6 things to look for in a Draft Red Herring Prospectus

Initial Public Offerings (IPOs) always tend to create a big buzz among investors. The recent IPO for Indian Railways Catering and Tourism Corporation (IRCTC) is a prime example. But when so many companies announce IPOs regularly, it can be tough to identify the right company to invest. Reading the company’s Draft Red Herring Prospectus (DRHP) is a great way to identify whether it has good potential or not.

Also read: What is IPO and advantages of IPO?

What is a Draft Red Rerring Prospectus?

A Red Herring Prospectus, or offer document, is filed by a company to SEBI (Securities and Exchange Board of India) when it intends to raise money from the public by selling shares of the company to investors. The document is very useful to investors because it provides detailed information about the company’s business operations, financials, promoters and the company’s objective for raising funds by filing an IPOs. It also elaborates on how the company intends to use the money that will be raised, the possible risks for investors.

As an investor, here are a few things to look at in a draft red herring prospectus:

Business Description:

This segment talks about a company’s core operations and how it conducts business. As a prospective shareholder, you should pay attention to this part as your investment will be utilised by the company in its core business and you will be entitled to hold ownership of this very part should you choose to become a shareholder.

Also read: Why understanding valuation is key to IPO investing

Financial information:

This is one of the most important segments and contains the company’s audit reports and financial statements. As an investor, the financial statement will help you get an idea of future dividends based on the profits disclosed. You can gauge the safety and profitability of your future investment based on the financial statement.

Also read: What can you learn by analysing a company’s debt profile

Risk Factors:

Companies lists out the potential risks that could impact their business and operations under a section titled ‘Risk Factors’. While many are routinely listed risks, some risks need to be scrutinized. For instance, if you find that the company has a number of pending legal cases, it may be a good idea to avoid the IPO. As an investor, you should be able to read between the lines to identify the real risks that could pose a threat to the company’s growth in the future.

Also read: Challenges-investing-ipo>Challenges in investing in IPO

Use of Proceeds:

Companies announce IPOs for various reasons. Find out what the company intends to do with the capital it raises through the IPO. Does the company plan to reduce its debt, purchase new assets or meet its working capital needs? Also check the capital structure of the company to see if any big private investors have put money into the company.

Also read: Why do companies go public?

Industry overview:

A red herring prospectus carries information about the position of the company, relative to its competitors. The performance trends of the industry to which the company belongs to is also included in the document. If you are looking forward to a particular company’s IPO, you should analyse the various business and economic variables at play, the demand and supply mechanism and the future prospects.

Management:

A company’s prospects have a lot to do with the people who run it. The management is responsible for planning strategies on varied fronts like driving growth, pushing expansions, renovation, marketing etc. This section has details such as names, qualifications, designations about directors, promoters and key management personnel. It may also have information about any criminal cases or that of financial delinquency or pending litigations against these people. It is important to check this section because all these can be a risk factor.

Also read: Fundamentals of company analysis

One related number : 101%

IRCTC made a fantastic debut on the stock market. At Rs. 644, it listed 101% higher than the issue price of Rs. 320. And at the end of the first day, the stock closed at Rs. 728.60 with a market capitalisation of Rs. 11,700 crore. This is the most successful IPO by a state-run company in terms of over-subscription.

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