Dispelling myths about bogus IPOs

Updated: Nov 29 2006, 07:18am hrs
Several analysts are talking about the deluge of IPOs and the losses to small investors arising from IPO overpricing. First, there is no deluge. In the preceding one-year period, only 79 IPOs have been floatedless than seven a monthraising a meagre Rs 12,898 crore. In the last four-and-a-half years, only 152 IPOs have hit the market. Some analysts are simply confused: they include FPOs in their IPO analysis.

For another, where are the losses Though I do not subscribe to any cut-off date analysis of returns on all IPOs of a given period, as there is nothing sacrosanct about the period or the cut-off date, I still decided to fall in this trap. I found that though 50 out of 152 IPOs floated between April 2002 and September 2006 are presently quoting below their offer price (impacted by the recent rethink on midcap stocks), the loss on these is a paltry Rs 1,863 crore, compared to the huge gain of Rs 43,602 crore on the 102 winners. What the analysts should remember is that the losses, if any, accrue to the small investors only to the extent of 35% of an IPO as that is the quota reserved for them.

But analysts are making a more fundamental error. IPOs, after listing, become a secondary market stock, and as all secondary market stocks do not perform well and forever, the same should be true for IPOs. When the market fell by over 25% in May-June this year, even the price of top-rung companies took a beating. Even now, despite the Sensex crossing the May level, nearly half of its constituents are still below their May levels.

Is it, therefore, not unfair to expect IPOs to quote above their offer price at all times and against all odds Any analysis of IPO returns should be done only at the time of listing and, at best, for a couple of weeks thereafter. After that, the stock is influenced by the state of the market, macroeconomic and company-specific factors, as well as market-related factors.

Jet Airways IPO, labelled very expensive, received an overwhelming response, listed above its offer price and stayed that way for months. The share price presently runs at nearly half. If investors were bullish on the industry or the company, or were plain greedy and did not use the exit opportunity, should pricing be blamed

The proof of right pricing can lie only in two parameters: the level of oversubscription and the listing price. On one hand, huge oversubscriptions prove that investors find the price very attractive and they subscribe out of their free choice as IPOs have to be bought, they cannot be sold. Subsequently, the confidence of all categories of investors who apply is validated by the gains upon listing; of the 152 IPOs floated between April 2002 and September 2006, only two have never quoted above their offer prices. Clearly, we are in an era of underpricing.

The analysts, it appears, are still carrying the hangover of the 1990s. During the 1992-1996 period, 3,911 companies raised equity. While several vanished, issue funds were misused by a majority. In those early days of liberalisation, eligibility norms were weak. Moreover, issuers could decide the price in connivance with investment bankers and could easily sell their issues, courtesy the hype that they were allowed to create, as they interfaced directly with retail investors (there was no compulsory participation of QIBs then).

At the extreme are people who are demanding re-instatement of CCI forgetting that it never bothered about the quality of the issuer or the disclosures. That had been exploited by hundreds of bogus companies to raise money at par and run away with investors money. Since the pricing was apparently low, the CCI was comfortable. Today, Sebis entry norms are very stringent. The only two remaining exchanges are stricter in approving IPOs. Most importantly, there is a compulsory participation of QIBs in all IPOs, backed by margin money, which ensures not only validation of the issue but also of the issue price. Grading of IPOs is unnecessary and dangerous.

Accusing investment bankers of complicity in overpricing is absurd. Half of an IPO has to be bought by QIBs and they will not take just any price. In any case, no issuer would want his IPO to flop by overpricing it. The charge that QIBs gain by selling on the hyped-up environment on the listing date is also weak as this option is also available to all small investors.

The writer is MD, Prime Database