After a lull last year, the IPO frenzy seems to have re-emerged in recent months, albeit at a lower scale as compared to 2021. 50+ times subscriptions and 100 per cent listing gains are back, reflecting scant memory of many stocks that witnessed similar craze in 2021, but are faring poorly today.

Recent months have witnessed a spate of IPOs including those like IdeaForge, Netweb Technologies, Cyient DLM and the momentum is continuing with the much awaited IPO of TVS Supply Chain Solutions, Concord Biotech this week. Many more are lined up in the weeks ahead. Typically, IPOs are a good reflection of sentiment and liquidity. So if you are a short-term investor looking for listing gains, these two are the crucial factors that usually matter. But markets are an interplay of fundamentals, liquidity and sentiment. For a long-term investor, fundamentals matter most. If you are one such investor,  when it comes to IPOs, RHP document is your acreage to mine for information before investing.

But here is the irony: the very document that is supposed to help fundamental investors in making their investing decision is also structured in such a way that unless you are alert and can patiently mine through scores of pages, you may end up missing the most important information. “It is a testimonial to how information disclosure requirements have had the perverse consequences of making the disclosures useless, by drowning investors in data and meaningless legalese” – said the Dean of Valuation, Aswath Damodaran after reviewing a 285-page IPO prospectus of a US company. In India, we may even end up having a record for the largest prospectus, with some RHP documents even extending to as high as around 750 pages. How exactly is an investor supposed to capture what is important from so many pages, most of which may be irrelevant to your investing decision, but may, once in a while, have some important data tucked within these? Here is a lowdown.

LinkedIn profile

To begin with, it will be better to treat an RHP and the company/management and investment banker presentations, interviews like a LinkedIn Profile or a job resume – maybe true at core, but typically jazzed up.  While the intention here is not to paint all IPOs with the same brush, it needs to be noted that this is their sales pitch to you. It is in the interest of the company/management and investment bankers to present as pretty a picture of the facts as much as they can. Unlike already listed companies that are much more researched in detail and have views on both sides of the spectrum, IPOs are not so well researched, given the companies are private and prevailing information asymmetry. So playing it safe with your money should be one of the guiding factors. Always take it with a pinch of salt.

Check for objects of the offer

IPOs can be a combination of fresh issue or secondary sale or a combination of both. If it is a fresh issue, where the IPO proceeds will be infused into the company, check for objectives of the offer in the RHP. For example, while deleveraging via IPO is fine, if the offer is to deleverage a balance sheet bloated with unsustainable liabilities or poor working capital management, you need to question the management wisdom that needs public money to wriggle itself out of a problem. On the other hand, if the proceeds are to be used for expanding capacity of already well-functioning business, that may be a better case to consider.

In the case of secondary sales, you need to check whether it is the promoter or an external investor like a private equity or VC company seeking an exit. While secondary sales are fine, if it is done at bloated valuations, it is your money that enriches the promoters and VCs. This is the case with quite a few new-age and other IPOs that are trading below their IPO price in 2021. Hence in the case of secondary sales, you need to research more on the valuations at which they are exiting and understand why.

Understanding the business

RHPs have detailed sections titled ‘Industry Overview’ and ‘Our Business’.

The industry section provides detailed overview of the industry in which the company operates, its prospects, opportunities and key competitors. These will typically present the large, macro opportunities and long-term growth prospects that the industry presents. Given this is the company’s sales pitch, you need to stress-test the opportunity presented. What if some growth forecasts do not work out? How have competitors (if they are listed companies) fared in the space? How does the company’s IPO valuation fare versus competitors valuation?

The business section provides the micro details.  It explains the business of the company within the industry, its core segments, its competitive strengths and new business opportunities it is planning to tap. This will provide nuanced details on customer relations, supply chain dynamics, trends in key financial and operating metrics in recent years etc. There can be finer details that can be extracted from this section like geographic exposure risks or customer concentration risks.

These two sections must be deciphered in detail and stress-tested to gauge the overall risk versus reward that the IPO offers.

Financial analysis and valuation

Mining through financial data can be a laborious task given it runs into 100s of pages in RHPs with accompanying notes and schedules. If you don’t have time for this, you must at least run through the consolidated P&L, balance sheet and cash flow statements, and if any doubts based on this, must check the schedules as well. Key things to check here beyond analysing based on the typical ratio analysis, are factors like balance-sheet strength and whether operating cash flows are in sync with trends in earnings. A private company with poor cash flows that don’t match up with earnings is no-go, given the fact that there is no way for you to ascertain the quality of earnings for a private company. Typically, companies approach the IPO markets only when they have had good earnings growth in the most recent year to maximise their value. It would be worthwhile to check what factor drove the earnings improvement – was it revenue growth and operating leverage, or was the company curtailing certain costs like employee benefits to show better profitability ahead of the IPO. Profitability achieved through the latter may not be sustainable.

Similarly, analysing how good the company has been in managing working capital can also be an indicator of efficiency with which company runs its operations

Corporate governance

One of the biggest challenges when it comes to IPOs is assessing the corporate governance. Information you can mine to assess this amidst this constraint is by checking sections like related party transactions, any auditor qualifications, any legal cases against company or its promoters, past track record of the promoters etc. For example while not necessarily a red flag, if promoter as management is taking an abnormally high salary or has taken loans from the company, it needs to be investigated further.

Other sanity checks

Given the voluminous pages, it may still not be possible to gather all the relevant information and you may end up missing something. So searching the prospectus with some key words can be done. For example if the company is claiming to be advanced tech company, ‘patents’ can be a key word to check if the company genuinely owns intellectual property to give it a technological moat. Similarly using company names and other keywords in social media/ websites like Twitter, Glassdoor can bring to your attention something important you may have missed.     

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