Module 10: ASEAN Finance and Accounting
Table of Contents
Reading Text & Presentation
10.5 Interpreting a company's IPO prospectus report
Interpreting an Initial Public Offering (IPO) Prospectus
Reading long and tedious IPO prospectus isn't very exciting. But it can tell you a lot about a company and its intentions. The prospectus is a legal declaration and so must meet legal transparency standards. Companies try not to mislead potential investors in any way in their IPO prospectus, but they do try to sell the reader on the investment. In other words, the prospectus is a mixture of vital investment information and slick advertising. The task necessary skill for investors is to learn to distinguish between the advertising and promotional verbiage on the one hand, and statements that tell you about the distinct qualities of a company of the company on the other.
10.5.1 Lessons in interpretation
Consider a sample prospectus for an online retailer. We'll start with the "Risk Factors" section, which contains important information for investors. Every prospectus is likely to have some statement saying that figures are based on events the company anticipates, but cannot guarantee. The task for the investor is to determine if what the company anticipates is at all credible.
The Prospectus Says: |
What it Means: |
"Information contained in this prospectus relative to markets for the company's products and trends in net sales, gross margin and anticipated expense levels, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "expect" and "intend" and other similar expressions, constitute forward-looking statements ... actual results of operations may differ materially from those contained in the forward-looking statements.” |
Every forward-looking figure in the prospectus is only a projection. Therefore, there is no guarantee the company will meet all or even any of its targets for sales and profits. |
Because these are just projections and the actual outcomes uncertain, investors need to consider if the assumptions are realistic. If, for example, the company stated in its prospectus that it would capture 10% of the online global dog treat market within one year, as the failed Pets.com did, investors should seriously question the basis for such an assumption and determine whether it is realistic. Forecasting capturing such a huge portion of market sales is almost certainly overly optimistic, and investors would do well to be skeptical.
The Prospectus Says: |
What it Means: |
"...risks for the company include, but are not limited to, an evolving and unpredictable business model and the management of growth .... There can be no assurance that the company will be successful in addressing such risks, and the failure to do so could have a material adverse effect on the company's business, prospects, financial condition and results of operations." |
This company faces significant risks. If it fails to address these potential problems - and this is very possible - there's a good chance that the company will go broke. |
The above statement would likely be associated with a company that has a revolutionary new business model. It is not likely to be found in many other prospectuses, as most companies tend to use tried-and-tested business models. Therefore, a potential investor reading such a prospectus must decide whether the risk of its business model has great potential or is just plain dangerous
Using Pets.com as an example again, it tested uncharted waters with its business model, which is based on selling pet supplies to the masses online. In the beginning, there was a great deal of uncertainty about whether people would actually stop buying from local retail stores and order pet supplies online. Ultimately, it failed and investors lost the whole of their investment. But the same model was used with spectacular success at the same time by Amazon.com, only it sold books instead of pet supplies.
The Prospectus Says: |
What it Means: |
"The company believes that it will incur substantial operating losses for the foreseeable future, and that the rate at which such losses will be incurred will increase significantly from current levels. Although the company has experienced significant revenue growth in recent periods, such growth rates are not sustainable and will decrease in the future." |
According to the prospectus, this company is losing money and will continue to lose money in the foreseeable future. Company growth rates will slow. |
If you find such a statement in a company's prospectus, this is a true gold nugget. It tells you that profits will be negative for some time. This is definitely the type of thing you want to know before investing in a company. If you are still interested in investing in a company that is currently unprofitable, you need to dig deeper to uncover why there are losses and determine what it would take for the company to turn this around.
The Prospectus Says: |
What it Means: |
"This market is new, rapidly evolving and intensely competitive, which competition the company expects to intensify in the future. Barriers to entry are minimal, and current and new competitors can launch new sites at a relatively low cost." |
The prospectus is telling us that this company operates in a highly competitive industry, and one that is cheap and relatively easy for new players to enter. |
The nature of the barriers to entry is unique to each industry, so the above statement offers some very valuable information. Low barriers to entry can lead to fierce competition. If this company manages to turn a profit, it can expect a rival firm to spring up and attempt to take away valuable market share. This creates additional risk for investors.
10.5.2 The bottom line
From the portions of prospectus cited above we know that this company's business model and profits are uncertain, and that the competition is expected to be fierce. These are important factors to know even if an investor can handle the associated risks and feels the company will persevere.
Reading the prospectus means getting through some legalese and long cautionary statements that protect the company more than the investor. However, it's the legal nature of the prospectus that can give an investor some important information about prospective companies, namely the nature of their risks, prospects and industries. When reading a prospectus, pay more attention to information that is unique to the company than information that might apply to almost any public company.
Some useful links about financial organizations in ASEAN can be found in Resource 3.
(Source: http://www.marapets.com/shares.php retrieved 4/7/2014)
Language Focus 10.5
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