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Pros and cons – Do your homework and evaluate every IPO on a long-term basis

06/06/2014

Ian Kelly

Ian Kelly

Fund Manager, Equity Value

“P2P global investments (P2Pgi) will be the first global pool of permanent investor capital that seeks to profit from the rapidly growing peer-to-peer lending market now beginning to disintermediate retail banking. raising £200m, we forecast P2Pgi will offer a low-risk 2016 [estimated] roe [return on equity] of 10.1% with a dividend yield of 9.3% …”

So begins the 126-page broker research note for the upcoming flotation of a global hedge fund-backed peer-to-peer (p2p) investment vehicle and, let’s be quite clear, everyone is entitled to their own views. It may well be yours is that this Initial Public Offering (IPO) represents every bit the splendid investment opportunity those who wrote the research evidently consider it to be.

Here on The Value Perspective, however, our view is somewhat different – and not just because of our misgivings about the P2P sector previously outlined in articles such as Chinese takeaway. As a rule, we tend to translate much of the IPO-related literature we receive as saying: “Dear potential investor, here is a new and untested idea and, to test it, we would much rather use your cash instead of ours. It goes without saying it is your capital that will be at risk if it all blows up although, if things do work out ok, we will of course be charging a performance fee.” As a general point, we would also add that, when brokers focus on metrics that relate to the return on an investment rather than the safe return of an investment, it does make us nervous.

Meanwhile, on the specifics of this particular IPO, there are a number of areas where potential investors might want to do some further investigation. For starters, the prospectus states that up to 50% of the proceeds could be invested in trade receivables, which – being very much a wholesale industry – does not sound very peer-to-peer to us.

In the past, The Value Perspective has invested in trade credit insurer Euler Hermes, which despite (or because of) its century of trade credit experience exited trade receivables financing years ago. Its reasoning was this is a cost-of-funding business so the banks with zero-cost deposits will always be willing to lend cheaper – and the companies the banks reject are not the ones you want.

Another question mark we see hovering over this IPO relates to the fact the small business fund into which the top fund will invest currently charges a weighted average interest rate of 38.5%, according to the prospectus. Here on The Value Perspective we have to wonder – and you might like to as well – whether businesses that need to pay that sort of rate can and indeed should remain in business.

And while we are engaged in this sort of analysis, we might also wonder whether trade receivables lending via online platforms is such a great idea in itself – not least because, as the prospectus tells us, “Platforms that lend to corporations conduct due-diligence but do not always conduct on-site visits to verify that the business exists”.

As a final point, while a 15% performance fee may serve to align the fund manager’s interests with those of its investors, what effect – particularly in combination with a 1% management fee – will that fee have on the compounding of its investors’ returns?

Come to think of it, there is some irony in introducing a middleman into a process being championed for “disintermediating retail banking” and … no, let’s leave it there. Look, we are not offering any kind of specific investment advice here – only the most general of counsel that potential investors do their homework and evaluate the pros and cons of this – and any other – IPO on a long-term basis.

We also concede we may be going too early in our caution on P2P lending and may be dismissed as naysayers for some time – those who had made money from tech stocks in 1998 spent two years telling us we were wrong. So, if you believe you can trade this fund’s shares over the short term, go ahead – knock yourself out. Here on The Value Perspective, however, we want to own the assets we buy for years and, as such, need to be both confident in their long-term prospects and comfortable with their associated risks.

Author

Ian Kelly

Ian Kelly

Fund Manager, Equity Value

I joined Schroders European equity research team in 2007 as an analyst specialising in automobiles. After two years I added the insurance sector to my coverage. In early 2010 I moved into a fund management role, and then took over management of two offshore funds investing in European and Global companies seeking to offer income and capital growth. 

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