Too many IPO valuations are set at fairytale prices and companies floated at these prices will reap the consequences.
Are you sitting comfortably? Then I’ll begin. Stock markets are based on the idea of telling ‘stories’ to sell shares and, at present, markets are excelling themselves.
In the US, for example, the S&P 500 has 33 companies with valuations that require a belief in magic, trading at more than 10 times sales and 20 times future earnings - always supposing there are any earnings.
To put this into context, at the peak of the dotcom bubble there were only 25 such stocks.
These ‘story’ companies are forecast to grow regardless of the global economic realities, while the new ‘virtual’ companies do not even appear to need a profit model that produces a profit. And retailers lend themselves very easily to telling stories.
Markets have short memories (except perhaps in the case of Debenhams) but are driven to extremes by greed and fear. That has created the opportunity for the current wave of retail IPOs, particularly given the frantic desire to find growth in the post-credit crunch world.
The problem is not the stories but the valuations that leave no room for any disappointment. The higher the price you value a business at, the higher the rating it commands and the higher the expectations investors will have of growth.
This almost inevitably leads to unrealistic demands and disappointment, which the City hates and punishes severely. Just as surely as night follows day, a number of the recent successful market newcomers will live to regret their decision to go public.
“A number of the recent successful market newcomers will live to regret their decision to go public”
You could be excused for thinking I would never advise a company to go public. Not true - I see significant advantages in terms of PR, raising money, creating a market in your shares and allowing employees to share in a company’s success.
However, the essential prerequisite is to have a good advisor who is independent and objective. It is never too early to seek advice, and is increasingly critical as the IPO process becomes more transactional and commoditised.
A company must be ready to float both in terms of its management structure and business activities. Full marks to New Look for saying ‘we need to deliver international and ecommerce growth first. We know there’s a window but we need a more solid business’.
Obtaining the highest price is not necessarily the optimum outcome. A float is not an end in itself but a new beginning that brings with it a variety of unaccustomed challenges, disciplines and temptations.
What the City likes is not necessarily the fastest growth rate but consistency and predictability. Hence with the original DFS float in the 1990s I positioned the company to aim to deliver a relatively modest average long-term rate of growth per annum.
With proper advice, the like-for-like hamster wheel and the short-term pressures on decision-making can be managed successfully.
A public listing need not be onerous but think of the process as a marriage - you have to live with the consequences for better or worse and feel comfortable waking up ‘in bed’ with your advisor/broker after the honeymoon is over.