IPO – The Gainers and Losers in 2020 and 2021

With Indian Equity Benchmark Indices trading at historical high levels there has been a lot of traction visible in the primary market as well. It is natural that when the secondary markets are running full throttle, it gives impetus to the primary market also. As the equity benchmark indices hit the new all-time high levels even the initial public offering (IPO) hit the roof.

Historically it has been seen that IPOs are usually a sought after investments especially by the retail investors. And the way IPOs have performed over the last two years, the interest has increased significantly. If the number of few over subscriptions (in some cases even 200 times the IPO size) are anything to go by – the investors are clearly visible. While the IPOs have always been keenly followed by the retail investors – it is not necessary that all IPOs have generated returns. While there are winners – similarly there are losers as well. Rather there have been times where the IPOs returns had suffered (witnessing decline) so much that the Regulatory body Securities and Exchange Board of India had to come out with regulations to keep the retail investors’ interest in the primary markets.

It is true that recent performance of IPOs has been very good and the majority of the issues (past 30 months) are trading above the issue price, there are few instances where the investors have lost investments. Further the current rally in the secondary market (strong comeback in broader indices) after hitting a low in March 2020 has also supported the sustenance of IPOs above the issue price.

The problem is investors have Recency bias and hence with IPOs providing strong returns in the past two years, everyone has inclination towards having exposure to IPOs. The following table shows how the various IPOs were oversubscribed indicating investors interest.

The above data clearly suggests the likes of MTAR Technologies witnessed huge demand and was oversubscribed 200x of its issue size. MTAR issue was worth Rs 596 crore and the 200 times issue subscription means almost Rs 1,20,000 crore of funds. The story was no different with Mrs. Bectors Food, Nazara Technologies, Easy Trip Planners witnessed 198x, 176x and 159x oversubscription respectively. Rather there are at least 10 companies that witnessed more than 100x subscriptions.

While this kind of frenzy for IPOs is visible and retail participants are considered as more tilted towards it, the following chart depicts another story. The chart clearly indicates that even the qualified institutional buyers (QIB), high net-worth individuals (HNI) and Retail (RI) everyone was running behind the IPOs. There is another story why the HNI participation is higher on account of funding available. We have discussed the same in this blog going ahead. But the following chart clearly shows the rush from all kinds of investors for IPOs.

IPOs a golden opportunity? – Not everyone thinks so!

While the above data clearly shows how the IPOs were oversubscribed, there is another stratum of investors (yes, seasoned one) that believes IPOs are not a great opportunity. They suggest that all investors should be wary of IPOs, which means simply that investment in IPOs should be subjected to careful examination and unusually severe tests before they are purchased.

To put it in the exact words of Benjamin Graham “There are two reasons for caveat. The first is that the new issues have special salesmanship behind them, which calls therefore for a special degree of sales resistance. The second is that most new issues are sold under favourable conditions, – which means favourable for the seller and consequently less favourable for the buyer”.

Though there are exceptions to all styles of investments, we have seen in the past during the bull phase of the market a lot of companies try to get maximum premium for off-loading their stake.  Rather in the new era a lot of Private equity players look at IPOs as an exit route after enjoying great run and growth of the company. If we take a look at the issue objectives – more of them are offered for sale and only a few are raising capital for future growth.

Rather, a few of the objectives of the issues are for repayment of debt which has already provided  growth to the earlier investors and is now paying the debt back by raising funds from the new investors.

Further as we stated earlier, the promoters try to get maximum advantage of bull-run and try to get maximum valuations. Investment bankers link the valuations to the industry leaders and ask for high valuations. The latest example would be Indigo Paints which was enjoying richer valuations as compared to industry leaders like Asian Paints and Berger Paints. We are not saying that the issue is good or bad based on the price it quotes but, we must focus on valuations and pay as per the correct value. In the IPO frenzy investors forget the valuations part conveniently. Remember, in bull market periods a lot of privately owned businesses transform into listed entities. Hence applying a funnel (may be a double funnel) for analysing an IPO is a necessity. If the legends say so, why does the HNI category get so much of a subscription? Let’s understand that.

How does the HNI portion get oversubscribed exponentially? 

You may be wondering how the HNI part of an IPO gets massively oversubscribed. In an IPO, HNIs are assigned proportionate shares. If the issue is 10 times oversubscribed in the HNI category, you will be issued one share for every 10 shares you bid. On some occasions, the HNI section is oversubscribed by 500 times. This is usually due to something called IPO funding.

The idea is to get money from a financier and invest in IPOs to sell the stock to get listing gains. In simple words, you take money from a bank, give them a specific interest rate for the borrowed amount, invest it into the IPO, and hope to earn much more than the interest amount. This way, you put in someone else’s money in the game and try to profit from it. However, it’s not as easy as it sounds.

There are risks to investing in an IPO via a funding path. Before investing in an IPO through funding, there are a few things to consider about. Above all, the IPO funding procedure differs slightly from the standard IPO investment procedure. The majority of banks and financiers provide financing for IPOs, and the risk is reduced since the investor has a margin and has the first lien on the shares.

There are a couple of things that an HNI has to factor in, such as the funding cost. Preferably, everyone wants a low funding cost to earn the maximum. What is the magnitude of oversubscription? Higher the subscription, higher the percentage of funds locked in. You might not want to do this because you pay interest on the entire borrowed amount. That is why having a higher oversubscription works against you because you are paying more interest on funds that are not being used. All said and done, let’s look at how the margin funding calculations work. Though the calculations of margin funding are quite complicated, we have tried to explain it very simply.

If a share issue is 20 times oversubscribed, and an HNI applies for Rs1 crore worth of shares, he will receive Rs 5 lakh worth of shares. The bank will now give them a loan with the aid of funding. For every Rs1 lakh an HNI invests, he receives a loan of Rs49 lakh, allowing him to apply for a loan of 50 lakh.

The investor puts in a total of Rs 2 lakh, with the remaining Rs 98 lakh coming from the bank as a loan. Assume a 7 percent interest rate and that HNIs usually invest on the IPO’s final day. A total of Rs 5 lakh worth of shares will be allotted to the investor. He has invested Rs2 lakh and borrowed the remaining Rs 3 lakh. After 5 days, the un-allotted cash of Rs 95 lakh is redeemed. The investor would pay a total of Rs 9,110 in interest for five days at a rate of 7 percent per annum. After 15 days, the IPO will be listed on the stock exchange. On the day of the listing, the investor must repay the investor (although not mandatory). As a result, he will have to pay a total of Rs 3 lakh in interest for 15 days, which comes to Rs 863. So, even before the IPO is listed, he will be paying a total of Rs 9,973 in interest. This amounts to approximately 1 percent of his total allotment. As a result, the IPO must trade at least 1 percent higher on the day of its debut.

The bottom line is that you need a mixture of fair oversubscription and a healthy premium listing if you want to make money after factoring in the cost of funding. Aside from that, IPO funding isn’t as easy or straightforward as it seems. In addition the retail investors need to be lucky to get the issue. As the oversubscriptions have been significant in almost the majority of the issues.

The IPO Gainers and Losers

As we mentioned earlier the listing gains of most of the IPOs have been strong in the past 30 months. If we ignore the period of pandemic time low, the IPOs have provided significant gains. There are many multi-baggers emerging from the IPO space only.

What is a Grey market? Is it reliable in predicting IPO listing gains?

The grey market and the initial public offering (IPO) market are two distinct markets. Grey market is an unregulated market that operates outside the ambit of SEBI regulation. IPO is an official market for corporates to raise funds via a new issue of shares, while the Grey market is an unofficial market for corporates to raise funds via a new issue of shares. An unofficial deal between an IPO investor and a stockbroker enables investors to lock in gains before the stock lists on the exchange are known as grey market transactions. Brokers sell shares allocated to IPO applications without moving the shares to their accounts under this system. The IPO grey market premium is the amount that buyers are willing to pay in addition to the IPO’s quoted price in the grey market. Grey market rates fluctuate in the same way as listed stock prices do. It all comes down to supply and demand in the end. The grey market premiums will rise if there are more buyers than sellers, while the premiums will fall if there are more sellers than buyers. Investors in the IPO market felt they had cracked the code to finding sure-fire winners. All they had to do was look at the grey market’s indicated listing price for an IPO and bid accordingly. However, grey market premiums do not always result in IPO revenues.

Based on this logic, Easy Trip Planners was considered a sure winner. The grey market suggested a listing price of more than 310 per share, roughly 70 percent higher than the IPO issue price. Easy Trip’s listing has turned out to be a complete flop, despite all of the excitement during the book-building process. On the listing day, it’s stock traded at a volume-weighted average price of 210, a premium of about 12 percent over the issue price. Grey market can misguide investors, and you should always be cautious of it.

Conclusion

Overall if we take a look at the IPO performance since the past two and half years there are more IPOs that have performed well providing good returns.  However most of the gains are on the back of the bull phase in the equities market. We believe that there are certain valuation issues in most of the IPOs that have provided returns in the past two years. While the returns may show that returns have been good for past IPOs, it may not be sustained as we move ahead to invest in future IPOs. As stated earlier it is important to apply a double caveat of analysing every issue in detail. If promoters (guided by the investment bankers) have kept something on the table for the investors, then only the issue should be subscribed. There are already listed opportunities available in secondary markets. With retail participants needing to get lucky in terms of getting allotment, it is easier to find an opportunity in the secondary market. Rest if the valuations are lucrative, one can apply for the IPO.