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Should you buy Dick Smith?

Owners of consumer electronics retailer, Dick Smith, are expected to retain a 50% stake in the business after relenting to pressure from potential investors.

The memory of the performance of Myer Holdings (ASX: MYR) and Collins Foods (ASX: CKF) after their IPOs, in which their private equity backers completely sold out, is still front of mind for many investors. Myer has yet to reach its listing price of $4.10 after 4 years and is trading well below that level currently.

Private equity firm Anchorage Capital Partners is reported to be keeping its stake until at least Dick Smith’s next earnings period. Dick Smith CEO Nick Abboud is also reported to be keeping his entire stake now.

The Australian Financial Review (AFR) reports that one of the strongest supports of Anchorage keeping a stake was the joint lead manager, Goldman Sachs. The investment bank is even reported to have considered walking away from the deal altogether, if Anchorage and management didn’t retain a substantial stake. Anchorage will instead sell 50% of its stake.

The AFR also reports that the price has also been lowered to a price earnings multiple of between 12 and 13 times, compared to JB Hi-Fi’s (ASX: JBH) P/E ratio of 16 to 16.5 times.

But investors need to have their eyes open with this float. Anchorage is reported to have reconsidered its stake, so that it can get the IPO away before Christmas while demand for new listings remains hot. That sentence alone indicates that retail investors may want to pass on this float until the company has gone through at least one reporting season.

Another issue with Dick Smith is that investors should be wary of the extremely quick turnaround that Anchorage has managed with the business. Anchorage is reported to have doubled earnings before interest, tax, depreciation and amortisation (EBITDA) within just 12 months, since buying it from Woolworths (ASX: WOW) for just $20 million in 2012.

Our main concern is the quality of the business. Arguably, JB Hi-Fi and Harvey Norman are better consumer electronics retailers, so why would you want to invest in the third string company? Additionally, Dick Smith has announced it will be taking over the electronics departments in David Jones (ASX: DJS) department stores. But DJs had been contemplating closing those departments down. It will be interesting to see how Dick Smith plans to turn that trend around.

Foolish takeaway

Institutional investors may have been sucked into the float of Dick Smith, but that doesn’t mean retail investors need to as well. Investors might want to sit this one out until the business model has been proven to be profitable.

A better bet that Dick Smith?

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

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