Are you looking to invest in these new age IPOs? - The 5 Minute WrapUp by Equitymaster
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Are you looking to invest in these new age IPOs?

Jul 8, 2015

In this issue:
» Corporate leverage remains high
» What Fitch has to say about PSU banks...
» Within BRICS, India is unique in its own way
» ...and more!

One sign of a booming stock market is a slew of companies announcing IPOs. Indian stock markets may not have exactly set the pulse racing in 2015, but a general sense of optimism still prevails when it comes to future growth prospects. And it is enough to not dampen the sentiments of companies wanting to come out with public offers.

What makes 2015 a bit interesting is that there are a lot of new age companies with different business models wanting to tap the equity market. So as reported in an article in Mint, you have e-commerce firms, a coffee chain, a payment services firm, a contract research services firm among others; all looking to come out with IPOs. These are the new 'new IPOs' so to speak. The focus is no longer centred only on the traditional companies such as energy, automobiles, metals, power, real estate etc.

These new age companies are businesses, which managed to find funding from venture capitalists (VCs) and private equity (PE) firms in their early days. For these VCs and PE firms, the IPO route is a way for them to exit from their investments.

But what does it mean for investors? One of the things that India can pride itself upon is that it has people with great entrepreneurial skills. Indeed, one of the reasons why the US has become such a force to reckon with was its pioneer spirit and its focus on innovation which saw the birth of global behemoths such as Google, Apple, Walmart to name a few.

And so starting ventures and new businesses is something that certainly needs to be encouraged. And so this access to funding becomes important. The VCs and PE firms in that sense play a critical role here.

When these new age businesses come out with IPOs, it starts to get a bit tricky. Firstly, these are new businesses and so the element of risk is always higher. Second, it could be the first of its type in the business area it is in and so there may not be any comparable company.

However, because these businesses are something new, it always generates utmost interest among the investor community. These are also companies that hold huge promise for robust growth. And this is what lures investors towards them.

But in our view whether a company coming out with an IPO is a new age company or a company with a traditional business model, the basic criteria that need to be looked at does not change. And that is whether the company in question is generating profits. Because ultimately, the valuations that a company will get will depend a lot on the kind of profit it is generating.

So a loss making enterprise is hardly something that investors should consider however strong its growth prospects. Further, just because VCs and PE firms have invested in these businesses because of exciting prospects, does not make a compelling reason for putting your money into them. The e-commerce firms are a classic example of this case where the revenues are growing by leaps and bounds. But none of this is getting converted into profits.

Thus, investors will need to study the prospectuses of these companies thoroughly to gauge the profit making ability of the business model before they take the decision to invest in them.

Do you make it a point to look at the profitability of companies coming out with IPOs? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
India has been very sensible in keeping its debt levels under check since the global financial crisis in 2008. While central banks around the world have been scrambling to print more money in order to stoke the economy out of slumber, the Reserve Bank of India has been conservative in paring interest rates. As a result, India's indebtedness as a % of GDP is among the lowest among emerging and developed countries.

However, high levels of leverage in India Inc remain a point of concern. Additionally, demand slowdown and downturn in the investment cycle have exerted pressure on the financials of companies thereby further constraining their debt servicing capability. This in turn has adversely impacted the balance sheets of banks, particularly public sector banks. As a result, interest rate cuts have not exactly led to a pick-up in the investment climate in the country.

Corporate leverage remains high
Note: Gov. debt data for 2014 are estimates

The fallout of high debt levels in India Inc is being borne by the banks. The financial year 2014-15 has been a really difficult year for the banking industry. However, public sector banks (PSBs) have been hit harder by the piling up of bad loans and slowdown in the credit offtake. Even higher provisioning has impacted earnings, leaving PSBs high and dry for more capital infusion. Going ahead, things should improve as asset quality issues begin to ease off. But according to a Fitch report, a meaningful recovery in the earnings of PSBs is unlikely to happen anytime soon.

The report has said that the gradual improvement in GDP growth rate to 7.8% and 8.1% in FY16 and FY17 should enable an improvement in the stressed assets in the system. But the recovery is likely to remain slow as corporate debt continues to remain high and banks have not been forthright in passing the rate cuts by the RBI. The capital needs of PSBs are also likely to increase substantially each year until 2018-19. To add to this, with the government's decision to recapitalize only the better performing banks, the turnaround in the profitability of PSBs is likely to be delayed further.

India is an integral part of BRICS that comprises Brazil, Russia, China and South Africa as well. But while they are clubbed together as a group, as reported in an article in the Economic Times, there are stark differences between all of them. But is India similar to Russia and South Africa? Or are its prospects more closely linked with that of China? None of the two. For one, India is a democracy. This cannot be said of either China or Russia. When it comes to the economy, there are many differences as well. For one, India is not dependent on commodities and exports the way Russia and China are. And in that sense, has been better insulated than these two countries.

However, that does not mean that India is necessarily better than the rest. For all the advantages that it enjoys, it has not made much headway when it comes to infrastructure or raising the standards of living of its vast population. This is something that has already been addressed in a lot of emerging economies. Having said that, in many other ways India has emerged superior despite various handicaps. For starters, the growth opportunities are quite huge. And many of its entrepreneurs have built great businesses of lasting value. That is why it has become very critical for the government to do its bit and ramp up the infrastructure and business environment in the country. The seeds are there but it requires the right climate and nurturing according to us.

The Indian stock markets opened the day in red on concerns of meltdown in the stock markets in China and continued to fall freely. At the time of writing, the BSE-Sensex saw a modest recovery but continued to trade lower by 353 points (down 1.3%). All sectoral indices are trading in the negative territory with metal and auto stocks being the biggest losers.

 Today's investing mantra
"Successful investing takes time, discipline and patience. No matter how great the talent or effort, some things just take time: You can't produce a baby in one month by getting nine women pregnant" - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Radhika Pandit (Research Analyst) and Madhu Gupta (Research Analyst).

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1 Responses to "Are you looking to invest in these new age IPOs?"

satish chandra bramhe

Jul 8, 2015

yes,I am looking forinvestment in IPOs.generally a common man sees the profitability of the company coming with ipo.Here they commit mistake.Mere good profits can not be regarded as only criteria to invest.Besides profits,there can be other factors to have success in running a unit with profits such as good financial and technical standing.having taken competition into consideration.have done market research, having considered all odds in future,and having good management team.

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