Shrewd investors can still find value in IPOs

In addition, company owners – be they private equity or entrepreneurs – often wait for a window of opportunity created by strong valuations before filing an IPO.

Predictably, last year’s strong returns sparked a boom in issuance not seen for some time. This has been especially true with private-equity owners since many have pipelines of divestments that they have been waiting to monetise since the financial crisis.

According to the London Stock Exchange, IPO issuance on the LSE totalled £4.3bn in Jan to March, following £6.9bn in the fourth quarter of last year. This compares with a total of £12bn in 2013, of which just £1.6bn took place in the first quarter of that year.

So what next? Theory would have us believe that we can potentially expect weak returns to continue for the next few months, now that the market is tipping from hot to cold following a period of high issuance volume.

However, shrewd investors should bear in mind that IPO market cycles are not uniform across sectors. Notably, the recent boom in volumes sparked by last year’s remarkable initial returns was particularly strong in technology firms. According to Dealogic, in the first quarter of this year, global technology and internet-related IPO volumes reached $9.3bn (£5.54bn) – their highest first-quarter total for 14 years.

Despite an environment in which some people still have significant sums to hand, the fundamental disciplines of investment have come into play. Investors want proven management teams, with strong strategies and compelling equity stories that are sensibly priced.

Every financial market participant is aware of what happened in the dotcom bubble. Promises of high growth, combined with a low base of tangible assets and often a dependence on popular trends (think Candy Crush), make for a risky IPO investment and a real potential for overpricing. Technology stocks have led the equity market’s decline for precisely this reason.

Just Eat, initially valued at more than 100 times earnings, priced its IPO at 260p at the start of April, and recently has been trading as low as 200p. Boohoo.com, which saw its shares bounce up to more than 85p in its mid-March IPO from an issuance price of just 50p, has since underperformed, falling well below its offer price in recent trading.

However, not all of the IPOs in the past year have been from technology and internet companies. IPO activity here has been increasingly driven by sectors exposed to the upturn in the UK economy; our economic growth is outstripping that of the rest of Europe and is expected to remain robust in the coming year. Unemployment is falling, and real wages are showing signs of recovery for the first time since the crisis.

Aside from the obvious Royal Mail example, UK-exposed companies have been performing well compared with their internet peers. Leisure group Merlin Entertainments and retailer Poundland, for whom we act as in-house broker, are both trading comfortably above their respective offer prices.

Additionally, although technology stocks have been underperforming in general, shares in SafeCharge, whom we advised on its IPO in early April, are trading above offer price, showing that even companies in this sector, if underpinned by a solid business model, can deliver good performance.

But what of companies with strong UK exposure and a strong growth element to their stories? The domestic banking sector is surely a prime example of an industry that is bound to benefit from the improving British economy.

TSB’s launch of its ITF last week, along with the flotation of OneSavings, has given investors a choice between banks with very different characteristics – and other banking sector offerings are expected in the pipeline.

TSB, which is being carved out of Lloyds Banking Group, will have a retail element in its offering via intermediaries, but because of its growth plans may offer no dividend until 2017. It is employing an interesting sales tactic to encourage retail interest, dubbed in the media as “buy 20 shares, get one free”. Tapping retail investors in an increasingly difficult market is a sensible idea, and while offering them a discount for loyalty is attractive, the mechanism might be considered a little gimmicky.

OneSavings, formed after the recapitalisation of Kent Reliance Building Society, is luring investors by targeting a dividend payout ratio of 25pc or more, which provides confidence in management’s expectations of sustainable cash flow to fund the payouts. The choice for retail and institutional investors to consider between the two offerings is whether the scale of TSB is preferable to the smaller, more agile OneSavings.

With a wide variety of choices available on the market today, value can still be found in IPOs by sensible investors who carefully select companies supported by robust fundamentals.

Howard Shore is chairman of Shore Capital Group

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