In the recent days of economic boom, investors have cashed in small amounts of money into the Initial Public Offering (IPO) and ended up with astounding proceeds. Companies like Kenya Electricity Generating Company (KenGen) and Scangroup have realized more than 300 percent investors. For majority of Kenyans, taking positions on these two counters meant a quick exit on realization of capital gains.  That made investing look too easy, a feature that changed business headlines not only in Kenya but also in the region.

However, experiences in other parts of the globe prove that such a phenomenon could have been the result of a knowledge gap:  the so called market inefficiency.  Kenya’s stock market has been bubbling and is set to keep the pace as we wait for the much hyped Kenya Re IPO and other companies such as Safaricom, Eveready and other profitable companies yet to be confirmed.  As all these opportunities come close to fruition, investors have to belt up for a harsher reality; that investing is not always about making more than double returns within a short period of time. 

Indeed, investing in IPO’s will soon shift from first day sale to for capital gains to a longer-term investment. As more and more IPOs flood the market this last quarter of 2006 and early next year, there is need to be wary of the imminent risks associated with IPOs and not necessarily stocks trading in the secondary market.

One of the points to look out for is the amount of information available on the company being listed.  Such information originates from objective research.  The problem usually is that it is difficult to get information about a company prior to its listing.  A non listed firm will not have a swarm of analysts trying to uncover possible cracks in their corporate armor.  A good example is the KenGen Company.  Prior to its listing, differences still existed between them and the power supplier, Kenya Power and Lighting Company (KPLC) over the bulk tariff.  Now that the entity is listed at the Nairobi Stock Exchange (NSE), everyone is raising concerns about the long term profitability of the venture. 

Caution should be taken when checking the prospectus of a company because the prospectus originates from the company and no opinion is given by a third party. 

It would do an investor a lot of justice to search for information about the competitors, how the company raised its capital, and what the media has had to say about the company in the past. Getting concrete information to support your decision may be hard but if well done, it could make a whole lot of difference and mean a lot to you as the investor. 

There is a rule in investment banking that goes like ‘quality investment banks bring quality companies to the bourse’.  Perhaps that explains why most underwriting deals have in the recent past been going to 3 major investment banks in Kenya.  Without giving examples, any brokerage firm/investment bank will be willing to underwrite a firm that is going public.  Trouble however arises when a small brokerage firm underwrites a company being listed. This could mean that more small retail investors will be more attracted to the IPO than high net worth and corporate investors. 

As much as the prospectus offers biased company information, it is not good to leave it out altogether but analyze it very carefully.  Of the most important pointers to this is the company’s debt position.  If the company has financed most of its capital through debt, then it is likely that their listing is a way of raising money to pay off their debt.  This is a bad sign and a big risk to the shareholders.  While looking at the current balance sheet’s strengths and current earnings, be wary of how the projections vary from the present earnings (forward ratios).  The wider the gap, the more one needs to be concerned. 

According to analysts from most efficient markets, skepticism does pay a lot when it comes to IPOs.  This is because information availability is not always guaranteed which could result to decisions being made based on inadequate information.  In addition, there are always the additional provisions that brokerage firms give their favored clients.  This could shut one out even after he has tied his funds for a period of time.   

When lock-up period exists, there is a legally binding contract that prohibits the underwriters and insiders of a company from selling stock for a period of time which can range from 24-36 months.  The fact here is, a good company will remain so and if the insiders continue holding stock even after the lock up period, then it is an indication that the company will be doing well and is not likely to change.  However, if the insiders start selling off their stock after the lock up period expires, that should cause worry. 

Previously, we barely had a single IPO getting into the market. That has changed and recently, we have had one company going public almost every quarter.  Soon, things might change hence having one company every month. Our market capitalization recently hit the billion mark but that shouldn’t cause any excitement because with more and more IPOs, there will be a mixture of reactions- and not all will be smooth sailing.  But again, ‘an IPO is always an IPO.