07 Apr 2015 21:43 IST

Make sense of an IPO document

Here are a few guidelines on how to pick relevant information.

The past few years have been dry as far as Initial Public Offers (IPO) go. But with a string of IPOs lined up for the next few months, representing a motley group of sectors - logistics, infrastructure, restaurants – the primary market looks set to bounce back to its heydays.

Though its tempting to invest in an IPO given the notion that you can snag a stock for cheap, know that IPOs are tricky beasts. Their history doesn’t give much hope either, with more than half the issues since 2007 below their issue prices.

The IPO prospectus is the best possible source of comprehensive information for a company tapping the primary market. The prospectus can be downloaded from SEBI’s website (www.sebi.gov.in).

As this bulky document may appear intimidating to the new investor, here are a few guidelines on how to pick relevant information.

Business

The key to understanding an IPO prospectus is to not read it in order.

Turn first to the ‘About Us’ section, available a good way into the document and one of the sections that demands your complete attention. It gives a detailed description of the nature of the company and its business models and the industry it operates in. Understand how and where the company accrues revenue, and if it is sustainable.

This includes going back to the history of the company, since it explains how the company has developed over the years, acquisitions made, subsidiary activity, all of which are indicators of the consistency of performance and sustainability. Remember that companies coming out with IPOs will tend to paint a brighter picture, so use your own judgement when reading up what the company lists as its strengths.

Scrutinise the industry details to get a grip on the future of the industry and the company’s own prospects within it. Details on the management team, related party transactions, group company entities, all will be found here.

Then turn to the other all-important financials section, since you now understand the business. Analyse financials as you would for any other company. The management discussion and analysis provided in this section can provide useful explanations on growth in revenues or costs.

Compare revenue models with those of existing peer companies to identify if, and where, the company has an advantage. Most IPOs will have listed peers so use these as a performance yardstick. Comparing valuations and financials with listed peers will help understand whether the issue is expensive (which leaves little room on the table) or reasonably priced (which improve your profits).

Risks

Next, look to the section detailing risks regarding the company, given at the start of the document. These risks are very wide-ranging, so concentrate on those risks which are company-specific or which can affect business.

Legal issues that have a significant bearing on the functioning of the company will be given here. Understanding this brief allows you to skip most of the section on legal issues that appears later in the prospectus. Read the legal section provided separately only if the company has several agreements material to business operations. IL&FS Transportation Networks, for example, had several service concession agreements for its toll roads, its main business, and understanding what the terms of the agreements were is thus important.

Most IPOs will list litigation risks arising from sales tax or excise duty or other tax notifications. If these sums aren’t big, ignore them. For obvious reasons, also ignore general economic and market risks, which are usually applicable to all companies, regardless of industry and whether or not they are IPOs.

Objects

Now look into why the company wants to raise funds and what it plans to do with them. This information is available in the section headed Introduction, early on in the document. Proceeds from the issue can go towards any number of purposes, from repayment of debt to working capital, from capacity expansion to company acquisitions besides covering issue expenses.

Fund utilisation should ideally contribute to revenue generation and/or earnings expansion. For example, companies may raise funds to either ramp up production capacity which may lead to increased sales, or to pay back high-cost debt resulting in lower interest costs and more leveraging capability; or for acquisitions that may add to revenues. However, the time taken to accomplish the stated objectives needs to be gauged.

Check the amount of funds set aside for issue expenses, which include advertising and promotion, printing of the prospectus and so on. Check also whether the proceeds of the IPO go entirely to the company; some IPOs involve a stake sale by the promoters in which case funds raised would not accrue to the company.

This section also gives the earlier capital structure and how it has changed. It will give details on what prices earlier investors in the company came in at.

Reading the sections mentioned above will be enough to help you figure out whether or not to invest in an IPO. The remaining sections can be skipped, unless you have the energy to read more jargon.



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