Alton Towers-to-Legoland operator Merlin Entertainments (MERL) has got off to a decent start with life as a listed company. Its shares rise 10% to 346.13p on its market debut, valuing the business at £3.5 billion.
Today's dealings are marked as 'conditional', meaning that trading is restricted to institutional investors like pension funds and investment banks and retail investors who took part in the IPO offer. The broader investment community will be able to freely trade the shares from next Wednesday (13 November) when dealings go 'unconditional'.
The IPO was priced at 315p which was the upper half of its 280p to 330p expected price range. We're pleased to see that the stock hasn't galloped ahead like Royal Mail (RMG) and Twitter's (TWTR:NYSE) market debuts. It perhaps shows that investors are paying closer consideration to the fundamentals behind Merlin and its risk/reward outlook.
Royal Mail was simply priced cheaply so the IPO would get away smoothly. The high dividend made it a no-brainer that the stock would initially fly. Now the euphoria has died down, investors should remember that Royal Mail's success is totally dependent on cost cutting which could be a lot harder than you think, given the strong labour union interference.
Twitter's 90%+ gains in early trading yesterday were simply ridiculous. The business is loss-making so why should it deserve a $24 billion valuation.
We'll take a closer look at the Merlin investment case in a forthcoming issue of Shares. But on first glance, we do like the business proposition. It is well positioned to benefit from a recovery in consumer spending and stronger economic conditions in Europe and the US. The ongoing capital expenditure requirements mean that investors won't get much of a dividend, but this is a long-term, global growth story so investors should be compensated through capital appreciation.
Stockbroker Numis earlier this week initiated coverage on Merlin with a 'buy' rating and 360p price target. It reckons 'material' shareholder value will continue to be generated from capital investment in rolling out its Midway Attractions brands (which include Madame Tussauds and SeaLife), Legoland Parks and themed accommodation. Numis adds: 'If it increases EBITDA from the current estate at 5% annually and hits its return on new business investment targets, it should be able to grow group EBITDA by 10% per year over the medium term with mid-teens EPS growth.'
As we wrote last month, best-in-class companies deserve premium valuations, as per our positive stance on Whitbread (WTB). Merlin certainly falls into this category. Yet as always, investors mustn't buy a stock simply because they like its brands. You must always look at how the stock is valued and the risk/reward profile.
Market opinion has been split so far on Merlin with many commentators nervous about the company's high debt and high operational and financial gearing – read our feature in this week's Shares to better understand the concept of gearing. If you want to research Merlin further, a good starting point is its prospectus. You can download the (302 page) document here.