Initial Public Offering or IPO of India’s largest life insurer- Life Insurance Corporation of India
(LIC) has been in the works for several months now. A multitude of changes and regulatory measures have been implemented to make the company IPO-ready. With the central government giving a constant push to this big-ticket IPO, its prospectus is likely to be filed next week, going by latest news reports. Market participants are keenly awaiting this prospectus. Though the company publishes its annual report every year, the prospectus will provide much more detailed and latest information.
While LIC needs no introduction and is a household name for most Indians, we present 5 most important topics to read in an IPO prospectus. This guide will help investors make better and well informed investment decisions. More importantly, it will highlight important red flags, if any, for investors to remain alert amid all the hype surrounding the IPO. If the IPO frenzy of 2021 has taught us one thing, it is to exercise enough caution for optimizing the value of our investments. Reading the offer document carefully is one way of doing this.
Where to find an IPO prospectus?
It is available across multiple sources, namely SEBI website, website of the company launching its IPO, website of the investment banker(s) of the IPO, your stock broker and also business news websites. A simple google search typed as ‘XYZ company IPO prospectus’ will lead you to the prospectus document. Download it for ease of use and navigation.
What are the 5 most important things to read in an IPO prospectus?
1)Overview of the company and the industry it operates in
This is where it all begins. Understanding the company’s business, its strengths and weaknesses provides some insights into its future prospects. Investors must try to gauge whether the company has a long term economic moat (competitive advantage) in place.
LIC, though enjoys unmatched leadership in the life insurance space in India, despite tough and rising competition from its counterparts in the private sector. its commands 61% market share in new business premiums and 71% market share in total number of policies of India’s life insurance sector.
Like Warren Buffet says, “Buy a stock the way you would buy a house. Understand and like it such that you would be content to own it in the absence of any market.”
Similarly, understanding the dynamics of the industry the company belongs to and an overview of its competitive landscape is critical. A prospectus contains information about the demand-supply mechanisms, future growth potential and trends witnessed in an industry. Moreover, watch out for any structural disruptions in the sector (e.g. rising digitalization of life insurance companies). It will be interesting to understand in detail the digitalization initiatives implemented by LIC and its future plans to step up its digital capabilities. A key weakness of the company is its traditional mindset, unlike the highly customer-centric approach followed by its private peers.
2)Financial profile of the company
Worry not, you don’t have to go through the detailed financials of a company, typically mentioned in section V of a prospectus. Instead, a quick read of the summary financial information in the Introduction section should suffice. The purpose of reading this information is to understand the revenue growth, margin profile, cash flows and balance sheet strength of the company. Some well established companies also have a consistent history of paying dividends. As a general rule, be wary of companies incurring losses regularly or having huge debt on their books. Also watch out for details around price to book and price to equity ratios, which indicate whether an IPO is valued reasonably.
In case of LIC, you may have to understand terms such as persistency ratio, value of new business and a few other terms which are applicable only to life insurers and helps evaluate their financial performance.
3)Objects of the offer
Appearing in the Introduction section of the prospectus, it explains how will the company use funds raised via the IPO. A company’s plans to use the money for reducing the debt on its books and/or for expansion purposes is generally perceived as a good sign.
Read details about the experience, qualifications, expertise and track record of the company’s founders, directors as well as management team. These details help understand how the company’s strategies are implemented and also highlights the quality of corporate governance practices of the company.
This section appears in the beginning of the prospectus and holds very high significance. Here, the company explains various internal and external risks which can affect its business and financials significantly. While some risks such as impact of COVID might be general and apply to most peers, others are more company-specific. These include high dependence on 1 or 2 customers/industries or geographies, withdrawal of tax incentives, pending legal cases against the company/promoters, details about contingent liabilities, among others. A recent example is where independent decision-making of a government-owned company came under the scanner. The risk factors in the company’s IPO prospectus had clearly mentioned, that its businesses and revenues were substantially dependent on xxx government entity and that any adverse changes in that entity’s policy may adversely affect its business and result of operations.
A key risk in case of LIC is the fact that it is owned by the government and is subject to several rules and regulations. It has often acted as ‘investor of last resort’ in loss-making companies as part of these rules.
The author of this article is Sheetal Agarwal, AVP - Content and Communication, IIFL