I have never understood the retail interest in Initial Public Offerings. For every star IPO, many more disappoint or burn investors with overhyped pitches.
For my sins, I covered IPOs for nearly a decade for the Australian Financial Review, analysing several hundred and compiling the paper’s annual IPO special. Lots of small floats were garbage and some prospectuses mixed fiction, fantasy and fact.
Like a house sold at auction, IPOs are often “dressed up” to maximise the sale price. No vendor pours money into an asset getting readied for sale. Worse, investment and other costs are cut, to inflate earnings and the company’s valuation, causing longer-term operational damage.
It’s not until a year or two after listing – sometimes sooner – that cracks emerge. By then, key vendors of the IPO, often private equity firms, have taken their profits and exited.
Small IPOs have other challenges. The Australian share market has a habit of consigning disappointing floats to the small-cap graveyard for years. Drop below the IPO issue price by too much, for too long, and the market gives up on the stock. That can be an opportunity.
Aftermarket profile and stock liquidity are other factors. Even small IPOs attract attention when their promoters get in front of financial advisers, investors and the media. When the IPO lists, research coverage of it falls or stalls, weighing on stock turnover.
Escrow dates are especially important with small-cap IPOs. ASX Listing Rules sensibly require restricted securities in IPOs to be placed in escrow. Restricted securities can include those issued to seed investors, promoters, vendors of certain assets and so on.
The upshot is that early investors in small floats cannot sell all or some of their shares until a year or two after listing. Applied on a case-by-case basis, the rule stops investors who bought shares at 1 cent, for example, dumping them at listing when the issue price is 20 cents.
IPO investors in small floats are sometimes shocked when the share price tumbles after the escrow anniversary and early investors, itching to cash in, sell their stock. That too can be an opportunity if seed investors sell when the company is undervalued.
Perhaps the biggest challenge is most stock in the best IPOs going to institutional investors or high-net-worth clients of the float’s lead manager. If you get offered lots of stock in a tiny float, chances are professional investors have looked at it and passed.
By now, you probably think I’m completely against IPOs. Far from it. There have been some wonderful IPOs over the years: Commonwealth Bank and CSL, for example. Every float should be treated on a case-by-case basis; blanket rules destroy wealth.
Excellent returns can still be found in the IPO market. A few of my best ideas for the Switzer Report – IDP Education and Reliance Worldwide Corporation – listed on ASX in the last few years and I still follow the IPO market closely.
My preferred strategy, however, is waiting until small-cap IPOs list and have more history as a listed entity and financial accounts subject to regulatory and market scrutiny. There are always exceptions, of course, and IPOs worth buying before listing.
But some high-quality, small-cap IPOs can be dumped after listing for no good reason and are far better value when the market forgets about them.
The Straker example
Straker Translations (STR) could be one of them. The translation-services platform sought $21.2 million through an IPO on the ASX in September 2018 at $1.51 a share.
The stock popped to $1.85 soon after listing, before tumbling to $1.20 during the fourth-quarter CY18 market sell off. Straker now trades at $1.17 on low volume.
There wasn’t much news to warrant the fall. In its November half-year presentation, Straker re-iterated it was on track to meet prospectus forecasts, as expected. The company’s actual pro-forma revenue slightly exceeded prospectus forecasts in the nine months to March 2019.
Perhaps the market expected more: some IPOs leave a little earnings “wriggle room” so they can under promise and overdeliver soon after listing to pump up the price. I prefer companies that play it straight and do what they say they will in the prospectus.
In February, Straker acquired Com Translations Online, a Spanish audio-visual translation company, for NZ$742,500 and an earn-out. The deal takes Straker into the video translation market and I like that it is an all-cash transaction; there was no dilutive equity capital-raising issue to buy the business.
The NZ-based Straker is an interesting business. Founded in 1999, it has developed a cloud-based, hybrid language-translation platform. Known as RAY, the platform helps human translators deliver faster and more accurate translations, and bigger margins for Straker.
RAY uses artificial intelligence to produce a first-draft machine translation, then uses one of its 13,000-plus human translators worldwide for the next review, then another human review. Essentially, Straker uses advanced technology to speed up human-led language translation.
The market for language translation was estimated at US$43 billion in 2017 and is expected to grow to US$67 billion, according to forecasts in Straker’s prospectus. Globalisation, the boom in online content, e-commerce and regulation are driving growth in language translation.
Consider a mid-sized Australian company that wants to expand overseas. It needs to replicate its website across ASEAN countries and in China and India. Website content, marketing materials, press releases, contracts and so on must be translated for those markets. It might also have explanatory videos that need translation.
Although translation technology is rapidly improving, it’s likely we’ll need a mix of human/AI translators for some time, particularly with important corporate documents – hence Straker’s hybrid translation model. Google translation services won’t be enough for this market segment.
Straker is no Appen, a star AI provider of language-technology data and services. Capitalised at $2.66 billion on ASX, Appen’s three-year annualised total shareholder return is 132%. Speculators hoping Straker is the next Appen will most likely be disappointed.
But the $62-million Straker looks well run and governed and has benefited from having venture capitalists as investors and on its board. ASX-listed Bailador Technology Investments was an early investor and reduced its holding from 20.4% to 14.1% after the float.
Straker is growing organically and through small acquisitions offshore. Europe, the world’s largest translation market, now contributes the largest share of Straker’s revenue. The business has 122 employees in 10 offices in Europe, the US, Asia and Trans Tasman, and a genuine, expanding global footprint – usually a feature of high-growth small-caps.
Slide 14 on Straker’s latest investor presentation caught my eye. It shows Straker’s business model and operating leverage in action. The company charges clients by the word and pays its translators an hourly rate. As the AI technology learns, it is capable of translating more words each hour, but the hourly rate for human translators has been mostly flat for the past few years.
Straker averaged 1,023 English words translated per hour into French in CY18, up from 469 words in CY15. Over time, this higher word count boosts Straker’s volumes and margins, potentially supercharging profits.
I suspect the market has underestimated other aspects of Straker. First, the value of having a relationship with 13,000 translators worldwide and being able to draw on translators in lower-cost markets.
And second, the immense distraction of an IPO and how small-cap management teams have so much more time for the business after the listing is done.
To be clear, Straker suits experienced investors who understand the risks of micro-cap IPOs and lower-liquidity stocks. This is not a stock for conservative investors or those who cannot tolerate volatility, short-term price falls or recover from capital loss.
Straker made a small loss in the first half of FY19 and there are always potential landmines when emerging ventures try to grow rapidly in global markets. The stock should be considered speculative and receive a portfolio allocation that reflects the risks.
Moreover, there is no obvious catalyst to re-rate Straker in the next few months, excluding a takeover. Straker looks like a neat bolt-on acquisition for a larger global tech firm but buying companies solely on the basis of takeover speculation is dumb.
Also, 27.6 million Straker shares were subject to escrow in the IPO and cannot be released until the company’s half-year FY20 results in November 2019. That could trigger selling if early investors decide to exit, but much will depend on Straker’s price at the time.
Either way, Straker is worthy of a spot on portfolio watchlists for investors who like to track promising micro-caps. The stock’s early performance has disappointed IPO investors, but prospective investors would be buying it 22% below the issue price.
Straker looks to have more substance that many micro-caps with similar valuations. The company has almost $20 million in cash and a high proportion of repeat revenue growth, meaning it should be able to fund small acquisitions internally – another good sign.
Chart 1: Straker Translations
Source: ASX
Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without considering your objectives, financial situation or needs. Before acting on the information in this article you should consider its appropriateness, regarding your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 3 April 2019.
