Applying for IPOs? 7 things you must do to ensure your money is safe

The primary market has been buzzing with the stellar response to two latest initial public offerings – that of new-age IT firms Happiest Minds and Route Mobile. Three more from Chemcon Speciality Chemicals, CAMS and Angel Broking are hitting the market this week to raise an aggregate Rs 3,100 crore.

There are hopes that a gush of liquidity and a sharp rise in the number of new investors will continue to support these issues, encouraging more companies to go public.

If you are considering investing in the primary market, you must first understand the basics and financials of the company before applying for an IPO. You can get all the information about the company in the draft red herring prospectus.

However, going through bulky document may be a very tedious and confusing task. So what you can do is focus only on a few essential parts of the document, which will be good enough to understand the business and its prospects.

For instance, the introductory section of the document highlights all the essential facts like what is the company and its business all about, the size of the offer, future prospects as seen by the promoters and the risks involved in the investment.

Here are the key points one must look at the DRHP before applying for an IPO:-

• Promoter background and management team

An investor should first check who is running the show. Promoters and top management are the biggest assets of any company. Therefore, reading about the background of the promoters and the top management is important. The average number of years spent by the top management in the company can provide some insight into the company’s working culture.

“The experience of promoters in the business when cross-checked with either market share or revenue growth of last five years can give an understanding of the management’s ability to change and evolve circumstances,” says Rusmik Oza, Executive Vice-President and Head of Fundamental Research at Kotak Securities.

• Key strengths of the company

One should also read about the strengths and the company’s position in the industry it operates in. “An investor should understand the positioning of the company in its industry, and also figure out the business strategies it has adopted. By reading more about the company, its positioning and strategies, one should be able to visualise the future prospects of the business,” said Oza.

• Financial summary and comparative valuations

Glancing through the financials is a must. Analysts say one needs to look at the past 3-5 years of revenue growth, margins, balance sheet strength, working capital, cash flows and other related financial parameters. One needs to see if there is any major spike in these numbers of last few quarters or last one year just before the IPO.

“The DHRP will have comparisons with peers – both on financial numbers and valuations. One can look at the comparative valuations to check if the company’s valuations are in line with its peers or if there is a big deviation,” said Oza.

• Objectives of the issue and shareholding post-IPO

It is important to check the promoter shareholding before and after the IPO. A higher promoter shareholding in the company is always better for minority shareholders. It is also important to know how much of money from the IPO is coming into the business, or is it a partial or full exit provided to private equity holders.

“If the purpose is to utilise the funds in the existing business or for an expansion, it will be a good sign of future prosperity,” says Vinod Nair, Head of Research, Geojit Financial Services.

• Check the valuation

Valuation refers to the relative price at which an IPO is offered compared with the historical and latest financials. Sometimes the offer price may be undervalued, fairly valued or overvalued, depending on the industry parameters and profitability ratios. “To understand the valuation, check the price to earnings (P/E) and price to book value (P/BV) ratios of the company and compare them with those of its peers, which are listed in the secondary market. Also, compare their growth potentials, market shares and competition to develop a better understanding of its position,” said Nair.

• Take inputs from valued research notes and anchor allotment

You may not be able to check all the points mentioned above. So, you can consider the views provided by various brokerages in their IPO research notes, which are publicly available.

In case, you are not well-versed with a brokerage note, compare a few of them to take a call accordingly. Many a time, there are anchor investors like mutual funds, private equity, banks and institutions who are the first investors in an IPO.

They have a better understanding of a company’s business and prospects. Such deals are announced before the IPO as a regulatory requirement. “Biggers the names and quality of anchor investors, the better will be the confidence of other investors to apply for the IPO,” said Nair.

• Major risk factors

Companies need to mention all major risk factors and negatives associated with the business in its prospectus. Reading the risk factors is a vital part to ascertain if there are any major concerns or risk associated with the company. At times there are certain litigations and liabilities, including contingent liabilities, which can pose a threat to the company’s future business prospects.