IPOs – Losing Sheen?

Posted in Finance Articles, Total Reads: 1783 , Published on 29 October 2012
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In 1977, Ponds came up with its Initial Public Offering, listing its share at a premium of Rs. 10. The stock rose 3650 % within 90 days, making participants of its IPO rich beyond their imagination. But can today’s investors expect something even close to this? Are there enough IPOs happening, that atleast out of chance, one might turn out to give such extreme gains? We have analyzed the current scenario and presented in this article some hindrances that exist to IPOs in the present day.

 

Current Scenario

In 2012 till date, 22 companies have called off their IPOs. This list includes companies of considerable size such as Reid & Taylor, a unit of textiles firm S Kumars Nationwide Ltd, auto parts maker Tata AutoComp Systems, home-grown mobile handset maker Micromax Informatics, realtor Embassy Property Developments, gold jewellery retailer Joyalukkas India, logistics firm VRL Logistics, engineering, procurement and construction firm Aravali Infrapower, IT solutions and services firm Semantic Space Technologies and Pride Hotels Ltd. These companies aimed to raise Rs 8392 crores together through their Initial Public Offerings. As the applications are valid for just for a year after the Securities and Exchange Board of India (Sebi) clears them, these companies will now have to lodge a fresh application if they wish to float a public issue since their applications lapsed on March 31, 2012.

Last calendar year 29 IPOs were cancelled. These IPOs had aimed to raise a capital of Rs 32,400 crore. IPOs in FY2011-12 were paltry, even though the number of issues was sizeable (34 firms) raising only Rs 5,892.88 crore -- the second lowest since FY05, during which as few as 23 companies raised Rs 14,662.32 crore. The worst performance in recent years has been in FY09 when the collapse of US-based investment bank Lehman Brothers had sent the global markets into a tailspin and in that period, 21 companies could raise only Rs 2,033.99 crore through IPOs.

Since last year, companies including Samvardhana Motherson, Goodwill Hospitals, Plastene and Galaxy Surfacants have withdrawn their IPOs from the market due to poor response. The Samvardhana IPO saw a subscription of only 0.23 times, Plastene India’s IPO was subscribed only 0.28 times.

Of the 10 IPOs that have made it to the market in 2012, 5 are trading at prices below their respective listing price. Only 9 issues from the 37 IPOs of 2011 are trading above their listing prices. Of the 73 issues that got listed in 2010, 68 are currently trading below their listing prices.

Some reasons:

There are some reasons that can be attributed to such a bad recent past that the IPO market has had. Though overall economic uncertainty has been a major reason, there are several other reasons too, some of which are mistakes on the part of the issuer and some on part of the investors too.

In the part of external environment, factors such as rising inflation, sliding rupee, widening fiscal deficit, contracting IIP numbers and policy paralysis are causing the secondary markets themselves to be in a dire state. This is robbing much of the investor confidence and making them hide in defensive investment and not making them ready to take part in the primary market activities.

In the part of the company issuing the IPO, several IPOs have received very low subscription rates solely because of the investors feeling that the stock is overpriced. Some companies are trying to adopt the IPO route to raise capital even before getting their fundamentals stable. This when coupled with over valuation utterly puts the investor off.

Price rigging is the next main reason why investors fear to invest in IPOs of small firms. Certain firms use improper means to inflate the bidding price by using fake bids. Retail investors who see heavy bidding, which are actually fake bids, think that there is heavy demand for the stock and end up subscribing at higher prices, only to later see themselves trapped at these higher prices and forced to sell low.

Instances of misuse of funds generated from IPOs by certain smaller firms towards promoters’ personal uses such as debt clearance have been surfacing in the recent past. These add to worries of the investor and refrain a certain section of investors from participating in IPOs.

In the part of the buyer, a good chunk of the retail investors see IPO as a shortcut to making huge gains. Though this was the case in the pre-liberalization era when prices were controlled by a regulator who would severely underprice the issue and investors were bound to make windfall gains, this is not the case where the prices are fixed by the merchant bankers. People who are seeing not much immediate bumper gains in the IPO are not willing to take the risk and stay in the secondary markets.

In the global level, volatility in 2011, especially as the euro crisis shot up during the second half of 2011 and S&Ps downgrading of US caused volatility to shoot up. Famously measured by the CBOE volatility index (VIX) indicates the degree of volatility present in the market. High VIX induces sufficient fear and uncertainty that IPO markets are usually temporarily closed down.

Due to the several reasons stated above, it is required of the retail investor to carefully scrutinize various aspects of the firm before subscribing for its IPO. Things to look at include size of the firm (larger well established firms are usually safer to invest), fundamentals of the firm (in terms of history and recent profits and revenues), trustworthiness of the merchant bankers involved and the end items to which the firm proposes to allocate the funds generated from the IPO(This is an important aspect as any deviation towards allotment of funds in the future can be taken as a direct cue to something wrong, unless it is properly justified by the management)

In the side of the firms, they have to keep the deal clean and transparent. Much of the success lies in correct valuation for the stock and proper pricing. Equally important is timing the IPO. As the windows in which successful IPOs can be offered (times when investor confidence is high and they are ready to invest) are usually very small, firms should be on the constant lookout for this window and be quick to finish the offer before the window expires.

Qualified Institutional Buyers:

The participation of QIBs in IPOs is a critical factor for the performance of the IPO. A maximum of 50% of the shares can be issued to QIBs in an IPO but in the recent past this number has rarely been achieved. Out of 37 IPOs in 2011, only three IPOs had the QIB portion subscribed more than two times the 50 % subscription quantity. The number of shares held by QIBs in the 2011 issues, after listing, now varies between a paltry 10% and 25% of what they had originally bid for.

The government has a 30 day lock-in period for QIBs during which they cannot sell their shares in the open market. Many QIBs take advantage regulatory loopholes to withdraw bids when they do not find the issue to be attracting buyers. This misleads the retail investors as SEBI only provides data for bids placed and not for the revised bids. There is no lack of availability of interested QIBs in the market which was proved by the 91% subscription of QIB quota of the MCX issue but the problem has been that these investors haven’t been interested in smaller firms leading them to call off the issue or worse withdraw due to under-subscription.

Disinvestment

The government’s disinvestment program has been in shambles. They were well below their target of raising Rs 40,000 crores from the market last fiscal until the ONGC issue covered up a major portion but still the total came up to only Rs 14,000 crores. Even from this, disinvestment of 4.9 % stake of ONGC resulted in Rs 12,800 crores, majorly from LIC which came to the rescue of ONGC and bought its shares at an expensive price.

The government is planning to raise Rs 30,000 crores this fiscal. But in order to raise this high an amount, the government will have to improve upon its strategy. The government has to consider the following factors before coming up with their next issues:

  • Setting a justified base price

The ONGC issue was priced too high and failed to attract investors. The retailer investors need to feel satisfied with the valuation of the firm in terms of the base price. Only in that case interest can be ensured.

  • Choosing an appropriate time for the issue

The current environment has been marred by domestic and global worries. The government has to postpone any immediate plans of disinvestment until the scenario improves. Coming up with an issue at a wrong time might mean under-subscription or the valuation falling drastically in a short period.

Qualified Institutional Buyers:

The participation of QIBs (qualified buyers who are generally considered a safer investors from the offering company’s point of view and generally invest large amounts) in IPOs is a critical factor for the performance of the IPO. A maximum of 50% of the shares can be issued to QIBs in an IPO but in the recent past this number has rarely been achieved. Out of 37 IPOs in 2011, only three IPOs had the QIB portion subscribed more than two times the 50 % subscription quantity. Moreover, QIBs sellers who take part in the issue sell off the stock as soon as they find an opportunity in the market. The number of shares held by QIBs in the 2011 issues, after listing, now varies between a paltry 10% and 25% of what they had originally bid for. The reason is not certain, whether they revised their bids downwards or sold shares after listing.

The government has a 30 day lock-in period for QIBs during which they cannot sell their shares in the open market. They have also increased the amount to be paid upfront for their bid from 10% to 100%. SEBI forbids these investors to withdraw their bids but they allow revision of bid number to ‘nil’. Many QIBs take advantage of this loophole when they do not find the issue to be attracting buyers. This also misleads the retail investors as SEBI only provides data for bids placed and not for the revised bids. Many QIBs wait until the very last day of the issue and watch for the response from the retail investors and bid accordingly.

The regulator needs to act fast in order to rescue the primary markets from being manipulated by the QIBs as they constitute a large number of buyers. Some of the possible measures include:

  • Restricting the revision of bids once placed by the QIBs in order to prevent them from revising their bids to nil at the last moment
  • Increasing the lock-in period to a larger period so as to reduce the sell pressure faced by many issues after the one-month lock-in period
  • Disbursing of information regarding withdrawals and revisions of bids, if this method is continued to be followed, to recognize the investors regarding the current bid pattern
  • Reserving a minimum number of shares for bids placed by QIBs, so that only the ones really interested buy the issue

There is no paucity of interested QIBs in the market which was proved by the 91% subscription of QIB quota of the MCX issue but the problem has been that these investors haven’t been interested in smaller issues leading them to call off the issue or worse withdraw due to under-subscription.

Disinvestment

The government’s disinvestment programme has been in shambles. They were well below their target of raising Rs 40,000 crores from the market last fiscal until the ONGC issue covered up a major portion but still the total was way off at Rs 14,000 crores. From the money raised through disinvestment Rs 12,000 crores were raised from LIC which came to the rescue of ONGC and bought its shares at an expensive price.

The government is planning to raise Rs 30,000 crores this fiscal. But in order to raise this high an amount, the government will have to improve upon its strategy. The government has to consider the following factors before coming up with their next issues:

  • Setting a justified base price

The ONGC issue was priced too high and failed to attract investors. The retailer investors need to feel justified with the valuation of the firm in terms of the base price. Only in that case interest can be ensured.

  • Choosing an appropriate time for the issue

The current environment has been marred by domestic and global worries. The government has to postpone any immediate plans of disinvestment until the scenario improves. Coming up with an issue at a wrong time might mean under-subscription or the valuation falling drastically in a short period.

Sebi recently put out stringent public issue norms for bankers. To enable investors to take better decisions while shelling out money, the market regulator has recently made it mandatory to disclose the track record of the bankers and the pricing rationale for all public issues. This assumes significance in the backdrop of the poor performance of newly listed stocks through IPOs. In FY2011-12, 31 IPOs got listed, but only 10 managed to yield positive returns on their offer price when markets closed last week

We feel that with factors like rising inflation, the sliding rupee, contracting IIP numbers and policy paralysis, the secondary markets are themselves in a dire state, and no immediate respite is expected. Thus, no let up can be expected for the primary markets either. The real problem with IPO's are pricing, very aggressive pricing is first and foremost reason for the very bad performance of these IPO's. The pricing of the IPO's are based on current market fundamentals and ratios, the numbers are for the future operations. This method of valuing IPO based on current market valuations and fundamentals does not leave any room for the further appreciation of the stock. It left the stock only one way, if anything goes wrong, very little down side of performance or negative news, newly listed stock goes down. The promoter has not left any room for the appreciation of stock and new investor, share holder may benefit from it. The promoter has eaten up all cream and what is left is offered to the market like skimmed milk.

This article has been authored by Keshav Jangra and Vignesh S from FMS.


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