Primary markets follow a pattern and are a function of intensity and duration of bull market cycles. Primary markets go through low and high tides in terms of investor appetite and sentiments. A low tide in the primary market is when investor fatigue is at its high with investors seeing their prior subscribed IPO shares either tending towards principal or going below water.
The primary market, commonly known as the IPO market, is in a steady state in terms of issuance since 2004 barring blips in 2009 and 2014. The average funds raised annually through the primary market issuances has been close to Rs 30,000 crore since 2004. However, the appetite for new issuances is cyclical and driven by sentiments in the secondary markets. Level of allocation to equity as an asset class also matters. Subscription levels to IPOs, valuations at which they get subscribed, promoter willingness to raise money vary based on market sentiments.
Cycles in primary market
Primary markets follow a pattern and are a function of intensity and duration of bull market cycles. Primary markets go through low and high tides in terms of investor appetite and sentiments. A low tide in the primary market is when investor fatigue is at its high with investors seeing their prior subscribed IPO shares either tending towards principal or going below water. Low tide in primary markets were in years 1999, 2003, 2009, 2014. A high tide in primary markets emerges when the bull cycle is in a mature stage, especially when secondary market valuations are not as cheap for investors’ comfort. As the bull phase matures, the primary market gathers steam as in FY94-95, FY2000-01, FY05-08, FY10-11 period. In the current bull phase, primary market has seen heightened activity since 2015.
IPO investors’ mindset
Investors in a bull market use careful discretion while increasing allocation to equities. Hence the allocations to equities start with mutual funds, followed by product offerings through PMS/AIF/PE fund route. As valuation in the market rises, investors become cautious and control their allocation to equities by selecting various instruments on a case-to-case basis. For investors, IPOs are a part of the product bouquet. As the high tide in primary markets develops consensus amongst investors on returns getting generated, it leads to over-subscriptions.
Interest rate is an important ingredient of the recipe. With low cost of leverage, HNIs typically leverage for getting a meaningful bite of the IPO action. Retail investors at large then fall into the habit of investing in almost all IPOs based on the success in a few IPOs. Applying for IPOs and booking profits on listing is seen as an easy game. Adrenaline rush continues with short term gains flowing. In the high tide in the primary markets, investment bankers start to price IPOs to perfection with future growth of few years fully captured. This leaves investors with little margin of safety. However, who cares for it during high tides. Selling small promoter stake (10-15%) of majorly owned promoter company through an IPO, with less floating stock post listing is an ideal success formula.
Current market conditions
The current phase of IPOs is driven by the need to monetise or provide exits to investors rather than need for capital in companies. Over the last few years, offer for sale component either offered by promoters or existing investors has been on the rise. This means the IPO investors’ contribution is being utilised for monetisation of stakes by promoters/past investors rather than asset creation in companies which can fetch future earnings. Promoters and past investors who have been associated with the company for many years understand exit valuations well through IPOs and hence would not like to sell at a discount. During the high tide phenomenon, investors turn blind to such aspects and these IPOs lead to a new set of investors buying shares at high entry valuations with high expectations. Later as the expectations and performance mismatch takes place, stocks become painful and start eroding investor wealth. In our view, we are already in a high tide phenomenon in primary markets. New, unknown, but differentiated, unique businesses are entering the markets over the past few years through IPO offerings. A business hitherto unavailable for investment makes a good recipe for success.
The writer is director and co-founder, Entrust Family Office Investment Advisors