When blue-chip multinational company Pond’s, nudged by the Janata Party government to dilute its equity stake, came out with an initial public offering (IPO) in 1977, its shares were lapped up by investors. Issued at Rs 20 a share—a premium of Rs 10—the stock eventually listed on the Bombay Stock Exchange at Rs 350—a gain of Rs 330 per share on the day of listing. That translates into a return of 1650% in about 90 days, or roughly 6700% on an annualised basis. The bounty continued to roll out for the next couple of years as many more foreign companies offloaded their shares to the Indian public.
In the 30 years since the Pond’s issue, the market has changed beyond recognition. Adam Smith’s invisible hand has replaced the Controller of Capital Issue’s stranglehold over the pricing and size of public issues. Companies are now free to price their issues, even though the market watchdog, the Securities and Exchange Board of India (Sebi), is more alert and surveillance is more rigorous. There is greater transparency and investors are more informed. What hasn’t changed, however, is that IPOs continue to remain the lottery they were have always been. In December 2003, Indraprastha Gas’ IPO priced at Rs 48 a share was listed at Rs 199.70, a 316% return in 28 days, or an annualised gain of 4119%.
Sure not all IPOs have given such spectacular returns and a few have actually resulted in equally big losses. Also, IPO investing requires a considerable outlay. If you have applied for 500 shares of a company at Rs 200, that’s Rs 1 lakh blocked for up to 45 days. Considering the extent of oversubscription to IPOs, you may be allotted only about 100 shares (see pullout section on allottment procedure). In cases where the allottees are selected by lottery, it could be that you get no shares. Imagine the opportunity costs of not fruitfully deploying Rs 1 lakh in a booming market.
The allottment hurdles notwithstanding, it is the assurance of returns that sets IPO investment apart—especially if the experience in the recent bull run is anything to go by. As many as 98% of the IPOs that came out since April 2002 opened at a premium to the issue price on listing day—a failure rate of just 2%. That makes the current rush of IPOs the rarest of the rare investment options: one that is high on reward, yet low on risk. Says Parag Parikh, chairman of Parag Parikh Financial Advisory Services: “IPOs are bound to do well till the markets are on the rise.”
An estimated 87 IPOs are slated to enter the market in the next 12 months, mobilising roughly Rs 19,500 crore (see table). Some of them are large and lucrative businesses. So, should you plunge into the primary market right away with all the savings in hand? The answer to this question is—and should be—more than just a yes or no. That’s why MONEY TODAY approached the best known and most trusted tracker of primary market, Prime Database, to undertake an exhaustive review of the present and past IPO market going all the way back to 1989. Just for the record, there have been 5,278 primary issues in the past 17 years, and they have collectively raised Rs 76,730.11 crore. The review, led untiringly by Prime Database Managing Director Prithvi Haldea, provides clear thumb rules of understanding and benefiting from IPOs. The six key take-aways:
A quick caveat. We are not suggesting that investing in IPOs is better than investments in the secondary market, or mutual funds or any other savings instrument. Investing in IPOs with your eyes and mind shut is as much a no-no as in any other form of savings. Especially when IPOs are inherently riskier than the secondary market. The companies making IPOs have no previous public record of performance. That’s one of the reasons why some of the world’s most successful stock investors, including the second richest person on earth, Warren Buffet, never bet their money on primary issues of companies. Sure, there was a period in the early and mid-1990s when the secondary market was on a slide and IPOs bombed badly, trapping many retail investors’ hard earned money for years and scaring them off the capital market.
But for reasons of their timing and pricing, more often than not IPOs do tend to be a means of making quick and assured returns if not the best returns. In fact, since 2003 IPOs have been even better than a lottery. It’s a game that you almost never lose. The odds against making money in IPO are so minuscule that it could well be the acronym for Instant Profit Opportunity. The IPO investors would hit bull’s-eye issue after issue, only if they had sold their shares on the day of listing. What if they didn’t do that? The gains were substantially more or substantially less. But more on that later.
Other than the timing and pricing of primary issues, what’s made IPOs so fail-safe? There are several reasons for the primary market boom. The record growth of the Indian economy in the past few years, the phenomenal growth in earnings of companies, an infinitely better regulated and more transparent stock market and a fairly regular supply of good public issues, starting from the harbinger of it all—the Maruti Udyog IPO of June 2003. This single issue alone has enriched investors by over Rs 6,800 crore in the past three years. The eight crore shares issued by the company at Rs 125 apiece are worth over Rs 900 now. Similarly, public-sector power generation company NTPC has created almost Rs 5,800 crore since 2004. A booming economy provides countless opportunities for creating new business, just as it does for expanding the existing ones. And more the number of new businesses, the more the number of IPOs.
So obvious has been the opportunity to make easy profits that in April this year, the Standard Chartered Mutual Fund launched a closed-ended scheme only to tap this form of equity investing. The Standard Chartered Enterprise Equity Fund raised Rs 1,548 crore and was mandated to invest up to 15% of its corpus in IPOs. Of course, the mandate was also to sell the shares allotted in the IPOs on the day of listing. However, the fund has not been able to move much in that direction because there were not many good quality IPOs since April.
Of course, there have been times when new business, and therefore the IPOs, were announced only to raise money from the public—and do no business. The mid-90s were one such period for the Indian primary market. The market is far safer today. The stringent norms laid down by Sebi mean that fly-by-night operators can’t enter the primary market easily. Earlier, any company could come out with a public issue. Now, only profitable companies with net tangible assets of Rs 3 crore and a net worth of at least Rs 1 crore will pass muster. The issue size too cannot be more than five times the preissue net worth of the company.
The disclosure norms have been made stricter. That means investors, those who care to, can know more about the company they are investing in than they could earlier. A company now has to disclose detailed information about the promoters, the management and its own financials. The average thickness of the red herring prospectus, the preliminary document that a company has to file with Sebi, has increased from just 10-12 pages to about 300-350 pages now (see pull out ABC of IPO).
The raising of barriers did have a demonstrable effect on the quality of IPOs. Only 102 companies came out with IPOs in 2005-6, compared with 1,423 issues in 1995-96. But the amount raised was almost three times higher: Rs 23,684 crore in 2005-6 compared with Rs 8,882 in 1995-96. “There are fewer but better public issues now,” says Haldea. Among the IPOs in recent years, four were for over Rs 5,000 crore and only seven for less than Rs 10 crore (see table Quantity . Quality).
Another, arguably contestable, step to make the IPO market transparent is the recent provision for grading of IPOs by rating agencies. The objective, from Sebi’s point of view, is that since most retail investors don’t have the skills or the time to go through the lengthy prospectus, ratings could give an idea of the quality of primary issues (see accompanying story Understanding Red Herring Prospectus and box on ratings).
But as the rating agencies themselves say, a higher rating isn’t an assurance for gain on listing or even any time soon after that. For retail investors, the institutional investors, called qualified institutional buyers (QIBs) act as beacons. Before these institutions put money in the issue, they put a red herring prospectus under a microscope. “For us, investment in an IPO is based on several factors—the fundamentals of the company, its prospects and the market conditions,” says Sandeep Neema, fund manager for equity schemes at JM Financial Mutual Fund.
In some ways, the participation of QIBs in an issue is a validation of the company. Retail investors should wait and watch the institutional investors’ response. If QIB interest in the issue is high, go ahead and apply. If it is tepid, stay away. Since QIB started vetting issues in April 2002, four IPOs have bombed, indicating the efficacy of the screening process that seeks to separate the chaff from the grain.
But not everyone looks at QIB participation as a positive development. Many small investors are miffed that 50% of book-building issues are now reserved for institutional investors. Almost all the investors MONEY TODAY spoke to complained that only a tiny portion is now left for retail investors. “The large institutional quota is squeezing the retail investor out of the primary markets,” agrees Parikh.
Also, some of these gods of the financial markets have clay feet. Till last year, QIBs were not expected to part with any money while applying in a public issue. This led to some QIBs conniving with issuers to create hype around an issue by oversubscribing it and then offloading their allotment on the day of listing to make stupendous gains. Last year, Sebi made it mandatory for QIBs to deposit 10% of the value of the shares applied for. This would ensure that only serious money came into the market. Sebi has also ensured a level-playing field by abolishing discretionary allotment of shares to preferred QIBs and replacing it with the proportionate allotment norm. This lays to rest the fears that FIIs, not assured of big allotments and forced to pay upfront money, will stay away from the primary market. “The margin money commitment by QIBs has helped separate the serious bidders from the nonserious ones,” says Amitabh Chakraborty, business head and head of research at Brics Securities.
Given institutional investors’ ability to make informed decisions, experts like Haldea propose that a mechanism should be evolved where QIBs should be used to discover the most appropriate price for an IPO, or any public issue for that matter. And the price so discovered should be offered to retail investors for soliciting their subscription. “The so-called price discovery in an IPO is something that is practically impossible for the retail investor,” says Chakraborty. This means going back to the system of fixed pricing—as opposed to the current book building process for retail investors.
Having applied and got the shares of an IPO, what should you do? The answer depends what you are investing into: just an equity share or a company or, better still, a business. If you treat IPOs purely as a trading opportunity, it is best to sell on the day of listing and book your profits. However, if you are buying into a company, into a business, then a long-term perspective is necessary. Even if the share lists at below the issue price, there is no need for panic if the business itself is on firm ground. Going back to the example of Maruti Udyog IPO, if you had invested in it as a trader and sold all the allotted shares on the day of listing, your gain would have been 36%. But if you had invested in Maruti as India’s largest manufacturer of passenger cars—a product whose demand was going to zoom— the absolute returns from your investment till now would have been 626%, or an annualised yield of 86.73%.
Similarly, if you invested in the Deccan Aviation issue as a trader, you would be ruing a loss of 27% on the investment (annualised -53.3%). The share that was issued at Rs 148 listed at Rs 101 (one of the only two IPOs in the past four years to have been listed on a discount to their offer price). But if you invested in the future of Indian civil aviation, and especially of the low-cost carriers, through the airline’s IPO you don’t have reason to panic. Deccan Air is a successful airline and has been able to increase its market share in Indian skies despite fierce competiton. There is nothing to say it won’t reward its shareholders once, and if, it is able to improve its profit margins. Says Parikh: “Everyone is acting as a punter. Retail investors often do not realise the importance of staying invested and being patient.”
Besides, it is patently unfair to sit in judgement over the pricing of an IPO on the basis of the share’s market price on a particular day. The argument is simple: do we hold a company responsible when its shares tumble from a high in the secondary market? IPOs are generally priced not with the future in mind but on the basis of the current market situation. Branding it as flawed on the basis of its market price on some day in the future would not serve any purpose.
Even if the issue is very good in terms of prospects and as a business, if the price is high, the gains for the investor will be limited. Aggressive pricing of IPOs in the past 12 months have pared the gains that investors could have made from these issues.
Still, it is not as bad as in the past decade when issues used to be priced at astronomical price to earnings (PE) ratio. “In no way will we see the repeat of cases where an issue priced at, say, at Rs 400 slid to Rs 20 post issue,” says Haldea.
So, what should you do when you next see ads of an IPO issue? Well, as long as the bull run in the secondary market continues you can keep making money by investing in almost any decent IPO, as long as you sell on the day of listing or soon after that. But the golden rule to keep in mind is: IPO investing is primarily for boom times. Long-term stock investing is for all times.
