VR Logo

Disliking IPOs

The huge losses faced by investors after Facebook’s IPO is an example of the problems faced by IPO investors in India as well

In living memory, there hasn’t been a more eagerly awaited IPO anywhere in the world than that of Facebook. For months now, the investing world has been agog with excitement about the fabulous value that this poster child of the web’s power was going to achieve. And yet, when the IPO was actually over, it had been transformed into the poster child for everything that could be wrong in an IPO.

One short week after Facebook listed, investors have lost a fabulous 16 billion dollars (Rs 88,000 Cr) of wealth, a number that happens to be exactly equal to the actual amount of cash raised by Facebook from investors. What’s more, the issues that have been raised about Facebook’s IPO have called into question, once more, the very basics of the business model of the entire industry, raising fears of a new version of a general dotcom bust.

However, many of these problems that have come to the surface are not Facebook-specific, or web-specific or even US-specific. They are general problems that the whole activity of IPO investing gives rise to. Facebook’s high profile and the huge scale of its IPO has just given these a very high profile.

These are the same issues faced by every IPO investor in India too. The basic problem in IPOs is that, unlike secondary market investing, there’s a huge information asymmetry between the seller and the buyer. In Facebook’s case, years of hype had obscured the fact that Facebook doesn’t have much room for expansion, either in the total number of users or in the amount of display ad revenue that can be generated from each user. For its sky high valuation (ten times Google’s) to make sense, it will have to invent some completely new and fabulously profitable business model. On top of that, on some crucial information about declining margins was apparently hidden from retail investors during the IPO. In a sense, it seemed that Facebook and its managers had started believing in their own hype.

But these are just specific symptoms of a general disease. Actually, it doesn’t make sense for individual investors to be invest in IPOs at all. In India, we have long entertained this idea that IPOs are somehow specially suited for retail investors. In the days of the Controller of Capital Issues and administered price IPOs, that may well have been true, but not anymore. The market regulator SEBI, as well as other bodies, have frequently tried to encourage the small investors’ interest in IPOs. Parts of the IPO process have also been tailored to suit this purpose. Once upon a time, retail investors used to await IPOs eagerly. All one had to do was to do a few rudimentary checks to filter out the absolute duds and fill the application forms for all IPOs. The allotment ratios were not great but you could be certain that most of the shares you were actually allotted could be sold off at a reasonable profit.

Over the next year or so, if the markets are in a suitable mood, there could be a spate of IPOs. However, retail investors should studiously ignore them. There is nothing about IPOs that makes them specially suited for the casual retail investor. If anything, compared to listed stocks, IPOs are actually less suitable for such investors. The reason is simple. IPO companies are not understood well. The balance of power (in the sense of information being power) lies with the seller. The companies have not been in public eye at all. Invariably, the promoter has spent the preceding months carefully building up an image to ensure that the investing public has a positive image. Unlike listed stocks, the financials haven't been scrutinised closely for years and years. And of course, the price is the promoter's gambit, rather than one that has been found out by the price discovery mechanism of the markets.