Is it a good idea to invest in a loss making IPO?

Nowadays IPO market is hot. A lot of companies are filling Draft Red Herring Prospectus (DRHP) with the Sebi for IPO approval and benefit from the rising market. The bull market provides a healthy premium to the companies through IPOs and help them raise funds, avail listing benefits. In order to derive premium valuations, various manufacturing entities, digital platforms and futuristic theme-based companies file DRHP.

Investors usually check company’s financials before investing. Compare the firm’s valuations with the listed peers to rightly price the new issue. Valuation parameters start with the profit variable of the company and a firm that is unable to report profits is not considered a viable investment option. Normally, companies that file for IPO are profitable and dilute their holdings to get cheaper funds for capital expansion, augmenting working capital requirements or to get an exit. Recently, few digital loss-making companies have filed for IPO. Fast food restaurant chain Burger King, a loss-making company, got listed on Indian bourses recently. The upcoming IPO of Zomato is huge, but a loss-maker is going to make its debut this week. Forthcoming IPOs of digital platforms like Paytm and Policy Bazaar are not profitable too. In spite of reporting losses these IPOs have got a strong response from investors but have left various questions in the minds of retail investors and tier-2 and tier-3 potential investors.

Can a loss-making company file DRHP?

Yes, a loss-making firm can file for IPO. If, its restated losses are not more than the total value of assets. Moreover, it should not be under the Board of Industrial and Financial Reconstruction (BIFR).

Why digital platforms are loss-making in initial years despite strong revenues?

Initially, the tech platforms spend heavily on employee acquisition, advertisement & sales promotion and sophisticated technology.

> Skilled employees remain less interested in joining start-ups. Therefore, tech platforms pay higher salaries to bring employees on board.

> Tech platforms spend heavily on advertising to increase the reach of their offerings and sales promotion expenses to attract a lot of customers.

> Companies spend heavily on bringing sophisticated technology to augment their operations.

Is it good to subscribe to a loss-making IPO?

Investing in a loss-making IPO takes a lot of courage. The feeling of fear and anxiety is expected to reach their high levels while investing in a loss-making IPO. However, there are various factors that can trigger investment decisions.

> Indian economy is the second-largest country of population and claims to provide abundant opportunities perpetually.

> Internet penetration is rising with pace, which is a major catalyst that is increasing reach of the brand.

> The rising penetration of smartphones has increased their scope to a number of people through their AI-powered applications.

> Usage of these applications matches the busy schedule requirements of the urban population.

> Increasing per capita income has increased the purchasing power of the general public and it has increased their dependency on unconventional platforms.

> These tech platforms are supported by effortless UI/UX experience and powerful systems that can be handled by public of all ages.

How to value the ongoing and upcoming loss making IPOs?

Investing has always been critical and the rising digital platform culture having loss-making financials has made the valuation part more cumbersome. Usually, net profits are the centre point for valuation parameters and its absence can dampen the conventional process. In order to make it simple follow these principles to value a loss-making.

> Initiate the process by analysing revenues. Incremental growth in revenues state the rising popularity of products.

> Digital platforms spend heavily on employees and advertisement initially. But, after a period of time expenses get reduce. A decrement move in revenue/employee expenses and revenue/advertisement expenditure approach projects high operational efficiency of the firm and calls for a turning point to profitability in future.

> As the profits are in a negative trajectory it better uses enterprise value/EBITDA (Earnings before Interest, Tax, Depreciation and Amortization) parameter. If EBITDA figure is also negative better to shift for EV/Sales parameter.

> Compare the EV/EBITDA or Sales parameter with the listed, unlisted and global peers to get an inter-firm comparative analysis.

> There are a lot of IPOs an investor may find outperforming the peers on the basis of these parameters. Still, it is better to remain cautious before investing in a loss-making IPO.

(The writer is founder and CEO at INVEST19, views expressed are personal)