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Is Inghams Group Limited set to be the next disastrous IPO?

Photo: Cowgirl Jules

Based on the experience of recent larger Initial Public Offerings (IPO), I reckon Inghams Group Limited (ASX: ING) shares could rocket higher on 7 November, when the stock lists on the ASX. If that happy event occurs, shareholders might want to consider claiming their ‘stag’ profit and finding a better place to invest.

As with a number of IPOs in recent years, the initial share price movement on a company’s debut has correlated quite poorly with the prospects of the business in question. Shares in Adairs Ltd (ASX: ADH) jumped 11% upon debut around 18 months ago, but plunged today after a profit downgrade. Shares in Surfstitch Group Ltd (ASX: SRF) also rose steadily after listing, but are now down 81% since late 2014.

The work of nefarious private equity sellers?

It’s easy to pin the blame on private equity sellers like Texas Pacific Group (TPG) and The Carlyle Group. I tend to allocate blame here myself, mainly because average household investors are not always equipped to analyse what private equity is selling.

Healthscope Ltd (ASX: HSO), Estia Health Ltd (ASX: EHE), and Spotless Group Holdings Ltd (ASX: SPO) are just a handful of recent private equity IPOs that have all tanked after around two years of listed life.

Yet I’m not sure private equity is 100% to blame. The above IPOs have come unstuck in a wide variety of ways, including being overpriced by the market (Healthscope). Operating ‘aggressively’ and attracting unwanted regulatory attention (Estia). Operating poorly and potentially misleading shareholders (Surfstitch). High competition (Adairs), and poor acquisitions and restructuring (Spotless). Surfstitch wasn’t even a private equity IPO.

Perhaps it would be more accurate to say that if a newly-listed company is overpriced for its growth or is otherwise a poor prospect, it takes around 18 months to 2 years for this to work its way through to earnings and share prices (given that companies are dressed up quite carefully for their IPO debut).

Below we can see that each of these IPOs plunged at around the same crucial 18-24 months mark (chart only goes back to July 2015 because this is when Adairs listed).

source: Google Finance

source: Google Finance

Is Inghams Group next?

That’s the billion-dollar question. I have already outlined my thoughts on the Inghams float in some depth here.

Another way of looking at the company is this:

Private equity firm TPG says (implicitly, via its prospectus) that Inghams is a great business. TPG ownership has turned the company around, sales are up, there’s $200 million in cost savings (2x as much as total profits this year) coming, and demand for chicken is growing at 4% per annum. Increasing demand for processed chicken is expected to support margins into the future.

Inghams is such a good company, in fact, that if shares are 20% higher than their IPO price 6 months from now, 1/3rd of TPG’s shares (approximately 8% of the company) will exit escrow. All of TPG’s shares exit escrow in 12 months’ time regardless, meaning they become available to be sold.

If previous practice is anything to go by, TPG will sell its shares as they exit escrow. I’m uncomfortable with owning the kind of business where a 20% rise in the share price is a potential signal for a major shareholder to sell 1/3rd of their shares. That’s not investing.

If the experience of some of the other IPOs we’ve seen in recent years is any guide, Inghams Group might start to nosedive around 18 months from now, once its top five customers (which account for more than 50% of sales) start talking pricing and competitors Steggles, Baiada, and TEGEL GRP FPO NZX (ASX: TGH) start talking market share. As Inghams revealed in its sensitivity analysis, just a 1% decline in the average selling price of its chicken would result in a whopping $16.7 million (approximately 17%) decline in Inghams’ profits.

source: Inghams Group prospectus

source: Inghams Group prospectus

Foolish contributors don’t often recommend selling to ‘lock in’ a quick profit, but if I had money in the Inghams’ float that’s a course of action I would be tempted to take. Of course, shares could also plunge when they list, which would be even worse.

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. 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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