11 May 2012

How to spot a good IPO and a bad IPO in Malaysia

Here is a guide to spot a good Initial Public Offering (IPO) and a bad IPO in Malaysia. Whether you are looking to subscribe for flipping for first-day gains or to hold for the long run, understanding why companies go for IPO is equally as crucial as looking for pertinent points that will increase your chances of striking a good deal and avoiding a bad one.

Why Companies go for IPO?

All companies listed on the stock exchange have one common interest in mind – to raise funds. Initial Public Offerings is the company’s first time raising funds selling its stock to the public.

Fund are raised either for business owners themselves as they cash out from the company or for the company as they issue additional shares and sell them to the public.

As we all know, another alternative for raising funds is debt. Debt and borrowings have to be repaid, whist capital raised through IPO doesn’t. This makes raising capital an interesting affair for any company established in Malaysia.

Why does the general public always associate IPOs with huge first-day gains?

Being the first opportunity to purchase the newly listed stock on the stock exchange, everyone is excited with IPOs and if the prospects are decent, the IPO price may essentially be the lowest in the stock entire history!

More often than not you will hear the IPO stocks is ‘Oversubscribed’ by multiple times.

What many people do not realise is that there is no guarantee that an IPO stock will be oversubscribed and in some cases, under-subscription is a sure bad indicator of the stock’s first day performance.

Assuming it is oversubscribed. Then, only those successful in subscribing the IPO stock prior to listing are able to sell their stocks to the other unsuccessful applicants. The reverse is impossible. Many people wanting to buy from fewer people will drive stock prices up, simple? Sure…

But is this the case, really?

Then, you may ask why some IPOs failed and this prompts us to look beyond the no-brainer supply and demand theory. I can’t help but to mention one classic example of Vastalux Energy Bhd.

In 2008, Vastalux stocks were undersubscribed and since its listing the share price hasn’t climbed any higher than its IPO price and is currently facing threats of a delisting! The consequence of under-subscription saw the underwriters became substantial shareholders of them company – total disaster isn’t it?

Maybe it just wasn’t at the right time and right sentiment as the 2008 global financial crisis just reached Malaysian shores at listing time (this is why getting to know where the economy situation is important when assessing any investment opportunities)

The question really is how we can increase our chances to select a good IPO. If you asked me, here are some of the more pertinent things to look out for the next time you consider an IPO application.

Underwriters reputation and their past performance

Underwriters are engaged by the company when they are going for an IPO and part of their work is to prepare and publish a detailed thick booklet called the ‘Prospectus’ which has all the required information as regulated by the Securities Commission of Malaysia.

Believe it or not, many argue on judging an on-going IPO stock performance to the performance of the Underwriter’s previously engaged IPOs. Others disagree this should not be the sole point but still, a clean streak of successful past IPOs means there is hardly any debate and this is especially true in Malaysia and more so when the Underwriter is a Government linked bank.

More established big underwriter names like CIMB, Maybank and AmBank are generally preferred by both local and foreign investors.

On 11 May 2012, Bank Islam was chosen as underwriter for Pestech IPO on reasons that it is a Syariah-compliant bank which would give confidence to Bumiputera investors.

Even though Bank Islam is relatively small, having a Syariah-compliant bank as underwriter means they are in hope to attract investment interests from the prime pilgrim funds Lembaga Tabung Haji and Malaysian Armed Forces Fund Board (LTAT).

Subscribing to a substantial amount of shares, the funds are usually cornerstone investors in the IPO they are interested in. Having well-known names as cornerstone investors in any IPO is important to attract retail investor as they are better able to support the stock with their strong holding power.

Apart from their supportive role, the funds are active traders in the Malaysia’s stock exchange and they have the ability to drive momentum and direction of the market. This is especially important if you are planning to flip from first-day gains.

Other prominent Government linked institutional funds that include Employees’ Provident Funds (EPF), Kumpulan Wang Persaraan (KWAP) and Skim Amanah Saham Bumiputera

What to be aware of in the IPO prospectus?

Like any other investments opportunities, proper study and research on the company and getting sufficient training is important. 

Having access to a personal professional investment advisor will make life much simpler, but for many, we have no choice but to analyse by ourselves.

For a start, it is a good idea to know what industry the company is in, the management team as well as its business model.

Next, read the industry trends and business outlook report. This report is prepared by an Independent business advisor and will usually contain tons of useful data and statistics on market trend and their outlook for the industry.

Some larger stockbroking firms do provide some professional analysis and summary of key information picked from the prospectus so we may also rely on those reports.

Take note that there are forward looking statements and this is some of the data that should be read with caution. Statements such as expectation of sales or earnings to grow by a double digit in three years time may solely based on their own estimation and are usually not substantiated.

Use your own discretion to determine if the sales or earnings forecasts are reasonable and justifiable. Corroborate the points with economic data and trends.

Company’s purpose for IPO is crucial

As mentioned earlier in this article, understanding the company’s purpose of raising capital though IPO is vital in deciding whether to subscribe or not. 

Initial public offering of shares, like any other sales, will involve a degree of benefit to the seller.

Common purposes for IPO could be unlocking value at current valuations, business owner or founder cashing out, cash needed to seize opportunity for further expansion within the company or opportunity to acquire another company, urgent cash needed to repay debts overdue.

-There are effectively two groups of sellers in every IPO-

Proceeds from the IPO would go to the Company if the company issues new shares and sells them to you.

Existing business owners cash out by sell their existing shares to you and the proceeds would go to themselves instead of the company.

Investors will be eventually own the company stocks, so any money proceeds from the IPO going back into the company is more favourable than otherwise.

Lets take a closer look at the possible reasons .

Unlocking value at current valuations- This could be a double edged sword. While the company is performing at its best this year, the following year may be uncertain.

The business owners are in a better position to know when the industry is at its peak of the economic cycle than you and I and we all know the trough may be just after the peak.

Business owners usually sell a sizable portion of their stake for this reason so be cautious.

Business Owner cashing out- Business owners could be cashing out of the business for a variety of reasons, such as retirement age. This reason is common and should not be alarming at most instances as it is a natural progression for a matured company to seek business succession.

However, keep a look out for those who cash out due to disagreement with other owners or cashing out without a plausible reason. Business owners usually sell a large portion of their stake for this reason.

Urgent need of cash to repay debts and borrowings- You should be extra cautious if the company’s intention to raise capital to repay borrowings and debts because this may signal a weak cash flow management.

The business model should be thoroughly examined (by reading the prospectus) to determine if the company has a defective cash flow policy which may cause chronic financial problems that can lead to continuous bleeding even after the IPO.

In this situation. most commonly, the company would be the main beneficiary of the IPO proceeds, but it should be alarming if the business owners are selling a huge percentage of their stakes instead.

Seeking opportunity for acquisition or internal expansion- The reason for raising funds for potential acquisition or for internal expansion is healthy and like the reason suggests, you would naturally observe that most of the share sales are from additional shares created by the company and proceeds would be poured back into the company. Business owners may be selling a little of their portion but shouldn’t be much.

More uncommonly known reason to list its stocks is to gain publicity, which are usually consumer stocks that sell most of its products within the Malaysian domestic market.

Is the IPO stock price over valued?

Many argue that IPO valuations are often expensive in light of the current economic condition, business position, industry outlook etc. Just like any other sales, it only makes business sense that IPO stocks are sold at a premium.

It should instead be alarming if the company is sold at a discount to its value. This may indicate that the business owners are either lack in confidence in their company or in an urgent need of cash. Therefore, one should be wary if the company is selling at a discount, although rarely the case.

That being said, the question is whether the premium demanded is justifiable.

Normally, the price valuations are pegged to price-to-earnings ratio or price to book value that is comparable to the industry. This is the reason why stocks of other public listed companies within the same industry usually have a run up in stock prices before the IPO stocks are listed.

The question you should ask is whether the performance of the year is sustainable and can next year achieve similar results or even better.

Take note that earnings used in calculating the price-to-earnings ratio is the current or most recent financial year. Pay attention if there is a sudden growth in earnings for the particular year due to some non-recurring income. Non-recurring income are such as one time construction project or profits from sale of a building.

Lastly, be sure to know the par value per share and total amount of shares of the Company

Par Value illustration

Lower price per share does not necessarily means it’s cheap. Assuming the same company issuing the same number of shares, a 50 sen per share offered for shares with par value of 10 sen is more expensive than an offer of RM 1 per share offered for shares with par value RM 1.

Total number of shares illustration

Assuming the same company offering par value at RM 1, a RM 2 offered with only total 100,000 shares listed is effectively cheaper or more undervalued than a RM 1 offered with total 1,000,000 shares listed.

If you like this article and interested in reading further, here is another article on How to be a Successful Investor

If you would like to know more information on investing, just leave a comment below so that other readers will be able read (and hopefully answer) your question. And please read the disclaimer statement.


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