Contributors at fool.com.au habitually shy away from Initial Public Offerings (IPOs) because the risks of buying into a new stock are generally greater than buying companies already trading on the ASX.
This is because company insiders are selling something to less informed individuals (participants in the IPO) which naturally puts the less-informed person at a disadvantage. Furthermore, over 50% of IPOs trade below their issue price in their first 12 months, meaning investors can often get a better deal by waiting.
Another IPO crossed my desk yesterday – following on from NATVETCARE FPO (ASX: NVL) last month – courtesy of the folks at my brokerage website.
This one is for MainstreamBPO Limited (ASX: MAI), a fund administrator anticipating a launch on 23 September. It's an attractive long-term proposition, but like any IPO involves a certain amount of faith on the part of the investor.
Here's a brief overview:
- MainstreamBPO has three services, FundBPO, SuperBPO and ShareBPO, which provide administration services to managed funds, super funds, and share registry services for listed companies and exchange traded funds
- Ongoing organic growth thanks to macro tailwinds of rising personal and superannuation investment + increasing number of transactions, etc, in the market
- Potential for growth by acquisition
- Operations in Hong Kong and Singapore in addition to domestically
- Major step-change in earnings expected this year thanks to anticipated contract wins
- 15-25 million shares to be sold during IPO at $0.40 each, which is a minor stake of the 74.5-87m shares on issue at the completion of IPO
- Remaining shares held by company insiders with 50% escrowed for 12 months and remaining 50% escrowed for 24 months
- Proceeds from IPO used to repay loans from management to the company + buy back shares
- The price of $0.40 reflects price of 12.5-14.6x forecast 2016 Net Profit After Tax
The buy case for MainstreamBPO is strong, with long-term tailwinds for its segments and its eventual geographic diversification as well. MainstreamBPO is also certified for participation in the ASX's mFund program, which allows investors in managed funds to trade their units like shares, minimising costs and paperwork.
Additional benefits come from recurring revenue, which makes each new client win that much more important, while client losses could be critical (see risks below).
I anticipate a fair amount of opportunity for MainstreamBPO to grow its market share, especially in the share registry services if it can develop more compelling systems than incumbents. Several of its competitors like Computershare Limited (ASX: CPU) and the privately-held Link Market Services have portals that can only be described as clunky, counterproductive and ripe for disruption.
Along with the potential benefits there are several key risks:
- Management has forecast a 50% increase in revenue based on several major contracts that the company is in 'sole-source' negotiations with
- Offer price of 12.5-14.6x earnings is based on the assumption that management will win these contracts and experience a full year's revenue from them in 2016
- Profit margins are slim, with a Net Profit After Tax margin of 0.8%, 4.7% and 1.6% achieved in 2013, 2014 and 2015
- Margins of 11.1% pro-forma (6.9% statutory) forecast in 2016 (dependent on new contracts)
- 50% of revenue comes from the top five clients*, Magellan Financial Group Ltd (ASX: MFG), Hunter Hall International Ltd (ASX: HHL), Combined Super Fund, Macquarie Group Ltd (ASX: MQG), and Clime Asset Management
- 20% of revenue comes from the company's single biggest client (over 70 clients total)
These are just some of the risks, but they are the most critical. Obviously, a departure of any of the top five clients would have a major impact on revenue and the loss of the biggest client could be disastrous for shareholders.
Additionally, I'm uncomfortable with management basing their issue price on forecast 2016 revenue given that contracts are still in the negotiation phase. While they may be 'sole source' (ie MainstreamBPO is the only tender), I'm of the opinion that if the contract was a 'done deal' there wouldn't be 'negotiations.'
Be that as it may, MainstreamBPO does present a compelling investment case, and is well worth a closer look by investors. PLEASE read the prospectus booklet before participating, and always invest Foolishly (capital 'F').
