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Skydive the Beach Group Ltd shares skyrocket

Skydive the Beach Group Ltd (ASX: SKB) has seen its shares soar as high as 40% on its ASX debut.

Shares opened at 31 cents, well above their IPO price of 25 cents, and soared as high as 35 cents. Shares have dipped slightly since, currently trading at 34 cents in lunchtime trading.

Investors were clearly buoyed by the fact the company is profitable and expects to pay an initial dividend in October 2015.

Skydive began in Wollongong in 1999 but has expanded to include 11 drop zones in 4 states. In the 2014 financial year, the company had more than 40,000 tandem skydive jumps. The funds raised in the IPO allowed Skydive to expand through an acquisition of Australia Skydive, to offer 16 drop zones and expected to deliver an annualised 112,000 tandem jumps in the 2016 financial year.

Australia Skydive had 47,492 tandem jumps in the 2014 financial year – so the acquisition virtually doubles the size of Skydive the Beach business.

Revenues should also increase dramatically from $18 million in the 2014 financial year to more than $26 million this financial year and an estimated $47.5 million in 2016.

According to the prospectus, there is plenty of scope for Skydive to expand through further acquisitions as well as establishing its own ‘greenfield’ sites – although it will have roughly 54% of the market post-acquisition. Additional acquisitions may require ACCC approval.

As the company also notes, there are very low barriers to entry into the skydiving sector – only needing an aircraft, a pilot, parachutes, an instructor, one person on the ground, an Australian Parachuting Federation (APF) licence, somewhere to take off and land, and the ability to comply with relevant regulations.

That presents a problem for Skydive, as it means if the company generates high profit margins, which will immediately attract competition – with very low start-up costs – and force margins lower.

Unless Skydive can maintain some control over certain attractive locations and have a competitive advantage, then effectively tandem skydives become a commodity product – with price likely to be the key differentiator, much like airline seats. Skydive also has to compete with indoor skydive operators such as Indoor Skydive Australia Group Ltd (ASX: IDZ) – which can offer jumps that are cheaper, all weather and use less equipment.

As such, investors may be getting ahead of themselves. Skydive may do well initially and we wish it the best success, but Foolish investors should be looking for companies with more sustainable competitive advantages. I’m not sure Skydive the Beach is one of those companies. Additionally, at current share prices around 34 cents, the company is trading on a prospective P/E ratio of 25x for this financial year. That doesn’t appear cheap.

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We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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