Dick Smith Holdings Ltd shows why investors should avoid IPOs

Private equity firms are in the business of investing in companies that can be sold for a huge profit.

Apart from exciting new ventures or technologies, private equity firms also invest in existing businesses which are poorly run or struggling. The aim for such investments is to inject capital into the business so that it can be successfully turned around and then sold for a healthy profit. On average private equity firms hold their investments for a period of five years.

Private equity IPOs take place only when a private equity firms decides to exit the investment. Many famous names have been sold by private equity firms through IPOs, Myer Holdings Ltd (ASX: MYR) and Kathmandu Holdings Ltd (ASX: KMD) are two such names.

From an individual investor’s stand point, the key thing to decide is whether companies which are sold by the private equity firms through IPOs are being sold at a reasonable price. History does show that many IPOs are fully priced.

Two recent examples of a disappointing post IPO performances are Dick Smith Holdings Ltd (ASX: DSH) and Spotless Group Holdings Ltd (ASX: SPO). Dick Smith’s shares plunged in a black hole on Monday, after the company announced a massive write-down on inventory and a profit downgrade. Spotless’s share price also faced a similar fate after a profit downgrade.

Dick Smith’s share price is trading 81.38% below the December 3 2013 IPO price of $2.20. Spotless Group’s share price is trading 22.04% below the price at which its IPO was floated in May 2014.

And Myer Holdings is trading at 68.7% below the IPO price since its debut in November, 2009. After all who can forget Jennifer Hawkins on Myer’s IPO prospectus?

Many investors have suffered losses, from their investments in Myer, Dick Smith and Spotless. This raises a lot of questions about the IPOs being launched by the private equity firms. Such losses may deter investors from the new IPOs being issued by the private equity firms.

Foolish takeaway

Personally I never participate in IPOs, as they are almost always fully priced and rarely offer a margin of safety. Private equity firms are in the business of maximising profit and will continue to do so as they are running a business. So a Foolish investor could do better if they buy a share post IPO, only after its price has fallen to a sufficient extent, which will allow a margin of safety.

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Motley Fool contributor Qaiser Malik has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. 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.

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