IPOs: it pays to be picky

Now that we have passed the halfway mark for 2014, it’s time to take stock of this year’s IPOs. 

Alibaba headquarters: Alibaba, the next big IPO, is listing 8 August
Source: Bloomberg

The year has so far been a good one for the equity market, with the FTSE 100 hitting a 14-year high and the FTSE 250 reaching an all-time high. In many ways, this is no surprise; central banks have maintained their accommodative policies, while economic data has improved. In addition, there has been a rush of companies looking to list their shares on public stock exchanges.

In the UK, Royal Mail’s highly successful flotation in the last quarter of 2013 – where shares were purchased for 330p and hit 459.75p in its debut trading session – set the benchmark for the 2014 entrants, and began the new run of IPOs in fine style. However, as we shall see, some of the newer entrants have not enjoyed the same success as this darling of retail investors. What this rash of IPOs has told us is that investors should be discerning – new offerings should be looked at with a dispassionate eye on growth prospects, looking beyond all the hype that accompanies a new listing.

The table below shows the performance of a number of UK IPOs since their listing (data as of 10 July 2014, source: Bloomberg):

Company IPO date Performance
AA 23 June 2014 -0.20%
TSB 20 June 2014 8.08%
Zoopla 18 June 2014 15.34%
Saga 23 May 2014 -5.27%
Just Eat 7 April 2014 -4.23%
King Digital Entertainment 26 March 2014 -11.73%
Poundland 17 March 2014 13.50%
Weibo 14 March 2014 13.40%
Pets at Home 12 March 2014 -25.71%

 

At IG we offer clients the opportunity to speculate on the market capitalisation of companies that are about to list on the stock market. So far this year we have offered IPO markets on nine companies that are now listed. Out of those nine, five companies – AA, Zoopla, Saga, Weibo and Pets at Home – failed to meet their expected market cap, while the remaining four – TSB, King Digital Entertainment, Poundland and Just Eat –  raised more money than expected. This reflects an increasing sentiment that not all IPOs are created equal. As more companies come to market, investors have become pickier, seeking out the companies with better growth prospects and avoiding those whose outlook is cloudier.

Once a company is fully listed on the stock market, our clients have the opportunity to go long or short, instead of just being able to go long as with a traditional broker. Zoopla’s share price has risen 15% since it listed, more than offsetting the poor performance of the IPO in garnering investor funds. Weibo only raised half of what it hoped to, but the share price has gained 13.4% since its April listing. Pets At Home, on the other hand, only raised 83% of what it expected to raise and its share price has dropped 26% since March. This is an instructive comparison – Zoopla has tapped into the rising UK property market, and Weibo, marketed as China’s answer to Twitter, feeds into the idea that the Chinese market offers unrivalled growth opportunities.

Zoopla’s IPO timing was interesting; it took place one week after the Mansion House speech when the property market was in the spotlight for the wrong reasons, as Bank of England governor Mark Carney dropped the first hints about an earlier than expected rate rise. Rightmove, Zoopla’s big brother that has dominated the property website market for many years, saw its share price fall in the wake of the speech, but has since recouped its losses. In the short time that Zoopla has been listed, it has outperformed Rightmove, with the more well-known firm falling 2% over the same period. It is worth noting, however, that Rightmove is up 400% in the past five years – Zoopla has a lot of ground to make up. However, smaller companies such as Zoopla can expect faster growth than big firms like Rightmove. As the old saying has it, ‘elephants don’t gallop’.

Weibo, the Chinese microblogging service listed in April, raised a little over half of what it set out to raise. Dubbed ‘China’s Twitter’, on the run up to the IPO, the company was valued at 12 times its earnings, while Twitter was valued at 18 times. Twitter shares have lost 29% since the Chinese company floated, hit by fears about the firm’s ability to build on advertising as a source of revenue, while the wider NASDAQ 100 has risen 6% during the same timeframe. 

Lloyds Banking Group was required to spin off the TSB division as part of the government’s decision to provide financial support in the wake of its 2008 merger with HBOS. TSB listed only a few weeks ago and the stock has risen 8% since then, outpacing its bigger rivals. HSBC has lost 2% during the same period while Barclays has dropped 11%, making it the worst performing of the big five banks. A more prudent lending policy and a lack of scandal helped TSB get off to a relatively good start, and the company has made great play of its relatively boring business approach. With no investment bank attached, and a focus on local lending, the company hopes to attract the more staid investor that prefers long-term stability over fast money.

Saga does not fall clearly into any one business category. The company offers a range of services that are aimed at the over 50s, but it earns the bulk of its money from insurance products. Saga wanted to price the stock at the low end in order to make it more attractive to retail investors, but also invoked the ire of professional investors with its decision to join the travel and leisure sector rather than enter the market as an insurer alongside such names as Admiral, Prudential and Aviva. Since its listing the share price has declined by over 5%, while the FTSE 350 travel and leisure sector has dropped 3% and the FTSE 350 life insurance sector only 1.5%. Companies need to be careful to keep the big fund managers on side – evidently a desire to be popular with its customers overrode common sense, and Saga has paid the price as a result.

King Digital Entertainment, the maker of the highly addictive smartphone game Candy Crush Saga, listed at $22.50 a stock but within two months was trading close to $15 per share. Although recently it was again above $23, overall it is 12% lower since listing, an uncomfortable ride for those who thought they were onto a sure thing. Long-established game maker Electronic Arts is up nearly 20% over the same period. Whereas EA has a broad stable of games that appeal to a wide variety of games, King’s appeal rests almost entirely on one game. If Candy Crush falls out of favour, then King will rapidly find itself without a chief product. This is what investors mean when they talk about ‘key risks’.

Pets at Home and Poundland are both private-equity backed and listed on the same day. Pets At Home is the least leveraged of two, and the funds raised from the flotation will be used to pay down debt. With growing speculation that interest rates could increase early next year, Poundland could end up paying a pretty penny on its borrowing. Since listing, Pets at Home has declined 25% while Poundland has risen nearly 13%. However, it is worth bearing in mind that the UK retail sector has been hit hard; Home Retail Group and Debenhams are off 18% and 19% respectively over the same period. The greater debt levels of Pets at Home, over £190 million versus just £9 million for Poundland, indicates why the former is struggling and the latter has soared ahead. Pets at Home has laboured under greater worries about its growth profile – arguably Poundland has a more secure outlook, even if the economic recovery will see greater affluence among consumers and a possible decreasing reliance on such cheap stores.

Since its listing in April, Just Eat has dropped by 4%, a better performance than US equivalent GrubHub whose shares are down 6% since listing. Some argue that Just Eat shares similarities with Ocado, being a company mainly for trendy metropolitan types with little appeal outside London. Unlike Ocado, Just Eat has a more secure track record on profits, but even so a lot of the valuation is probably down to its internet element – a PE of over 170 sets the bar for performance at a very high level.

AA is the most recent of the major IPOs, but has already gained 8% in value. The share placing was oversubscribed and positioned at the higher end of the price range, a reflection of popular demand and the broad recognition afforded to the brand. AA has performed relatively well since its listing. In the same period, rival Nationwide Accident Repair Services has gone down 2.5%, and the FTSE 100 and FTSE 250 are off 1.9% and 2.5% respectively. Its future plans include reinvesting much of the money raised in the IPO to expand its services, as well as lowering its borrowing, a sensible way to capitalise on the momentum of the IPO.

Alibaba is set to list some time in September. This hotly-awaited IPO has the potential to be the largest offering of stock in the history of financial markets, a sign of just how big the Chinese market is. Finally, this is a company that might actually deserve all the hype that has been heaped upon it, having made more money in the final three months of 2013 than Facebook and Yahoo, while seeing a profit margin of 45%, almost double Apple’s 23%. IG’s grey market on the expected market capitalisation of Alibaba points to a valuation of over $200 billion, a sign of the confidence surrounding this offering.

So far 2014 has seen many IPOs, and more will be on their way. Alibaba is set to be the icing on the cake, but what investors have learnt is that not all IPOs have been created equal. Some involve promising companies, like Poundland and AA, but others are not so promising. As ever, it pays to do the legwork, looking into revenues and profits and assessing future growth. IPOs come with much fanfare and hype, but investors should look beyond this to the numbers, lest they end up holding on to underperformers. Picking the right ones, however, can be very rewarding.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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