Christopher Niesche: What IPO failures tell investors about the share market

Latitude Finance, which marketed itself using Alec Baldwin, pulled its sharemarket float after super funds shunned the IPO. Photo/Jason Oxenham

COMMENT:

Is Australia's long-running bull market coming to an end? The failure of six, separate Australian share market floats in recent weeks have investors wondering.

It may be that investors have become more cautious about initial public offerings, particularly after a few stinkers in Australia in the past few years.

All six failures were significant– seeking A$150 million or more – and all were pulled late in the sale process, often only a day or two before investors were due to stump up the cash and the stocks were to list on the share market. They all fell apart as investors got the jitters and backers realised their capital requirements weren't going to be met.

The latest failure was equipment rental business Onsite Rental, which was seeking as much as A$250 million. Other cancelled IPOs were in a range of industries; they included consumer credit company Latitude Financial, Retail Zoo (the owner of Boost Juice), mining services outfit MPS Kientic and digital real estate classifieds business PropertyGuru.

For many years, share market floats have followed a predictable pattern.

The investment bank marketing the float hypes up the company's prospects to try to create as much investor demand as possible and achieve the highest possible listing price.

It's a careful balancing act; the bank also has to ensure demand exceeds supply, so investors who miss out on the stock in the initial public offering buy it on the share market, thereby ensuring the share price rises after listing. This is important in case the company needs issue more shares to raise further capital in the future – if investors feel they got a good deal in the IPO they are more likely to buy more shares from the company.

The whole process is accompanied by carefully placed leaks to the financial pages, designed to create further price tension. The bankers are seeking headlines like "Such and Such to price near top of range" or "This IPO three times oversubscribed". Who would want to miss out on such a hot stock?

The IPO proceeds, the company's owners find themselves very rich all of a sudden – or even richer if they are a private equity fund – and the investment bankers wonder if they should upgrade their beach houses.

In the last few weeks, everything has gone to plan with the IPOs, except for the final step. Take the IPO of Latitude Financial, which provides consumer credit. The float was the biggest of the year and would have valued the company at close to A$3.2 billion.

"Latitude says IPO demand exceeds supply," The Australian newspaper reported on October 15.

The next day, the float was pulled after superannuation funds led by the nation's biggest, Australian Super, decided not to purchase shares in the company. The move cost the company's chief executive a A$22.5 million bonus for listing the company and investment bankers up to A$35 million in fees.

There are a few reasons why investors are shunning floats. One is the rise of so-called index funds, which are making up a larger and larger share of capital markets. These share funds operate by mirroring the composition of a share index, such as the ASX-200, instead of relying on analysts to research the market and pick stocks. As a result, there is no place for IPOs in their portfolio, at least not until their stock is included in a share index.

Secondly, the securities regulator changed the rules for research into IPOs by analysts, banning stock valuations. This means there is much less guidance for funds deciding whether an IPO represents good value at the offer price. Many are exercising caution and pulling back.

But perhaps the biggest factor is caution about private equity and questions about the quality of the businesses being flogged.

Most of the businesses mentioned above were being floated by private equity firms.

High profile failures such as Dick Smith haven't helped. Photo/Nick Reed

Fund managers have been burned by the Myer and Dick Smith floats in the past few years, which saw private equity funds pocket huge profits and investors take huge losses.

In the months and years after the floats, it became apparent investors hadn't a clear picture of the businesses they were buying at the IPO. These companies had been tarted up for a quick and profitable sale. Dick Smith ultimately went bankrupt and Myer shares continue to lurch to new lows – they were last trading at 55c after listing at $4.10 a share a decade ago.

Investors want to invest in companies with several years of financial results readily available and which have already withstood years of investor scrutiny, so they veer towards companies already listed on the share market.

The benchmark ASX 200 index has more or less doubled since 2009 and the recent investor caution might suggest the decade long bull market is about to come to an end.
Usually bull markets end with a crash and a roar. The height of the market is marked by euphoria where investors pay too much for any asset and any financial instrument they can get their hands on.

We haven't seen that this time, so possibly it's a sign of a new maturity in capital markets.

But probably not.