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Bruce W. Kaser, CFA
February 13, 2020

Opportunities in Busted IPOs

In our August 2017 article about initial public offerings (IPOs), we wrote about the strength of the overall stock market, how this was supporting robust investor enthusiasm for IPOs, and how a large proportion of IPOs were in the healthcare/biotech and tech sectors.  This past April we commented about how the (then) upcoming IPOs would test value investors’ discipline, just as previous hot IPO markets reminded investors that IPO also stands for “It’s Probably Overpriced.”


In many ways, not much has changed.  New offerings remain in high demand, raising nearly $41 billion so far this year, according to Renaissance Capital, a firm that tracks IPOs, and is on track to match last year’s strong $47 billion total.  Some debuts have produced remarkable gains: Beyond Meat (BYND), which produces plant-based meats often seen as a healthier and more environmentally-sensitive alternative to hamburger, surged 840% in the months following its May debut at $25.  Specialty insurer Palomar Holdings (PLMR) trades at more than triple its April pricing at $19.


Yet, some things have changed.  On one hand, investors’ appetite for IPOs have become more stoked, helping to fund ever-more-speculative stocks including microcap biotechs, obscure Chinese companies and special purpose acquisition companies.  The latter, known as SPACs, or “blank check companies,” carry several layers of speculation: they have no operating history yet promise to acquire an as-yet-undetermined company at an unknown valuation.  An expanding offering of SPACs can indicate the approaching end of an IPO boom.


On the other hand, investor have become more discerning, showing fading tolerance for money-losing unicorns with questionable business models.  The iconic (in the wrong way) We Company, former beneficiary of a private equity echo chamber that valued it at $47 billion, now grapples with ignominy.  Similarly, investors frowned at SmileDirectClub (SDC), a do-it-yourself orthodontics company that we’ve written about in the past, pushing its shares steadily downward by more than 60% in its eighty or so days as a public company.  Notable other members of the broken unicorn stable include Uber (UBER) and Lyft (LYFT), now trading well below their respective IPO prices.  Silicon Valley (and perhaps the current owners of a Middle Eastern mega-cap oil company) may be unloading shares at the top of the market, but investors are becoming more assertive in saying, “no, thanks.”


Listed below are four companies with worthwhile products and services, whose shares trade at or below their debut price.  The term “Value IPO” may be an oxymoron, but these stocks might qualify.


Focus Financial (FOCS) – This company is a leading acquirer of registered investment advisor (RIA) firms.  Its growth and profitability have been impressive, as it balances the benefits of centralized expertise with the operational independence of its 63 entrepreneurial partner firms.  The RIA market is ripe for more mergers as generational turnover often prompts a company sale, and as scale is an increasingly important competitive advantage.  Concerns over the firm’s debt (which it is now reducing), limited disclosures (which it is improving), rising competition for deals which can force up prices (Focus is staying disciplined while providing advantages over other bidders) and the sustainability of their growth model (most indications suggest it can continue) may be only temporary, offering longer-term investors the opportunity to participate at an 15% discount to its IPO price.


Graf-Tech International (EAF) – Graf-Tech is one of the world’s largest makers of graphite electrodes, with a 24% share of the non-China-produced market.  Founded in 1886, the company was public until its 2015 acquisition by the highly regarded Brookfield Asset Management. It returned to public ownership with its April 2018 IPO.  Graphite electrodes are critical components in electric arc furnaces used in steel production.  Graf-Tech is the only producer that is substantially vertically-integrated into petroleum needle coke, the primary raw material for graphite electrode manufacturing, which currently is in short supply.  Sluggish global steel production is contributing to the shares’ weak performance.  However, the company is well-positioned for any steel recovery with its low production costs, particularly as electric arc furnaces are gaining market share over traditional blast furnaces due to the abundance of scrap steel.  Its balance sheet is reasonable, with its debt partly offset by $342 million in cash.


Levi Strauss (LEVI) Levi Strauss owns one of the most highly-regarded brands in the world. Its ubiquitous blue jeans are sold in over 50,000 retail locations in 110 countries, as well as through Levi’s burgeoning online business.  Its shares debuted at $17 and surged to over $22 on the first trading day, but that enthusiasm has faded as the shares now trade at their IPO price.  Levi’s otherwise sturdy revenue and profit strength is being obscured by the strong U.S. dollar and some sluggishness in the wholesale channel.  The company continues to invest in its growth initiatives and expand its direct-to-consumer operations and product array.  The shares are valued at a reasonable multiple, and the modest debt is nearly fully offset by cash.  Investors might want to try on Levi’s for size.


Livent Corp (LTHM) – Spun off from FMC Corporation at $17, Livent remains mired in a weak global pricing environment for lithium, its primary product.  Industry suppliers ramped up output to meet the anticipated higher demand for batteries and electric cars, but the demand has not lived up to the hype.  Many analysts expect the glut to last for another year or more.  Investors might want to brush up on Livent as they wait for either a more attractive entry price (the current valuation implies some recovery) or a reversal in the lithium market imbalance.  The company will generate negative cash flow due to heightened capital spending, but it has a solid balance sheet and management appears capable and experienced.

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This article was originally published in our December edition of the Turnaround Letter.  If you'd like to get a free issue of our December number, fill in the form below, and we'll send it along.