This article explores what Initial Public Offerings (IPOs) are, how they work, the key players and the opportunities and risks involved for Australian investors.
If you’re new to Australian investing, it’s important to know what Initial Public Offerings (IPOs) are, how they work and the opportunities and risks involved.
Investing in something new is exciting and with the chance of riches on the other side of the rainbow, the listing of a new company on the Australian Securities Exchange (ASX) can pique the interest of regular investors and professional fund managers alike. So what exactly does it mean for a company to “go public”?
In this episode of The Australian Finance Podcast, Kate Campbell and Owen Rask explore the tricky terrain of Initial Public Offerings (IPOs) in Australia, including whether they’re worth your time, the different players involved (brokers, lawyers, investors), some of the key risks to be aware of and how to access them in Australia.
IPOs are a lucrative business in Australia. The process of an IPO involves the law firms drafting the documents, the brokers putting together the deal and selling it to wholesale and retail investors, the ASX taking their listing fee, accounting firms auditing annual reports and any marketing costs involved.
Risk warning : IPOs are not a Get Rich Quick scheme and many of the great companies IPO-ing won't be available to you as an investor until after they list. Retail investors get pitched many of the 'dribs and drabs' from brokers so you don't always know the full picture.
When I looked at the ASX list of upcoming IPOs in September 2021, there were over 30 companies ready to go public (and most had the words “metal”, “mining” or “mineral” in the company name).
Why do companies IPO?
When a private company wants to offer shares to the public as part of a new stock issuance and list on the ASX, it’s called an Initial Public Offering (IPO). In order to IPO, companies must meet the rules and requirements set out by the ASX and ASIC prior to listing on the ASX and fulfil minimum capital raising and disclosure requirements.
When a company goes public, it also gives private investors (founders/family/venture capitalists/angel investors) a chance to realise their investment and take some profits off the table. Going public also allows a wider audience to invest in the company moving forward.
According to Investopedia, “when a company goes public, the previously owned private share ownership converts to public ownership, and the existing private shareholders’ shares become worth the public trading price”.
For a company to maintain its listing on the ASX, it involves “ongoing costs such as audit costs, share registry fees, annual ASX listing fees, and annual general meeting costs” (Maddocks).
The following image shows you how the experts (bankers, lawyers, brokers, etc.) are paid to make a company sound sexier or exciting.
Who’s who in the zoo: investment bankers, CEOs, investors, advisers/brokers & PE companies
Investors often wonder how you can actually find out about these “secret” Australian IPOs floating around.
For large IPOs, there is often a huge amount of media coverage leading up to the event (companies need this for it to be a success). In recent years, think of names like Snowflake, Airbnb and BeyondMeat in the US, and Booktopia (ASX: BKG), Adore Beauty (ASX: ABY) and Sezzle (ASX: SZL) here in Australia.
In a research report published by the financial watchdog, ASIC, a few years back, they observed that some “small to medium-sized firms have started to use more innovative techniques to market IPOs, including social media (e.g. Twitter, Facebook, LinkedIn, WeChat and YouTube), OnMarket BookBuilds, crowd-sourced funding sites, and other connecting platforms which link issuers directly with investors.”
Basically, this means even the stuff you read on social media could be created by people who are being paid to make it a success!
Take note: Incentives matter. Understand the key players and how they are paid throughout the process before you trust everything they have to say.
Company IPO-ing: What are the company’s reasons for IPO-ing now? Have you looked into the board and CEO? How are they being incentivised? Do you like the company? Do others like the company?
Investors: Who currently owns the company? Who are they targeting as investors? Is the company still partly owned by the founders?
PE Companies: Who’s cashing out on this show? Find out the key groups involved.
Brokers: Who’s selling this show? What is their track record? How much are they getting paid? Is the research report you’re reading created by the broker selling the company?
Underwriters: In an IPO, an underwriter is a subscriber to the issue of shares, who offers to take shares not taken up by the public in exchange for certain fees disclosed in the prospectus. Most significant IPOs on ASX are underwritten. It’s a bit like insurance to make sure the IPO goes ahead as planned, even if there isn’t quite enough interest from investors from the outset.
Lawyers: Lawyers play a significant role in an IPO from preparing the IPO documents, liaising with ASX & ASIC, governance policies and prospectus to conducting the legal due diligence on the company. This all costs money, but there are many boxes to tick with the ASX and ASIC before listing so it’s important to get them all done correctly.
Behind the IPO: When should I buy and long-term opportunities
It might seem like a good idea to take part in an IPO if you:
- Can get an invite to buy shares (this is difficult for good IPOs)
- Thoroughly do your own, independent research in the company and sector
- The company’s valuation is reasonable
- You truly believe you need to “get in now”
In reality, what’s the harm in waiting for the completion of the IPO before buying shares on the market? For long-term investors (e.g. 5+ years), there’s almost always no reason to rush an investment. If you think there is a rush, it may just be the marketing playing into your biases.
Truth be told, the real reason most people buy into an IPO is to make a quick dollar through a stag profit.
A stag profit is made when the price of an IPO “pops” on day one. For example, if the IPO-ing company’s share price rose from $1 (the offer price) to $1.20 (a 20% gain) on day one. The investment bankers and advisers (see above) like this to happen on day one because it makes the investors (i.e. you) feel like they did you a favour by offering it “cheap”.
Remember, most companies will have their shares on the stock market for many years. You don't need to rush the decision.
What to look for in an IPO
1) Financials – is it lipstick on a pig?
Another problem for investors buying shares during an IPO is that you’re often buying from someone who knows more about the company than you do. They are called ‘insiders’. Chances are, they have been ‘inside’ the company for many years.
So, it begs the question: Why are they selling their shares to you if it’s such a good investment?
It’s for these reasons some investors joke that ‘IPO’ should really stand for:
- It’s Probably Overpriced
- Imaginary Profits Only
- Insider’s Private Opportunity
Australian prospectuses usually contain information on:
- Offer details
- The offering company’s business model
- Risks in buying or holding the securities offered
- Financial information on the position, performance and prospects of the company
- Related party disclosures
- A summary of material contracts
Keep in mind: All the usual investing rules apply for buying into an IPO. Follow a strict research process focusing on the accounts, management team, strategy, etc. before buying and always second-guess management's forecasts for growth and market opportunity.
2) Audited accounts
The company must provide to the ASX audited financial statements for the last two full financial years and a pro forma statement of financial position reviewed by a registered auditor or independent accountant.
Having audited accounts does not mean the company is reputable or a good investment. Do your own analysis, read the “Notes to the financial statements” as well as the four accounting statements. Go beyond the information that the company offers to verify the company’s products, services and customers for yourself.
3) Industry size
IPO-ing companies love to talk about how big their market opportunity is. Don’t be fooled by the marketing.
An IPO-ing company will often shop around for third party ‘researchers’ that do an analysis of the company’s key markets. For example, a company might say, “Our UK opportunity is worth $500 million per year, based on XYZ Consulting’s report for next year.”
Don’t be fooled.
Always check to ensure the research is valid, reasonable and stacks up against other official data sources.
It makes sense that if you plan to buy shares in a company that you think is great that the product/service they offer is also great. You would be amazed how many investors buy shares in companies when they don’t know what it does.
Do your research, try the product or service, talk to customers, read reviews etc.
5) Opportunities and risks for the company IPO-ing
These images are taken from the ASX, and highlight some of the opportunities and risks that a company listing will face when IPO-ing which are helpful to understand as an investor.
How do you invest in IPOs in Australia?
IPOs can often be difficult for regular investors to get their hands on in Australia as the more popular IPOs are often sold predominately to wholesale and institutional investors. Typically, a broker (or a number of brokers for large IPOs) will be given a certain allocation of shares to allocate to investors.
If you have access to a full-service broker you might be able to access IPOs if they have an available allocation. So, if you have an eye on a particular IPO, have a look through the prospectus to determine the lead brokers.
There are some new companies that have launched in the last few years that give investors access to smaller IPOs through their platform, without having to be tied to one broker. These include the likes of Fresh Equities, Equitise and OnMarket.
Summary of IPOs & takeaways for investors
So what can be learned from all of this?
This is an area of investing where patience is your friend. It’s easy to get caught up in the whirlwind that says, “This is the best IPO ever and you’re missing out on the opportunity of a lifetime if you don’t participate.”
But the truth is, if it’s an amazing business, then it’s going to be listed for a long time, and you’ll have every opportunity to purchase the company one week/month/year down the track.
Extra resources on IPOs
- Understanding how Initial Public Offerings (IPOs) work in Australia
- Initial Public Offering (IPO) Definition
- IPO market en route to new highs as it rebounds from Nuix flop
- ASX upcoming floats and listings
- When and Why Do Companies ‘Go Public’?
- ASIC reviews marketing practices in IPOs
- A guide to IPO listing in Australia | DLA Piper Insights
- BDO ASX listing guide: IPO handbook 2020
- Maddocks: A Guide to Listing & the IPO Process in Australia
- ABC: Want to make some money in 2021? IPOs are luring investors, but the risks are huge