ScanGroup IPO - July 2006

ScanGroup has posted the prospectus online on July 12 which is 5 days ahead of schedule.

Salient Points - My observations (read at your own risk & do your own research!) in Blue:

• KShs 10.45 per share. Priced to sell i.e. the price will attract many investors like the "cheap" shares solely on account of price & not fundamentals!
  
• 9 Million "new" shares will be sold to raise KShs 74 Million for ScanGroup. These funds will go to reduce debt, increase working capital & for acquisitions.
  
• 60 Million shares will be sold by the "Vendor" (Bharat Thakrar - CEO & founder) for KShs 584 Million. He is cashing out a good chunk of his shares. Plus he will still own an additional 45 Million shares after the IPO thus effectively he is a Billionaire! Our first (public) media BILLIONAIRE! Not a bad deal... This listing will open the eyes & doors for other private businesses to go public as a way to cash out.
• NAV of KShs 1.58 (Price = 6.61 x NAV) High ratio for listed Kenyan firms & there will be little left for ordinary shareholders if ScanGroup goes under! Nevertheless, in this business it is the earnings/creative talent that counts. How do you value creativity & ideas?
  
• EPS 2005 = 0.96 thus P/E of 10.88 Not cheap but in line with many other listed firms on the NSE. Was it "boosted" for the IPO?
  
• EPS 2006 (estimate) = 1.05 thus P/E of 9.95 Not cheap but in line with many other listed firms on the NSE. An estimate is just that... an estimate!
  
• AJL White (Creative Director) is not selling his shares but has "contributed" 3 Million to Bora Services (an ESOP-like structure). The shares will vest after 5 years for the benefit of Key Management. Hopefully, this will keep the Key management on board for at least 5 years. Thakrar contributed 12 Million shares towards Bora. Venkataraman contributed 3 Million shares to Bora - though he is sole beneficiary in 5 years.
  
• High dividend payout since this is not a capital intensive business. A bad year can mean reduced dividends thus the shares could be volatile.
• Management team is relatively young. Bodes well or new ideas but ScanGroup will experience poaching by other firms (thus the Bora incentive!)
• Most MDs & GMs of the subsidiaries are not Kenyan e.g. A.J.L White, S. Ambegaonkar, S. Venkataraman, M. Shah, S. Sundaram, P. Sham, etc. Why aren't there more Kenyans? Anyway, the incentive to stay on in Kenya is not as strong for expats as for Kenyan managers thus reduces the expats' loyalty to ScanGroup.
• Executive compensation (2005: KShs 25 Million) will increase substantially as the management feels they were underpaid as "owners". How much more? This also disincentivises management since lower profits does not necessarily reduce their income.
  
• Shares in the IPO: 5% reserved for employees, 45% reserved for corporate buyers & 50% for individual investors. I would have preferred all investors (corporate & individual) be treated as equals thus "spreading" the wealth. To reduce costs for ScanGroup & BT the minimum application should have been for a minimum of 1,000 shares.
  

Pros

• Promoters (Thakrar & White) will not be able to sell (except with "permission" from the Company (ScanGroup) any shares for 3 years. Even then only 25% of their shares. They can dispose of all their shares after 5 years. Note that BT+AJLW control ScanGroup so it might be "easy" to get permission from themselves!
• Key Management has incentive for prices to rise in the long-term since the value is locked in the shares' value in 5 years. Basically the higher the price in 5 years the more the Management makes! This is a HUGE incentive for the longer-term. But we do not have access to the documents thus they may be clauses that allow opt-outs.
  
• The economy is geared for growth for the next 2 years leading up to the elections. Whereas there are always chances of pre-election violence, I don't think Kenya will see it on a large-scale. Spending on ads will increase as we see American-style electioneering e.g. DSTV carried Raila's ads. The savviest firms will be used by all politicians to make themselves look good. The ads will cut across all mediums!
  
• Increased viewership on TV means slicker ads thus increased profits. The big guns can afford the fancy equipment for these ads. BTW, the smaller shops will become very competitive with falling technology prices & greater computing power. This is a very real threat to the "Production" department of ScanGroup.
  
• Regional expansion esp by multi-nationals who prefers one firm doing all the PR & marketing instead of finding new partners in each market/country. Potential is huge for ScanGroup as incomes rise in the greater E.African region e.g. Uganda, Rwanda, Congo, etc.
  

Cons

• The salaries are going to be pretty high (i.e. direct costs will increase regardless of profitability). The promoters have taken a pay rise but the new salaries are not revealed in the prospectus.
  
• Section 6.4 (ii) seems to ALLOW for INDSIDER TRADING! I would appreciate someone reading the section & providing their interpretation!

Bottomline
Buy - at least for the short-term since there is a dearth of IPOs. Expect lots of speculation but support from the underwriters.