Nuix debacle puts fundies back on high alert

Fund managers have updated their IPO playbooks to protect themselves against dud floats. Here’s what is in their financial analysis armoury.

If Nuix isn’t already considered Australia’s most disastrous sharemarket float, then the latest controversy must surely tip the scales in its favour.

There have been a string of initial public offering horror shows since the listing in 2009 of Myer by private equity giant TPG (which announced on Thursday it is planning a float itself).

But the Nuix debacle once again has fund managers back on high alert. Assessing an IPO has always proved a real test for institutional investors. They must balance two competing emotions: hope, and cynicism in the face of relentless management and stockbroker promotion who feed on their “fear of missing out”.If they’re too hopeful, fund managers are left holding a dud stock inviting the tag that they’re the greater fool. If they’re too cynical, they risk missing out on a short-term pop, underperforming their peers, and being tagged grumpy and risk averse.So how do institutions deal with IPOs that are marketed aggressively by stockbrokers aided and abetted by blanket public relations campaigns to accentuate the positives?

One experienced fund manager, who sidestepped Nuix, applies a simple but intuitive approach to screening IPOs. If the funds are being used primarily to fund growth and investment, then on balance it has the potential to be a good investment. If the business is founder-led and has long-term leadership, that’s another plus.

However, if the float is intended to monetise previous purchases or to reduce onerous debt loads, an investor may have the potential to make a short-term gain from aggressive marketing, massaged numbers and subsequent deals.

But over the long run these investments tend to fall into the dud category once the escrow period has passed.

Some IPO red flags, according to the manager, are short holding periods for vendors, acquisitions, material dividends and high-profile director appointments just before going public.

Changes to accounting policies – in particular R&D capitalisation – and allusions to large total addressable markets or growth plans that don’t have significant capital committed also tend to be signs that the float isn’t built to last.

Another IPO error, according to published research from Montgomery’s small caps manager, Gary Rollo, is to invest in the “hot themes” of the market. Over the past 12 months peppered by lockdowns, that’s included meal kits, e-commerce retailers and buy now, pay later.

He says these floats can look good in the short run but eventually the hot money that chases the deal looks elsewhere and a solid investor base often doesn’t exist at a price anywhere near the IPO price.

Rollo called out two hot thematic stocks that proved to be dud IPOs: one was Youfoodz which came to market to capitalise on the boom in meal deliveries. It floated at $1.50 but has since lost 70 per cent of its value.

Another was a company that came to market with an arguably unhealthy dose of fanfare and adulation: internet retailer Adore Beauty. Adore’s IPO was “opportunistic”, Rollo says, as it was acquired by private equity a short time before listing.

The company downgraded expectations before delivering its full-year financials, “a sin not easily forgiven by institutions”.

“Adore Beauty is arguably now an illiquid micro-cap with a lot to do to re-build its reputation with investors after its warning that it’s not growing at the rate investors expected,” wrote Rollo.

Do IPO disasters ever recover? Sometimes a good management team overseeing a decent business does genuinely struggle with the transition to public life where there’s less tolerance for even small surprises.

It’s worth remembering that Facebook’s 2012 listing was a disaster, so much so that Mark Zuckerberg reportedly moved his mortgage away from Morgan Stanley, which managed the sale (the remarkable reveal is that he had a mortgage).

Closer to home, Collins Foods was an IPO that went pear shaped in 2011 as it more than halved in value within a year. But it has since proved a good long-term investment.

That is the exception rather than the rule. Most failed IPOs languish for years with little attention. And after investors got sucked in by Nuix, it may take some time before they let their guard down again.