On 16 June 2017, HRnetGroup’s IPO on the SGX Mainboard created much hype among retail investors and local finance bloggers. Many investors had wanted a slice of the IPO because of the excellent financial performance indicated in the prospectus. But many investors may not be aware of Temasek Holding’s Pre-IPO investment in HRnetGroup.
What is pre-IPO and does it matter to you from the perspective of a stock investor? Read on to find out how the big boys make money in this game.
Fundamentally, how big boys like Temasek Holdings make money is very different from retail investors in the market. Most of us made money upon selling the shares allocated during IPO. But then again, there is no guarantee that you would be allocated the IPO shares because for the public, the shares are allocated through balloting. There is also no assurance that the share price would rise above the IPO offer price. In short, for the man in the street, it is like punting when it comes to IPO.
However, pre-IPO works in a different manner. Big boys like Temasek Holdings want certainty in their return of investments and they also want to win the game. In return for a sum of initial capital, they would demand for a portion of the IPO in the form of pre-IPO shares. Usually the pre-IPO shares would be offered at very dirt cheap level, maybe at only a fraction of the IPO price. After two or three years, the big boys would slowly divest their shares at market price to make explosive profits.
Hence, big boys make money at the point of buying the pre-IPO shares because of the safety margin given to them. This is how the rich become richer.
Most investors have been asking why HRnetGroup chose to go for equity financing instead of debt financing. They don’t realize that pre-IPO is the real money to be made for both the listed company and the big boys.
Take for example, HRnetGroup offered placement of 85.6 million shares to private investors while only 3.8 million shares to the public. Imagine if the placement shares were offered to the big boys at only $0.05 per share and then few years down the road, the big boys decided to divest the shares at market price. The profits would have been explosive.
Apart from institutional players like Temasek Holdings, some of the private investors may be accredited investors. These are the people with certain income level or net personal assets. Previously I have written a few articles on how to qualify as an accredited investor.
- Scary truth about accredited investor rule
- What does being an accredited investor mean in Singapore?
- Hellfire from Swiber Bond and Lehman Brothers MiniBond
Effectively, big boys like Temasek Holdings create money out of thin air through such mechanism. Institutional players like private equity, hedge fund or sovereign wealth fund are not interested to manage the firms because their goal is basically to make money out of their investments. Thus, they would usually have some exit strategies. So be wary when the whales flip and don’t be get caught by the waves.
Being the first recruitment agency to be listed in SGX Mainboard, the financial performances for HRnetGroup seemed to be solid at first glance. But upon deeper examination, things were not exactly that rosy. Current assets had been declining from $189 million in 2014 to $176 million in 2016. On the other hand, current liabilities increased from $46.8 million in 2014 to $81 million in 2016. Perhaps the acquisitions made over the years had impacted the balance sheet. At Net Asset Value (NAV) of only $0.109, the IPO offering price of $0.90 looked inflated.
Analysts may argue that the business model is asset-lite and thus it is unfair to use NAV as a gauge to value HRnetGroup’s worth. Indeed, as a recruitment agency, the key assets are the employees and not the equipment. However, it should be noted that the recruitment industry is a low-entry barrier sector. It is not difficult for HRnetGroup’s employees to strike out on their own and form rival companies once they learn the rope.
Nevertheless, revenue had been rising since 2014, from $324 million to $365 million in 2016. What I like about this company is that its business is very profitable and able to generate cash. Net cash from operating activities increased from $40.2 million in 2014 to $53.4 million in 2016. As the business do not need huge capital expenditure, HRnetGroup is able to use the cash to fund more overseas acquisitions and thus drive higher revenue in the future.
Then many investors may ask why equity financing and not debt financing? After all, HRnetGroup has been self-funded through cash generated by their business, without any debt financing. In each of FY2016, FY2015 and FY2014, their operating activities generated substantial cash even after adjustment for working capital requirements and capital expenditures. To answer this question, one must not view this issue from the perspective of solely expenses.
It is true that debt financing generally incurs less cost when compared to equity financing. But let us not forget that the stock market is a platform that offer opportunities for companies to raise capital. Pre-IPO and IPO are just two of the various means for companies to raise capital. Then there are rights issues, bond offering, preference shares, etc. So, the opportunities to raise more fund is greater through a stock market listing rather than getting bank loans.
Overall, the growth potential of HRnetGroup is there if the management play the game well. There are certainly risks – such as economy downturn, currency fluctuations, competition from rivals and technology disruptions. However, with Temasek Holdings’ backing, I am convinced this counter would do well because for the foreseeable future, the sovereign wealth fund would want to grow this pot of gold.
HRnetGroup could be an interesting stock to invest but I would place this counter under monitoring for at least three more years to gauge the performance of its management. Till then, enjoy the ride.
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