I recently had a long conversation with a friend about initial public offering (IPO) which happens to be the wet dream of many entrepreneurs. As much as I see the mouth-watering incentive of an IPO for the business owners, I never liked the idea of investing in an IPO and I’ve never participated in any exercise. To me, the process of an IPO presents a lot of inherent risks to the investors due to some obvious reasons. For the purpose of an analogy, investing in an IPO is like playing on a baccarat table against the casino with the odds stacked against you. Here are the reasons.

Asymmetric Information

Prior to the IPO exercise, all financial data never go through the same standard of scrutiny and we know that there is so much an auditor can do when it comes to historical numbers. I’m not suggesting that companies would cook their books for an IPO, but I’d imagine the numbers to be heated up to a certain extent. Very often, the idea of an IPO would be planted 2-3 years in advance and the management would manage their finances according to the roadmap. Some decisions would be made (or avoided) in a manner that wouldn’t be done if the management is driven by long-term value creation. Personally, I’ve come across examples whereby certain liabilities are shifted off-balance sheet and potential litigation is deferred to pave ways for an IPO.

I always think that it’s important to know what you don’t know. In the case of an IPO, there is a lot of things I don’t know which the issuer doesn’t want me to know.  

Timing

Almost every business owner would choose to list their business during a bull market, or when his particular industry is favoured by the market. It’s the right thing to do for existing shareholders because they get to exit with good return and the company gets more cash than what it sacrifices in terms of equity. During a bull market, it’s much easier for the investment bankers to sell the stories to the investors and the public sentiment would turn the IPO into a self-fulfilling prophecy.

We all know that all companies have good and bad years, but they only go public during the good years. If the general public only hears and sees good things at the chosen time, it’s easy to form a confirmation bias all other risks are immaterial.

Salesmanship

Companies pay a big fat sum to investment bankers to complete the IPO and underwrite the whole process in some cases. The whole machinery of the bank will kick into action, with glossy prospectus, roadshows and favourable research reports carefully curated to support the IPO. You will often see that the quality of information is judged primarily based on its aesthetic and promotional value rather than its completeness and integrity. It’s generally not easy to evaluate a bunch of information when you know that its source is biased. Have you ever heard from your hair dresser that you look so gorgeous that nothing needs to be done on your hair?

Speculation

Most of the unofficial pitch of an IPO will tell you that the offer price is X, but it will go up by Y% in a short period of time because there is a group of speculators in place to “fry” (i.e. illegal price manipulation) the stock. Some may even boast that the share is actually worth X% over the current offer price, so it’s a once-in-a-lifetime opportunity to make money. I doubt this would happen even if the issuer happens to be a charity.

Now think about this. If the share price is artificially pushed to a certain price, it’s a matter of time it would fall but the promoter would never mention how many percentage drop is expected. Everyone else somehow conveniently forgot to ask this question.

The odds of making money in this way is probably similar to winning a few rounds on the baccarat table. Wouldn’t it be more fun and simpler to just go to the casino?

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A simple logic goes like this. If a company is so fantastic to be worthy of your investment, why not buy its share from the secondary market. The advantage of that is you can turn the baccarat bet into a poker game. Instead of buying shares from the issuer who has so much advantage over you, just buy the same thing from the public which could potentially misprice the share just like how some poker players misjudge their odds in the game. This is possible because the public shareholders don’t have the house advantage (similar access to information) and they could be misled by emotions and many other reasons you never know.

Next time when you think doing a quick slip from IPO, just bear in mind Genting Casino is just 45 minutes away from KL. Just my two cents.