Sometimes, initial public offerings (IPOs), or floats, don’t float at all – they sink. While this is a blow to the hopeful “stags” who hoped for a quick profit, a poorly received float can be a bargain situation for those who turn the situation to their advantage. Here are three such situations from 2021 floats.
1. Lynch Group (LGL, 3.29)
Market capitalisation: $405 million
FY22 expected dividend: 3.9%, fully franked (grossed-up, 5.6%)
Analysts’ consensus valuation: $4.80 (Thomson Reuters), $4.60 (FNArena)
Lynch Group is a unique stock on the ASX, which can be a difficult situation for analysts and investors, as comparisons are difficult. The 100-year-old company is the largest distributor of flowers and potplants in Australia, primarily through the supermarket channel, and the largest grower of premium flowers in the Chinese market. Lynch Group is the largest importer of floral products into Australia. It operates seven flower farms, using state-of-the-art greenhouse technology.
Lynch Group has been active in China since 2004, building its first processing facility in 2008, and developing its first farm in 2012. The company now has four farms in the Kunming region of Yunnan province in South-West China, covering 61 hectares, supported by local procurement, processing, logistics and sales teams. Lynch is the largest premium rose grower in China, and the Chinese operations now represent 38% of its earnings base. The Chinese retail floral market is estimated to be worth about $19bn, compared to Australia’s $1.37bn.
At home, the Lynch Group strategy is all about changing the way that Australians buy flowers and potted plants, pushing that more toward the supermarket channel. In the UK, the company says, 55% of all floral products are sold through supermarkets. In Australia, that share is 19%, but it’s growing quickly – LGL expects that over time, the grocery channel will approach the share of the total floral market that is currently achieved in the UK. However, it also supplies general wholesalers, florists and the online market, through its four hubs, located in Melbourne, Newcastle, Canberra and Brisbane.
Lynch Group was floated, by the Lynch family and private equity shareholder Next Capital, in April at $3.60, raising $206 million. On listing the shares dropped to $3.50, but by August, they had recovered to $3.80 – however, LGL has subsequently slid to $3.29. The company was hit by COVID-19 slowdowns, and there is also the “China factor” hanging over any company with a significant business in China; on the first issue, the November AGM heard that the company was now “operating at or above pre-lockdown sales volumes” in Australia.
The AGM heard that the expansion of the Chinese growing operation was “proceeding on time and budget” and that Lynch Group would have an additional 18 hectares of greenhouses fully planted and operational by the end of June 2022, with a new processing facility to manage the additional volumes to be completed and operational by the end of January 2022. A further 10-plus hectares of greenhouse space is planned for construction in FY23. That will increase Lynch Group’s ability to give the huge Chinese market year-round supply.
On FY21 reported numbers, revenue came in 4.7% above prospectus forecast, EBITDA was 12% ahead, and net profit was 12.7% above forecast, at $32.4 million. (This figure is NPATA, or net profit after amortisation expense.) At the AGM, Lynch Group reaffirmed its NPATA guidance for the twelve months to December 2021 of between $31.6 million–$32.6 million, being the remainder of the prospectus forecast period, would come in on-target with the prospectus forecast. As expected from the prospectus, there won’t be a dividend for FY21, but Lynch Group expects to begin paying dividends in March 2022 (that is, an interim dividend for the first-half of FY22), and it will be targeting a dividend payout ratio of at least 50% of annual NPATA.
I think Lynch Group is a really good story and great value after its post-IPO difficulties. Just today, for example, broking firm Ord Minnett released its first analyst report on the company, with a “buy” recommendation and a price target of $4.70.
2. Pepper Money (PPM, $2.00)
Market capitalisation: $892 million
FY21 expected dividend: 5.8% (level of franking not known)
Analysts’ consensus valuation: $3.30 (Thomson Reuters), $3.075 (FNArena)
Pepper Money, a non-bank residential mortgage, asset financing and consumer lending company, was floated by its parent, Pepper Financial Services Group (owned by private equity giant KKR), in May 2021. Issued at $2.89 a share, PPM opened at $2.61, and, apart from a brief surge to as high as $2.80 in August, it’s been mostly downhill for the share price, which currently sits at $2.03.
Pepper Money was priced attractively – at just 10.5 times forecast 2021 earnings – but floats were struggling a bit at the time. The company operates in a very competitive market, but its strength is that it focuses on “under-served” customer segments – Pepper Money specialises in “non-conforming” (or “specialist”) loans, which are those to self-employed borrowers or customers with poor credit history. The company says it leverages its market intelligence data and proprietary loan-decision “engine” to design products and make lending decisions for these segments. At the time of listing, PPM’s loans were 59% “prime,” 34% “near-prime” (borrowers that have some negative credit history events) and 7% “specialist”.
The prospectus forecast the total asset (lending) book to increase by 11.5% to $16.8 billion in calendar 2021, with total operating income (net of losses) forecast to increase by 4.3%, to $332.7 million, and net profit forecast to rise by 13.6%, to $120.7 million. A dividend of 9.5 cents was projected for 2021, yielding 3.3% at the issue price: it is to be “franked” – the level of franking was not forecast. The company forecast net interest income to decrease by 4.1% in 2021, to $259.5 million, with the net interest margin (NIM) forecast to slide from 2.53% to 2.3%, amid general expected NIM compression in the lending market.
There’s no question that Pepper Money has been a mostly disappointing experience for the IPO subscribers, with the stock trading at $2.00, down 31% on the issue price. But a lot of the margin and competition pressure appears to be well and truly priced-in to the shares, while the volume growth ignored. According to the analysts that follow the stock, Pepper Money is great value right now, at about 6.3 times expected 2021 earnings, and a dividend yield (franking level uncertain) of 5.8%.
3. PEXA (PXA, $17.10)
Market capitalisation: $3 billion
FY22 expected yield: no dividend expected
Analysts’ consensus valuation: $23.00 (Thomson Reuters)
Fast-growing e-conveyancing (digital property settlement) business PEXA was spun-out of parent Link Administration Holdings (ASX: LNK) in June, in a $1.2bn IPO – the biggest since 2018 – that gave it a $3bn market capitalisation. Link hived-off PEXA as a response to a takeover bid from a private equity consortium, which criticised Link for under-valuing the technology business.
PEXA was, and is, very highly regarded as a business: it has a virtual monopoly position as the $300bn paper-driven property conveyancing industry moves online. The platform has plans to expand into New Zealand and the United Kingdom, and there are quite a number of features that the company intends to add to the PEXA platform.
In the financial year ended June 30, PEXA processed 2.3 million property transfers, up 51% on FY20, and 650,000 refinances, up 11%. Its volume grew by 37%, compared to total market volume of 19%, and PEXA’s share of the transfers market rose from 66% to 80%. The final FY21 figures for revenue and EBITDA came in ahead of prospectus forecasts, with revenue up by 42%, while PEXA made a net loss of $4.9 million, in line with the prospectus estimate. PEXA makes a gross margin of 87%. At its annual general meeting (AGM) in November, PEXA reaffirmed its FY22 prospectus forecasts, of revenue of $246.9 million, EBITDA of $107.6 million and underlying net profit of $19.6 million.
PEXA’s float did not go smoothly: embarrassingly for the company, the platform went down on the eve of the listing, but that did not wholly explain the poor reception for the shares. Issued at $17.13, PXA shares opened at $16.68, before recovering to $17.15. But by September, the shares were trading at $14.85, a 13.3% discount to the issue price, which tells you that Link and the sponsoring brokers got the pricing wrong.
That discount has almost been closed, and the shares are nearly back in the black; so, it’s take-two for investors. PXA should always have been a long-term prospect, and that’s how investors should view it. If it does proceed with a meaningful expansion into the UK, that will require a big investment to achieve the scale required; but PXA is a very successful business, and investors should be looking at the platform’s potential beyond just dominating the property transfers market, and the rewards it could win by emulating this in New Zealand and the UK, and more into leveraging the unique data position it gains from doing so. While it would have been nice to have picked the September bottom in PXA, the market now appears to be more comfortable with the stock, and now sees it as justifying the issue price. The only price target in the market is $23.00 – and that’s from Barrenjoey, which was one of the sponsoring brokers in the IPO – but even taking that with a pinch of salt, PXA appears to offer attractive value.
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