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Get Smart on IPOs

Investors don't buy into IPOs for the long-term. They target the big gains on listing day, but when that doesn't happen, they lose interest

This article appeared in the January, 2010 issue of Wealth Insight magazine. It looks to soundly ground investors' expectations from initial public offerings (IPOs).

IPOs have an oversized presence in the minds of retail investors. Despite all the dangers, they are drawn towards IPOs like moths to flame. The temptation comes, traditionally, from the fact that IPOs have generated huge windfalls for investors. But now, investors are smartening up.

Shunning IPOs

The year 2009 has seen intermitent action on initial public offerings (IPOs). And, retail investors have looked to spurn them. Why? Either due to having realized the dangers that they pose to their financial health, or simply because they had been hit by the bursting bubble in 2008 or, perhaps, both.

But institutions are participating in this IPO season with full enthusiasm, even though many are trading at a loss, or at minuscule gains to their issue prices.  This is strange indeed: institutions are willing to bid for stocks that open at a loss, while retail investors plot for market opportunities. So, who is savvier, now?

Retail investors are in an enviable position as, by staying, away from the primary market they can cherry pick their choice of stocks at discount. In this strange situation, we take a look at what 2009 had to offer, chart the trend created by investors and map the way forward in 2010.

Tracking Trends

Since March, 20 IPOs have been unveiled, including public sector ones like NHPC and OIL India — in all 21 IPOs in 2009 raised Rs 19,558 crore. This amount is a slight improvement from 2008, but in terms of the number of IPOs, the trend was down by 44.74 per cent, though a lion’s share of 2008’s total was cornered by the Rs 10,600 crore Reliance Power  (RP) IPO. Hence, discounting RP, the 2009 amount is 209 per cent more than what was raised in 2008, but it is still over 56 per cent down from the 2007 level.

This would imply that business is picking up after the brief hic-cup in 2008. But that is as far from the truth as it can get.

Performance Paradigm

Ten of the 2009 IPOs are trading below issue price, at an average loss of 23.74 per cent, while seven are trading above it. Compare this to 2007, when out of 106 IPOs, only 10, on listing day, went below the issue price, while the average gain was over 9.12 per cent. The biggest listing gainer in 2007 was Everonn Systems (now Everonn Education), at 300 per cent (based on day’s high price).

There has been a sea-change in the performance of IPOs in the market rally of 2009, compared to the rally of 2007. The illusion of sure shot returns went into a tailspin after the RP IPO. It got a phenomenal response, with the retail portion subscribed 9.02 times — it raked in over Rs 60,000 crore as application money even though it was raising Rs 10,600 crore. But to the dismay of retail investors, the stock listed under its issue price. Even now it’s trading 68.29 per cent (on December 21, 2009) below issue price. Its reverberations are still quite apparent. Of 21 issues this year, the retail quota was barely subscribed in 11. Even in an IPO like Godrej Properties, retail off-take was just 0.37 times.

Running To The Rescue

The saving grace for these IPOs came from institutions and foreign institutional investors (FIIs), who got much of the flak for last year’s market crash. They rescued these IPOs and filled up the void created by the lack of retail participation. Their action kept primary markets alive. They have subscribed to the extent of 11.42 times the total amount allocated to them in the IPOs, while retail subscription was a mere 1.86 times; six issues’ retail quota wasn’t even fully subscribed. 

Compulsions at Play

To comprehend this one needs to understand how a company sources capital. Other than debt and capital from the public, companies depend on venture capital and private equity (PE) funds to meet their initial capital requirements. But in the aftermath of the global meltdown, PE funds lost most of their money, and now, without an adequate safety net, they are reluctant to invest. For instance, Singapore-based Orient Global exited its Rs 850-crore investment in India Infoline, apparently booking a loss of over 50 per cent.

Total PE investment in 2009 is $3.73 billion, lowest since 2005. Even in 2008, when capital was scarce, PE investments were greater than this. Furthermore, cases like Subhiksha have not gone down well with PE funds.

They preferred to invest in IPOs instead, since in a listed company they can cut their losses any time and even lower their acquisition cost by buying at dips. Compared to pre-IPO or PIPE (private investment in public equity) deals, which come with some kind of a lock-in, qualified institutional placements (QIPs), or anchor investor deals, come with a shorter lock-in period. This is a win-win situation for both PEs and FIIs — if the stock rises after listing they can make a quick exit, or stay put, since they would be valuing the companies based on future potential. Also, unlike an unlisted company, a listed one does not require constant monitoring as the market regulator does that job.

Hence, we see a warm response in the QIB segment. In prominent issues like Mahindra Holidays & Resorts India (12.83 times), Adani Power (39), NHPC (29), Oil India (54), Pipavav Shipyard (11), the QIB portions have been subscribed over their allotted quotas.

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