Tuesday, January 12th, 2010 - Aberdeen Asset Management
The wave of IPOs (initial public offerings) currently hitting the market is likely to gather pace in 2010, reflecting the optimism produced by the 50% rally in the markets since the lows of March 2009.

As a consequence, many investors are now asking how they should assess an IPO investment and to what extent the criteria they use might differ from investing in a company with a long – and transparent –track record in the listed environment.

According to Michelle Lopez, Aberdeen Asset Management portfolio manager, many of the fundamentals remain the same.

“When comparing an IPO to an investment in a listed company, the fundamental research required is very similar. We do not differentiate between IPOs or listed companies when it comes to our due diligence on “quality”, where we look at the business model sustainability, management, balance sheet, cash flows and corporate governance and, of course, market conditions.”

“Where our approach does differ is in our consideration of the “value” proposition of an IPO. Given the limited published track record of an unlisted company, a discount compared to similar, successful listed companies with a track record of operating through cycles should apply.”

Ms Lopez expands on four key areas for investors to address when considering investing in an IPO.

What to look for in an IPO investment

1. Sustainability of the business model. Focus on the industry in which the company operates, possible barriers to entry and potential regulation that may de-rail the company. Consider factors such as trends in margins, return targets – including return on equity (ROE) and returns on capital employed (ROCE) – the competitive climate, and pricing power. Look out for exclusivity clauses, which enable a selling founder to set up another competing business in the same field.

2. Management. Consider whether or not the founders are still running the business and, if they are, what their track record is. Are they conservative in nature? For example, have they grown the business organically from internal cash flows or are they more aggressive, with significant debts and acquisitions? Are they keeping a solid shareholding in the company post IPO? It’s always good to have management with ‘skin in the game’ and therefore aligned to new shareholders. Many of the recent IPOs have involved private equity re-floating the company. Investors need to be a bit more cautious in such cases.

3. Balance sheet. If the company is coming out of private equity hands it is likely to be highly geared, so be very aware of how much must be paid down from the proceeds of the IPO. Intangible assets are also worth monitoring. In some cases, brand names or goodwill may make up the entire asset base, especially if the company has been acquisitive or changed ownership in the past.

4. Market conditions and, in particular, value. With a limited track record – at least a published one – an IPO should offer a discounted valuation. Market conditions are imperative in assessing this. Market confidence and a strong economy offer a significantly higher chance of success than turbulent times. This is particularly important if looking for a “stag” – that is, to take up shares in an IPO with the intention of selling shortly thereafter to make a quick profit, on the expectation that the shares will go up significantly on listing. So even if a business is a very good one, run by an honest management team and with a supportive balance sheet to help deliver the strategy, market conditions still need to be supportive to warrant due consideration.

Ms Lopez said investors’ expectations of further favourable market conditions are causing companies to either bring forward established IPO plans, as in the case of Myer, or to consider taking their businesses to market in order to capture the benefits of the positive sentiment.

“But the key message to investors is, even when market conditions are good, the fundamentals must also be sound to make an IPO a worthy investment,” she said.

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Aberdeen Asset Management

Aberdeen commenced operations in Australia following the acquisition of a local funds management company in December 2000. In June 2007, Aberdeen acquired the Australian equities and fixed income asset management businesses of Deutsche Bank AG. On 30 April 2009 Aberdeen completed its acquisition of parts of the asset management business of Credit Suisse in Australia.

Aberdeen is an active manager of both equity and fixed interest assets. Utilising a disciplined investment process, with a strong emphasis on proprietary research, Aberdeen seeks to construct high quality portfolios with little regard for benchmarks. Our aim is to outperform, both against peer groups and benchmarks, consistently over the medium to long- term (3 to 5 years).

As at 30 September 2009, Aberdeen Group globally had more than A$265 billion in assets under management and over 200 investment professionals.

Aberdeen Australia has total assets under management of around A$20 billion.
Lucy Garth, Aberdeen Asset Management
P: 02 9950 2829
W: www.aberdeenasset.com.au

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What to look for in an IPO


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