IPO growth and rising accounting dangers: Key concerns for institutional buyers
Earlier accounting blow-ups had two widespread traits 1) These corporations significantly resorted to excessive leverage and a couple of) there have been allegations of siphoning of cash (e.g. unwarranted, inefficient capex). Nonetheless, the strengthening governance panorama and the present situation of extra capital availability have introduced each constructive and detrimental modifications to the accounting dangers. Accounting high quality dangers have taken a special avatar in current occasions
On the constructive aspect, each buyers and corporates are conscious of the disastrous results of disregarding good governance; nonetheless, on the detrimental aspect, as extra liquidity offers the chance for important market cap rerating, it additionally motivates accounting gimmicks that are completely different from the earlier ones. Look out for earnings manipulation and excessive associated social gathering transactions dangers.
In a number of cases, there was spectacular income and profitability development within the backdrop of risky or low money conversions. Whereas attaining development required incremental investments in working capital, low money conversions over a substantial time frame may spotlight administration or timing of profitability. Median money conversion of current IPOs (CY21-24) was 65% vs 89% for IPOs over CY13-20, suggesting potential aggressive earnings reserving. 74 corporations (ex. BFSI) have filed DRHPs until 31 Dec 24. 33 out of those 74 corporations witnessed money conversions (3yr cumulative pre-tax CFO/EBITDA) of <50% in FY24.
Taking cues from IPOs that got here for itemizing within the final 11 years, one may discover an attention-grabbing pattern. Till the yr of itemizing, many of the IPO corporations had showcased important gross sales and EBITDA development, nonetheless after itemizing, the expansion fee considerably decreased. Apparently money conversions (pre-tax CFO/EBITDA) of those corporations have been at their lowest when the corporate witnessed spectacular gross sales/EBITDA development and solely elevated as development charges normalized
ETMarkets.comAn organization’s accounting income ought to ideally translate into money flows. A low ratio (i.e. CFO/EBITDA considerably lower than one) ought to elevate considerations concerning the practices adopted by the corporate; these may embrace: 1) adopting aggressive income recognition methods like channel stuffing and reserving income prematurely (i.e. even earlier than the products are literally delivered to prospects) and a couple of) elevated credit score interval supplied to prospects in anticipation of reserving increased revenues and many others.
Additional, First-level screening of their DRHPs means that a number of corporations are getting penalized for top RPT transactions and excessive off-balance sheet dangers. Buyers ought to maintain observe of those ratios to rule out any additional worsening. Key observations embrace 1) 23 out of 74 corporations have excessive contingent liabilities as a % of internet value (>20% of internet value on a 3 yr. median foundation) 2) Surprisingly, 17 corporations have a gross money outflow of >5% of FY24 income to the promoter entities.
One must be significantly conscious of those doable accounting pits in upcoming IPOs.
(The writer Nitin Bhasin is Head of Institutional Equities at Ambit. Views are personal)
(Disclaimer: Suggestions, options, views and opinions given by the specialists are their very own. These don’t signify the views of The Financial Occasions)
