The Changing Face of IPO


By

Sujata Sankaran
Finance Faculty
INC
Kozhikode
 


Abstract: Initial Public Offer is an important instrument of the primary markets. With India becoming a hub for public offers with one company or other coming forward with their IPOs , the moot question is - Are the investors there for the right reason? In the Indian capital markets, subscribing for an IPO is becoming more of a speculation than investment, with greed being the key driver for investors. They fail to follow the patient route, a prerequisite for investors and end up with dampened spirits. This article provides an insight on the relevance of IPO, the changing perception of investors and the dangers for subscribing to public offers.


Initial Public Offers have always been the most sought out strategy by the small as well as largely owned companies to garner capital for expansion and for being publicly traded. Initial Public Offers (or IPO) is the first direct issuance of its shares by the company to its investors. IPO act as a link between investors vying for lucrative investment opportunities and companies requiring funds to exploit growth avenues and future potentials. With the advent of liberalization, globalization and privatization the world has become a global market. More countries are earning the tag of 'emerging markets' thanks to a rapid economic growth. With global capital pouring into the Indian markets, the impact is visible in the investment pattern of Indian investors too with more than 150 companies going public in India last year for raising nearly $10 billion. This huge amount invested in IPO shows the shift of traditional Indian investors to risky equity ventures.

IPO has always been an important instrument of the primary markets enabling companies to pursue their objectives without facing the hiccups of financial constraints. It strengthens their capital base by providing access to interest free capital. The investors in turn reap the benefits in the form of dividends and capital gains. With the changing phase, the appetite of investors for IPO also increased. In 1976, Dhirubhai Ambani had gifted a broker of Madras Stock Exchange with a Vimal pant piece and Vimal saree to his wife for subscribing to the IPO of RIL and recommending the shares to his clients. Three decades later the IPO of RPower created history in Indian IPO by being 73 times oversubscribed.

The investors' response to the IPO is an ideal barometer of the investors trust in the company. However, the irony is that both QIB (Qualified Institutional Investors) and retail investors rush in for IPOs to take advantage of flipping on stocks (selling the shares at the time of listing to make profits). The greed driven investors want to reap the benefits of subscribing for an IPO in the short run. They offload their IPO holdings at the time of its listing to pocket the premium without waiting for the company to pass on the benefits to them through its operations. The premium with which the IPO gets listed in the stock exchange is used as a yardstick to measure the goodwill the company enjoys. The probability of IPOs faring at the time of listing has become exclusively dependent on the prevailing market conditions. Hence it provides a golden opportunity for the IPO of companies with bleak future prospects offering attractive returns on listing when the bullish trend triggers a rampage of the stock exchange. IPOs of companies with strong credentials fall victims to the traumatized equity markets with the immediate investor sentiments deciding its fate. The performance of the IPOs is not immune to the conditions that plague the secondary market. Even IPOs of reputed companies get listed and traded at a discount. The astuteness and patience of the investors take a back seat. They fail to give the company a chance to prove itself in the long run forgetting that recessions are never to stay forever.

QIBs have a major chunk of IPO quota of 60% as against retail investors who have a quota of 25%.The response of these large investors is now considered as a guide by the lay investors for subscribing to book built IPOs. This can prove to be misleading if the QIBs enter the issue for listing gains. In the case of Reliance Power IPO listing 7 Mauritius based FIIs sold in falling markets on the date of listing at Rs 370 against the allotment price of Rs 450. Such huge selling made the shares listed on NSE for 530 and BSE for 547, fall within 4 minutes by 26% in NSE and 28% in BSE sucking nearly Rs30,000 crores from the investors . This clearly is an indication that large investors are also in the game for short term gains and lay investors can burn their fingers by considering FIIs response before rushing for an IPO. Blind response to an IPO for short term gains makes the stocks overpriced with the investors ending up paying more than the value for companies which have yet to prove its credentials.

The company has the onus of providing attractive returns to its long time investors and not to the speculators. Still at times the premium with which a stock gets listed becomes a prestige issue for the companies. Hence ADAG (Anil Dhirubhai Ambani Group) rushed in for issuing bonus shares in the ratio of 3:5 to nurse the wounds of the bruised investors to make the price Rs.269 for retail investors and 281 for institutional investors.

IPO can be fruitful only by following the 'virtue of patience', that is, the wait and watch approach. It should be considered by investors only if they are ready to commit their funds for a long duration. Mahendra Shah a former broker of Madras stock Exchange had purchased the RIL share for Rs10 through an IPO way back in 1976 .Even in the present scenario where the capital market is sailing through rough winds these shares are priced at Rs2,500. Thus the real benefit of the IPO can be enjoyed both by the company and the investors by holding them in the long run. In the long run the benefits of IPOs can be magnified by avoiding flipping and retaining the share. Even though in the present turmoil the market for IPO have dried up the IPOs from 2004 have given a return of 180% till date which proves that investment in fundamentally good companies definitely yield good returns.

Company

Returns on listing %

Returns 6 months later %

Gremach Infrastructure

-2

137

Orbit Corporation

16

355

Atlanta

28

484


But due to the uncertainty and volatility surrounding the capital markets most investors prefer short term gains rather than long term .Holding shares bought through IPO can at times prove to be costly.

Company

Returns on listing %

Returns 6 months later %

AMD Metplast

5

-42

Abhishek Mills

-9

-63

House of Fashion Pearls

-15

-44


Data Source: Business Line Sept 30 2007

Hence more homework on the company's fundamentals has to be done by lay investors as well as the professionals before they leap for investing in an IPO. The investment guru Warren Buffet in his letter to Berkshire Hathaway's shareholders reveals his investment mantra that he looks out for companies that have a) business he understands b) favorable long term economies c) able and trustworthy management d) a sensible price tag. The same philosophy should be followed before subscribing to an IPO.

The biggest turmoil occurs when the subscribers apply for an IPO during bullish trend and the shares get listed when the bears take its toll. The sub prime crises of USA which paved the way for its recession can be likened to the Indian speculators subscribing for an IPO. When the real estate boom were at its peak in USA financial institutions sanctioned loans without the proof of income being a prerequisite. This attracted borrowers but as interest rates soared and home values shrunk the housing bubble burst. Similarly in India when the bulls were aggressively marching ahead IPO was a safe bet. Many investors borrowed money for subscribing for shares more than what they required for booking listing gains as was evident in the case of RPower. But poor performance at the time of listing set havoc for the investors who had financed the subscription for large number of shares by borrowed funds.

Till recently when the ripples of the US recessions started appearing it had been a safe bet raising capital through initial public offer. The last IPO to be withdrawn was Shirdi Industries in July 2006.In a turbulent market it is difficult to predict the investing moods of the investors .Two giants were coerced by the feeble investor response to withdraw their IPO. A minimum subscription of 90% is required for an IPO whereas the Dubai based real estate Emmar MGF was subscribed only 0.83% and Wockhardt Hospital 20% of the issue size. This was inspite the fact that the offer date was extended by 2days and offer price revised twice. Many IPOs including that of India's third largest mutual fund UTI mutual fund were postponed to escape the havoc of the meltdown. But two low profile companies V-Guard received 1.36 times subscription and Rural Electrification Corporation received 27.63 times subscription and got listed at a premium of 23.7%. In spite of the meltdown the recent China Railway IPO was 250 times oversubscribed priced at the upper end nearly 28 times of the forecasted annual earnings. This maybe a positive indication where the investors have started valuing the future prospects of the company before committing their valuable funds.

With the advent of modern technology a lot of transformations are taking place in the consumption pattern at a rapid pace. This has flung open new avenues of innovations and explorations for business entities. Initial Public Offers provide the much needed venture capital which results in the development of the economy as a whole contributing to the GDP. In 2007 India ranked second in IPO and fourth in M&A in Asia Pacific which is an evidence of the IPO being an important resort by companies for widening their market shares through mergers and acquisitions. An ailing IPO market can have a direct impact on the company's growth plans. Poor response to the IPO can makes businesses with good prospects face credit crunch. They loose expansion opportunities or resort to other sources like Private Equity (PE) as in the case of Wockhardt Hospitals. This results in the benefits of a successful venture being enjoyed by a restricted few. Hence investors can gain by subscribing for the IPO of companies having a good foundation and future prospects but a wrong move can make them burn their fingers.

IPO channelise the savings of investors and maximize their wealth thus giving a boost to the economy. IPO provides transparency in the functioning of the company. A better public holding will safeguard the interest of small investors and they will not stand to loose. Large holdings by promoters increase the chances of share price manipulation giving rise to speculation and volatility. Since an IPO is exposed to the roller coaster ride of the stock exchange retail investors should be properly informed and educated of the pros and cons of a public offer so that they do not shy and retreat from the primary markets.

Usually the secondary markets give higher returns than primary markets besides initial public offers being time consuming and costly. Secondary markets gave a return of 230% from 2004 till date as against the primary market which gave a return of 180%. But economies cannot survive and surge through secondary markets alone. Primary markets play a critical role in mobilizing the much needed funds for the business entities hence, their relevance cannot be undermined. A series of reforms recently introduced by the regulators of capital markets SEBI will make an IPO more efficient. The reduction of registration fee for venture capital funds from 10lakhs to 5lakhs and the rationalization of fee structure by slashing of fees for stock market intermediaries by 80% on filing of documents for public issue will pass on the benefits directly or indirectly to the common investors. The scrapping of  IPO close and the listing gap to 3 or five days from the current level of about 21 working days will help in eliminating the scourge of the grey market  and ensure early release of investors' amount lying as dead cash. But at the same time, speculators subscribing to the IPO as short term bets have reasons to cheer. They can book listing gains within a short period without their investment getting locked sans interest. Nevertheless, the benefit can also be enjoyed by serious investors.

Conclusion

The relevance of IPO in the development of economy cannot be undermined. Companies look out for financial assistance from the public through the IPOs. It builds and strengthens a symbiotic relation between the corporate and the investors/financial stakeholders. The company definitely owes to the investors for having faith in them. However, the investors should not be driven by greed while subscribing to a public offer. Adequate study on the future credentials of the company can help them get good returns. On the other hand, getting panicky under unfavorable circumstances can be detrimental to them. A patient, wait and watch policy is the golden rule for players of the primary markets.

References:

1. Cool as a cucumber:Business Line-25thJan08 pg16     

2. BusinessLine 6th March 08

3. Business.Standard 6thMarch 08  Pg1 

4. IPO close and listing gap maybe cut to 3-5 days:China Railway IPO set to buck trend: Business Standard 7th March pg 1,4

5. IPOs: FIIs too can take a short-term view: Business Line March 9 pg7  08

6. Investors lose 24%value as 13 out of 18 IPOs flop:Business Standard March 10 08 Pg 1

7. Business Standard September 11 07

8. Law and Public PolicyOpinion: The Public Benefits of Public Offeringshttp://knowledge.wharton.upenn.edu/article.cfm March 7

9. Bring on the public: Business World 25 February 2008Business World
 


Sujata Sankaran
Finance Faculty
INC
Kozhikode
 

Source: E-mail March 17, 2008

          

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