There seems to be a widespread belief that the NMDC FPO that opened on Wednesday, with bids for only 17% trickling in, is overpriced at Rs 300. There is probably no need to worry still about the issue being undersubscribed, because in the worst case, state-supported financial institutions can ultimately be nudged to take on whatever is left on the table. There are a few interesting takeaways from this entire matter, however, and most of them are in the nature of food for thought than final verdicts.
First, contrast this with the Oil India IPO in 2009 that was oversubscribed 31 times. Should that be called a success and the NMDC issue a failure? Hardly. For a fair organiser, it is the crowd size that determines success; for a seller at the fair participation is only worth the profits it makes. In making public offerings, the practice of leaving fat first-day or first-week gains for investors through overly conservative pricing of shares is worse than having undersubscribed offerings. Some would say the brouhaha surrounding an IPO or FPO helps bring attention to the company. Neither NMDC nor the government should need it too badly.
The second issue lies in pricing in turbulent times. If you look at the price of NMDC?s shares during the last one year, it rose dramatically from Rs 143 to past Rs 556 as late as January 20 before coming down to the Rs 360-400 range this week. When the price band was announced this Tuesday, the market price was close to 400. Surely a 25% discount is not too bad.
The real issue here is the float. NMDC had about 2% on the market, and is planning to offload close to four times that amount through the ongoing FPO. After accounting for institutional holding, the amount of actual float in the market is probably in the region of 0.5% of the company. While traditional finance theory would suggest that supply of stocks should have little to do with its price and in theory, one should be able to sell more shares of a company at the going market price, empirical evidence shows otherwise.
So the market price, highly volatile, is an unreliable gauge of the price at which people are willing to buy large amounts of share of the firm making an FPO. Given this fact is widely recognised in the media as well, it is surprising how much of the discussion around NMDC?s share pricing has hinged on the appropriate discount necessary to sell the new shares. If you cannot trust the market price, how can you meaningfully discuss optimum pricing in terms of a discount from that, extremely fickle, number?
So the approach to be taken should be that of fundamental valuation, always a far more difficult exercise. The ?chhota shortcut? to this is identifying a few comparable firms, nationally and globally, and making sure the price-equity ratio in those cases apply to this setting. Comparables, however, are frequently only citric approximations of the apple at hand and rarely do commentators take the trouble of looking at their financial structure and growth prospects to improve on the comparisons. Understandable, for then it would not remain the ?chhota shortcut?.
Other recent public sector issues, NTPC and REC, had scraped by largely on institutional investor support with their retail segment going unsubscribed. This is generally considered a shortcoming, on the argument that it does not give the small investor a ?chance to share the wealth?. This is true only in part. Many institutions actually channel retail investors? funds into the market. Besides, small investors who need a big discount to buy a stock because they are unsure of their own pricing abilities, are really much better served by not investing directly in the market at all. The ratio of retail to institutional investors in Indian markets is considerably higher than, say, in the US. That is not an empowerment of the aam aadmi, it is just letting innocents into the bull-ring to be ripped off by the institutions and informed players. Underpricing state-owned assets to ensure oversubscription is a far greater disservice to the taxpayers. If that needs to be done to support the market, it?s even worse, for such manipulation hurts all market participants.
So, at the end of the day, if the NMDC issue gets by on institutional support, that is just fine. One hopes this support would be spontaneous rather than orchestrated by government, but even the latter is not necessarily a calamity assuming government itself has reasons to believe that NMDC is a good buy for the long-run. Of course, a lot can happen on Friday, and given that this is Friday the 12th and not the 13th, there is every reason to remain hopeful.
The author teaches finance at the Indian School of Business, Hyderabad