Learning About Shares: IPO - just an abbreviation for raising piles of cash

Q. Barbara asks: There's a lot in the news at the moment about companies conducting IPOs. What does it actually mean when a company offers shares for sale in an initial public offering or IPO? Should I be applying for shares in an IPO?

A. Dan Dividend responds: As you've observed, Barbara, IPO is one hot abbreviation at the moment!

Kiwi companies that have recently completed IPOs include Kingfish, Mike Pero Mortgages, Just Water International and Feltex Carpets. Pumpkin Patch's IPO is about to close as we write this article and a handful of other companies also have IPOs open.

An IPO is a company's first-ever sale of shares to the public. In many cases, it's the first time people outside the company have the opportunity to buy its shares. That's why a company is often said to be going public or floating when it conducts an IPO.

Offering shares for sale to the public is just one of several options companies have to raise funds for growth and expansion.

An IPO means a company's owners must give up some of their ownership to the public. So why would a company choose to go public with an IPO?

There are different reasons for every company, but the main attraction for most is the ability to raise a significant amount of cash without borrowing and paying interest.

Once a company is listed, it can use NZX's markets to raise more cash in the future through subsequent public offers or by giving existing shareholders the right to buy more shares, for example.

Going from the private to the public arena means the company must abide by listing rules and securities legislation designed to protect investors.

The company must also publish a prospectus detailing its offer and its future plans, provide historical financial statements and, once listed, disclose any information to the market that an investor would expect to materially affect the company's share price.

I'll call on Carmel Fisher of Fisher Funds Management to discuss a few important things to consider before you rush out and apply for IPO shares.

Carmel says: You should subject an IPO company to the same scrutiny as you would an already-listed company.

Read the prospectus carefully Companies conducting IPOs must prepare a prospectus and investment statement (or an offer document in the case of the NZAX Market, NZX's alternative market).

The prospectus and investment statement contains details of the share offer, historical and projected financial figures, information on what the company plans to do with the money raised in the IPO, and other details.

Pay close attention to the company's reasons for raising money. Do you think they will help expand the business and create more value for shareholders in the future?

Sometimes a company will use IPO funds to pay off debt, so it can move forward from a debt-free position.

The prospectus and investment statement also covers the risks the company faces. For example, the nature of the industry might allow competitors to take away valuable market share.

Or perhaps the company is heavily reliant on factors outside its control, such as a large supply contract or third-party technology. As a potential investor, you should consider the significance of these risks.

Look at the company's earnings records A track record of increasing earnings is a good indicator of a quality company with competent management.

However, some new companies that conduct IPOs may not have positive earnings records yet. In this case, you should look carefully at the company's management and board.

Are they well qualified to expand the business and its profits in the future? How will they do so? Are they true and committed champions of the company?

Don't fall for hype Naturally, publicity is important to increase the likelihood of all the shares in an IPO being taken up.

However, a glossy marketing campaign is never a good reason to buy shares. It's vital to dig a little deeper and make sure the company is a sound investment prospect.

Every story has a moral. The moral of the IPO tale is don't buy shares in a company just because it's conducting an IPO - do it because it's a good investment.

* Email Carmel Fisher: carmel@fisherfunds.co.nz

* Catch up on Dan Dividend's past articles at www.nzx.com/education