Interactive Investor

Top tips for IPO investors

8th February 2016 12:14

Andrew Hore from interactive investor

There tends to be a disappointing lack of information available to investors prior to a company joining AIM. Estate agency Purplebricks is a good example of this. There was no mention of the monetary level of revenues in the pre-admission announcement last December. This may possibly be because it would have highlighted how high the valuation was.

This did Purplebricks no favours, because the share price fell by one quarter in the first month, although it has recovered since then. It does provide a warning to investors when it comes to making investment decisions without the appropriate information.

It should be remembered that these pre-admission and intention to float announcements are effectively marketing and should be viewed as such. Unlike results announcements, there is no set information that has to be included in these announcements.

No realistic judgement can be made about a company based on these announcements. Individual investors can rarely get hold of shares in flotations and they tend to be keen to know if a company is worth investing in prior to when the shares start trading. However, it is rare that a quality judgement can be made at that point.

It can be argued that, these days, the prospectus is available on the company's website. However, it is not usually available before trading in the shares commences. Even a scanning of the prospectus takes time.

Telltale signs

One telltale sign in an intention to float announcement is the lack of information about revenues or profit. If they are nowhere to be found, you can pretty much bet that they are low or non-existent, or at the very least they are meagre when compared with the valuation being put on the company.

An even bigger giveaway that there is little in the way of revenues is when no monetary figure is mentioned, but a large rate of increase is highlighted. This suggests a low starting base of revenues. Purplebricks stated in its pre-admission announcement that September 2015 revenues were ten times the level in September 2014.

Do not get sucked into a company just because it has a high profile or a well-known brand nameIn the year to April 2015, Purplebricks revenues were £3.4 million, which was slightly lower than the sales and marketing costs in the period. Over the previous three years, the company lost a total of £8.3 million.

Yet, the valuation at the time of the flotation last December was £240.3 million - admittedly after raising £25 million (£22.8 million net) of new money.

Existing shareholders took the opportunity to raise £32.2 million after expenses as part of the placing. That is more cash than had been previously raised by the company. Following the interim figures, Michael Bruce bought 320,000 shares at 78p each and this appeared to help the share price recover. However, he sold 10.6 million shares in the placing, generating £10.6 million, so he has reinvested less than 2.5% of the cash raised at a higher price.

No guarantees

The argument for the high valuation is that the business is going to grow rapidly. That is all very well, but there is no guarantee that trading will go as expected and forecasts two or three years ahead are rarely correct.

Hardman published research on the day the shares commenced trading and the forecasts appear optimistic. If things go to forecast, Hardman expects revenues of £71.2 million and pre-tax profit of £18.9 million in the year to April 2018. That equates to a multiple of 14 times prospective 2017-18 earnings, although the earnings figure is boosted by the use of tax losses to reduce the tax charge.

The interim figures did show revenues growing from £819,000 to £7.18 million, so this suggests that the full year forecast revenues of £17.8 million are possible.

Purplebricks argues that the estate agency market is worth around £4 billion a year. However, Purplebricks also says that the average charge for its service is £1,080. That is around one-quarter of the average cost of the services of ordinary estate agents. So, in effect, the potential market Purplebricks can address is likely to be nearer to £1 billion.

Do not get sucked into a company just because it has a high profile or a well-known brand name. Also, do not make investment decisions when there is a lack of information. It is tempting to think that you have to buy immediately or miss out, but there are so many investment opportunities that it does not matter if some are missed.

New admissions on AIM can tend to be a mixed bag and that was true of last year. There were a number of strong performers and the average performance of all new admissions was positive, according to Allenby. Some of the best performers and other companies that have not risen significantly are still attractive. Here are three examples:

Stride Gaming

Stride Gaming was no bargain when it floated, but it has a clear strategy of buying online bingo operators and the high share price helped it to make the significant and earnings-enhancing acquisition of InfiApp, which added social gaming to the group. The business is highly profitable and there is plenty of opportunity to acquire more bingo operators.

The larger online gaming companies are more interested in higher-margin poker and casino games. On top of this, the 15% point of consumption tax brought in by the UK government has increased costs and makes it more difficult for some of the smaller bingo operators to make money. Stride can make acquisitions, add the brands to its own software platform and reduce costs.

One of the attractions of Stride is that it has an experienced management team that has built online bingo operations in the past. Chief executive Eitan Boyd built up bingo network GlobalCom and Wink Bingo prior to their sales to 888 and chief operating officer Darren Sims was also involved with 888's bingo business.

A profit of £10.3 million is forecast for 2015-16, rising to £11.6 million in 2016-17. The shares are trading on 15 times prospective 2015-16 earnings, falling to 13 the following year. The business is cash generative and, despite a significant rise in the share price, Stride is still an attractive investment.

Bilby

Bilby joined AIM last March in order to build a business focused on gas installation, maintenance, electrical, water and building services for local authorities and social housing organisations in London and the south east. Two acquisitions were made last year.

Bilby has won preferred bidder status for gas support work for the South East Consortium, which is a group of housing associations that manage more than 140,000 residential properties. This framework agreement starts in 2016 and lasts for four years. House broker Panmure Gordon predicts that this framework will contribute £7 million to revenues in 2016-17. New contracts with Greenwich and Hackney will also contribute to revenues, which are expected to grow by more than 50% in 2016-17.

Panmure forecasts a 2015-16 profit of £3.1 million, rising to £4.9 million the following year. A total full year dividend of 2.75p a share is forecast and annual dividend growth of up to 10% is expected. The shares are trading on more than 20 times prospective 2015-16 earnings, falling to 13 in 2016-17. The shares appear fairly valued in the short-term, but they are attractive as a long-term investment with the prospect of more earnings-enhancing acquisitions to come.

Orchard Funding

Finance provider Orchard Finance raised £10 million at 96p a share prior to joining AIM on 1 July and this valued the company at £20.5 million. The maiden figures, published for the year to July 2015, were ahead of expectations. Orchard offers a combination of growth and income.

Orchard provides loans to cover insurance premiums or professional fees and this loan is typically for ten months. There is limited competition in these areas. The cash raised provides plenty of scope for growing the business. The lending book is expected to grow from £43.6 million at the end of July 2015 to £64.8 million in July 2017. As the lending portfolio grows, the cost income ratio will decline from the current level of 37%, as operating costs are relatively fixed.

Panmure Gordon expects pre-tax profit to more-than-double from £1.29 million to £2.73 million in the year to July 2016, helped by paying off higher cost debt from flotation funds, but earnings per share (EPS) growth will be held back by the additional shares in issue partly offset by a lower tax charge.

Even so, 2015-16 EPS of 10.2p and a dividend of 3.07p a share are forecast. Dividend cover is likely to stay above three times, but earnings growth will enable the dividend to grow. Orchard is trading on less than eleven times prospective 2015-16 earnings, falling to just over eight times the following year.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

Disclosure

We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Where relevant we have set out those particular matters we think are important in the above article, but further detail can be found here.

Please note that our article on this investment should not be considered to be a regular publication.

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