What to look out for in a prospectus-Shares etc..?

FOLLOWING better stock market sentiment, there have been a growing number of companies wanting to get listed on Bursa Malaysia.

In every initial public offering (IPO), the vendors, who are mostly the major shareholders of the company, will distribute a prospectus to provide the required information.

However, many investors find it difficult to digest the information provided in the prospectus. In this article, we will briefly go through a few basic pointers for investors to consider before taking up any IPOs.

The most important factor to be considered is the key owners of the IPO company. Despite the lack of track records and the difficulty in determining the quality of the management, we can still get some details on the background, qualifications and experiences of the key owners and management team.

If the majority of the board of directors is comprised of family members, we can expect this family-owned business to exist for a long time.

If the key owner has some corporate finance experiences, we should expect more corporate proposals from this company on, for example, merger and acquisition activities, rights issues and share buybacks.

For operational efficiency, the chief executive officer should possess relevant and long period of working experiences in the core business activities of the company.

Besides this, the independent directors need to have adequate financial training and related working experiences to provide useful inputs to the board of directors.

There are two main types of share offerings – offer-for-sale and public issue. The key difference between these two is that the sale proceeds from offer-for-sale will go directly to the vendors whereas proceeds from public issue will go directly to the company.

The company will need to explain how it plans to use the proceeds – whether the money will be used to fund working capital, reduce bank borrowings or for future expansions.

If the majority of the offering is offer-for-sale, then we will need to be careful as this may mean that the IPO is providing an exit strategy for some key owners of the company.

We may also need to take a discount on the future prospects stated in the prospectus.

As there will be a lot of uncertainties on the company’s growth prospects, we need to check whether the expansion plans stated are realistic and reasonable, given the size and capacity of the company.

Sometimes, certain owners may be too ambitious in their outlook.

In addition, we need to understand the company’s background, production capacity, types of products, locations of its factories, key major suppliers, customers and competitors.

We need to check the company’s sustainable competitive advantages, such as possession of any intellectual properties, technology, patents, trademarks, licenses as well as strong and recognisable brands.

Other factors to look at are whether the company is dominant in any particular geographical region and niche market, or whether there is a wide distribution network, strong marketing team as well as research and development capability.

A lot of newly listed companies will also explain in detail the key risk factors associated with investing in it in the executive summary of the prospectus. Although some may appear to be standard information, we can still get a feel of the inside risk factors about the company.

Examples of special risk considerations are dependence on a few key customers and suppliers, expiration of its patents as well as special arrangements with key major shareholders, suppliers and customers.

We notice that not many investors were excited about some of the recent IPOs. One of the possible reasons was that the offer price was too expensive.

Despite higher stock market volumes, we still have a lot of listed companies selling at very cheap valuations. If the pricing of the IPO is far above the overall market average valuation, the stock may be hammered down below its IPO prices after the listing of the company.

We can use price-earnings ratio and price-to-book ratio to determine the value of companies. A good company needs to state its dividend payout policy. Even though there may be slight differences compared with the actual dividend payment, investors still need to compute the potential dividend yields from the company’s dividend payments.

Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting.

Source: The Star