IPO Investments: Precautions for Investing in Deficit-Making Companies

IPO Investments: Precautions for Investing in Deficit-Making Companies

It is becoming increasingly common for many innovative companies leading the 4th Industrial Revolution era to record operating losses at the time of their listing. Investors must clearly understand the reasons for these companies' sustained deficits and possess an analytical framework to objectively assess their future growth potential. Ahead of the 'Chaevi' IPO subscription, we conduct an in-depth analysis of the nature of investing in deficit-making companies and key information for making successful investment decisions.

Background for Innovative Companies Recording Losses at the Time of Listing

Companies pioneering new markets through technological innovation tend to prioritize growth over profitability in their early stages. While this inevitably leads to short-term deterioration of financial indicators, it can signal high growth potential from a long-term perspective.

Innovative companies bear significant initial investment burdens to secure future market dominance. Companies in key 4th Industrial Revolution sectors such as Artificial Intelligence (AI), Big Data, Biotechnology, Renewable Energy, and Platforms invest heavily in R&D and initial infrastructure to secure leading technologies and capture future markets. For instance, biotech firms developing new drugs require tens to hundreds of billions of won for clinical trials alone, and developing next-generation AI algorithms demands vast computing resources and specialized talent. These expenditures occur before revenue generation begins, commonly resulting in short-term operating losses. Companies with an R&D expense ratio exceeding 10% of total revenue are actively engaged in such strategic investments.

Furthermore, aggressive marketing and intensified competition for talent are major contributors to deficits. In a rapidly changing market, innovative companies stake their survival on aggressive marketing and business expansion to gain a competitive edge and build exclusive market dominance, or 'moats.' Platform companies launching new services or startups introducing new technologies often spend heavily on advertising and promotions to acquire early users, while also offering stock options or high salaries to attract key personnel. While these growth strategies can accelerate top-line growth, they also lead to increased selling, general, and administrative (SG&A) expenses in the short term, significantly worsening profitability. In particular, initial marketing costs for acquiring subscribers to new services, or rising personnel costs to poach key technical talent from competitors, appear as increases in SG&A expenses on financial statements.

Recently, the trend of prioritizing growth potential over financial soundness before listing has strengthened. In the past, it was common practice to achieve profitability or at least secure a stable financial structure before raising funds through an IPO. However, with growing investor interest in high-potential new technologies and growth companies, there's an increasing number of cases where companies are listed based on high future growth expectations despite being in deficit. This aligns with the expansion of 'growth-oriented listings' or 'Tesla listing' models. For example, HYBE (formerly Big Hit Entertainment), Kakao Games, and SK Bioscience, which listed in 2021, all achieved successful listings with high subscription rates despite recording significant losses or low profitability at the time of their IPOs. This trend indicates that investors are placing greater value on long-term growth potential than on short-term financial metrics.

Evaluating Growth Potential and Essential Investment Checks

Even for companies incurring losses, several key analytical factors must be thoroughly examined to assess their potential for a successful growth story. It is crucial to objectively evaluate the company's intrinsic value and future revenue-generating capabilities, rather than solely focusing on its current financial status. First, an assessment of the market competitiveness and entry barriers for core technologies must precede other evaluations. Analysis should focus on the extent to which the company's core technologies are competitive in the current market and what differentiates them from similar technologies. For example, it is important to determine if an innovative drug candidate for a specific disease is superior in efficacy and safety to existing treatments, or if AI technology has the potential to significantly improve productivity in a particular industry. Furthermore, a thorough review is needed to ascertain if the company has established strong entry barriers (moats) that competitors cannot easily replicate, through patents, exclusive technology licenses, or the expertise of its core research personnel.

Verification of business model scalability and revenue-generating capabilities is also essential. Even if initial losses are accepted, the company's business model must demonstrate scalability in a sustainable manner, and a clear roadmap for how it will generate revenue in the future must be confirmed. For platform businesses, even if user acquisition is the initial focus, they must show potential to diversify revenue streams through advertising, transaction fees, or subscription models later on. In this process, it is important to judge based on objective indicators such as changes in revenue structure, new business plans, and projected break-even point (BEP) achievement timelines. Additionally, by analyzing management's leadership and financial management capabilities, it's necessary to assess their ability to present a long-term vision and drive innovation. Leadership can be understood through the founder's vision and the industry experience of the core management team, and specific fundraising plans and shareholder value enhancement measures to overcome the current deficit status must be confirmed through documents like the investment prospectus.

When making actual investments, a cautious approach using detailed guides for prospectuses and registration statements is advised. Key information for IPO investments is contained in the prospectuses and registration statements disclosed on the Financial Supervisory Service's Electronic Disclosure System (DART). Thoroughly read these documents for the company's business overview, risk factors, and financial status, and critically review how realistic the projected future revenue growth rates are compared to industry averages or competitors. Pay particular attention to identifying discrepancies between performance projections and market conditions. It's essential to examine whether the company's future performance projections adequately reflect current industry trends, such as the AI semiconductor market, or changes in the competitive landscape. Overly optimistic projections require re-verification with a conservative perspective.

Finally, attention must be paid to managing post-listing stock price volatility and liquidity risks. IPO shares of deficit-making companies often surge immediately after listing due to high initial expectations, but they also have a high probability of sharp declines if actual business performance falls short of expectations. Therefore, a long-term investment perspective is required, considering not only the initial trading price volatility relative to the offering price but also the unlock of lock-up periods and market liquidity for a certain period after listing. A large volume of tradable shares post-listing can exert downward pressure on stock prices, so it is imperative to minimize risks by checking the proportion of floating shares and the lock-up periods of major shareholders before making investment decisions.