tech firms are even higher up the risk scale, says O’Keeffe. These businesses do not have a formative profit and loss track record, and unlike “traditional” companies, such as retailers, the assets owned by tech firms are largely intangible.
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Investors should also be wary of the lock-up period – which is when large shareholders and insiders, including management, are forbidden from selling their shares. This can lead to a surge in sell-offs when this period has expired. “The shorter the lock-up period, the more wary you should be,” says O’Keeffe.
“The other factor to note is the tenure of the management team and whether they are planning to stay. There are substantially greater risks associated with businesses where it is all change at the top, or those that do not have much of a track record.”
But with great risk, comes great opportunity, and an IPO lets investors snap up a good deal.
A good example is Fever-Tree, which started with a share price of 134p when it listed on the London Stock Exchange three years ago. The premium drinks company is now trading at 1985p – a huge return in a very small space of time.
“When the IPO cycle starts, the quality of companies can be excellent,” says McDermott. “However, after a string of successes, the temptation is to try and float less-appetising companies.”
It’s crucial that you do your homework before investing in an IPO. Phil Harris, who runs EdenTree’s UK Equity Growth fund, says investors should look for the right attributes, regardless of the stage in the cycle.
This means finding companies with high margins, strong returns on capital, and profits converted into cash. You could also look at similar firms that are already public to gauge whether an IPO will be a success.
According to the fund manager, there are two principal types of IPO. The first is where the managers are looking to raise cash to expand, while retaining a significant stake.
The second is an attempt by private equity to unload companies they cannot trade sale – which is less attractive from an investment point of view.
Harris says you should avoid valuation premiums, adding: “IPOs should come at a discount to existing quoted comparators given their lack of quoted history and the market’s lack of knowledge and belief in a new management team.”
And when looking at IPO documents, you should start at the back of the prospectus, because you’ll find information on the company’s background, the directors’ histories, any conflicts of interest, and litigation issues.
You should exercise caution when there are sudden and seemingly impressive profit rises in the two years before flotation, because profitability is sometimes maximised to “window dress” a stock, says Harris.
On the surface, it might seem worrying that companies are abandoning their flotation plans. But perhaps it says more about the cycle we are in, rather than signalling that something is broken in London’s IPO market.