The market for new company listings is getting heated again. Stealing all the headlines just now is an absolute whopper – the £36bn flotation of commodities giant Glencore in London. In America, Chinese Facebook look-a-like Renren successfully debuted for $743m, while the owner of Dunkin’ Donuts fancies its chances of raising $400m. All told, 31 firms filed to go public in the US in April alone. The key question for investors is, should you join the rush?
By the time many investors hear about an initial public offering (IPO) it’s often too late to secure a piece of the action. That’s because the initial offering of shares by the firm to a wider public market is done largely in secret, behind closed doors. That’s partly what the investment banks advising and assisting Glencore are getting paid £264m in fees to do. One key job is underwriting – since the point of Glencore going public is to raise cash for further investment in expanding its commodities business, someone has to guarantee to pick up any shares that fail to sell.
Glencore is so huge it will be catapulted straight into Britain’s top 20 club on listing. Neither the firm nor any of its advisers will want to risk a flop. So institutional investors (pension funds and the like) are being seduced at what are called road shows. What’s more, the price will be pitched to be attractive. This is why you often (though not always) see share prices surge straight after an IPO.
- £36bn flotation of commodities giant Glencore
- Chinese Facebook look-a-like Renren
The trouble is this means there’s unlikely to be much of an opportunity for retail investors to get in at the ground floor before the share price lifts. Unless you happen to be a very large, loyal client of an underwriting bank and are prepared to commit some serious money, you just won’t make the invitation list. Sure, any firm can decide to offer at least some new shares to the retail market as part of its IPO. But it’s considered too much hassle and too risky unless you are, say, a telecoms firm rewarding loyal customers, or a football club sweetening loyal fans. Glencore is neither.
So how about piling into the shares as soon as they become publicly tradeable? After all, Renren’s share price jumped 29% on its debut. It might work in Glencore’s case, but we’d be wary of blindly jumping on IPOs for these three reasons:
Not all shares jump post-IPO
Piling into IPOs simply because you think the shares will have been discounted for institutional investors and therefore must rise post-float is little better than gambling. Sure, in the US, 32 out of 47 IPOs to May this year have risen since listing. But that leaves plenty that have sunk – and in a few cases, pretty fast.
The untested story
By definition, IPO firms tend to be less well understood than public companies. Often, they have been built relatively quickly via a mixture of organic growth and acquisition. That means much less is known about IPO firms than their public equivalents, partly because pre-IPO they make fewer disclosures. So it’s all too easy to get caught up in the inevitable hype. As my colleague Cris Sholto Heaton pointed out in his MoneyWeek Asia email last week, Chinese Facebook look-a-like Renren. “When a new stock jumps 71% in its first hours of trading, it tells you that someone has blundered” – either the advisers have priced it too cheaply or, more likely, buyers are just “getting carried away”.
The story that’s already over
Glencore announced its IPO details on the very day that the commodities market rolled over last week. The silver price tanked, while oil recorded its largest one-day fall in dollar terms ever seen. It doesn’t necessarily mean the commodities boom is over, of course. However, some analysts argue, not unfairly, that when a firm plans to go public, the owners – who should know the industry better than most – are likely to do so near the top of the market, so as to maximise the value of their stake. The IPO of private-equity house Blackstone in 2007 marked the top of the credit bubble, for example. As for Glencore, as Damien Hackett at Canaccord Genuity put it, “not too many people have made money out of dealing with [Glencore CEO Ivan] Glasenberg”, yet now “the market is going to do a deal with him”.
Are we suggesting you avoid all IPOs? No. But you have to be selective. Treat them like any other investment – rather than as a one-off route to a free lunch – and you’re less likely to back a dud.
First, ask yourself four questions: how long are insiders locked in and therefore committed to add value post-flotation (in the case of Glencore it’s an encouraging five years for the big hitters and two to four years for senior managers). Secondly, how big is the firm’s ‘moat’ (a phrase coined by Warren Buffett to describe what makes a firm unique)? In the case of Renren, it’s hard to believe that its short-term headline-grabbing status as the only listed social networking site in China will last. Thirdly, look at the fundamentals. This is where Renren really comes unstuck: the firm trades at a price that represents over 90 times 2010 sales and it doesn’t make a profit. That sounds a lot like the last tech bubble to us.
Finally, ask why the money is being raised – is the long-term story credible? In Glencore’s case, at least investors can take reassurance from the fact that the long-term commodities story isn’t about to change radically. But where will social networking be in ten years’ time? Who knows? So, of recent IPOs, Glencore is among the more credible. As my colleague David Stevenson notes in the Money Morning email, “you could make short-term money by buying in when the shares start trading”, particularly as there will be a rush from tracker funds to buy as it enters the FTSE 100. But with commodity markets looking volatile, be ready to take your profits off the table pretty quickly.