Investor,mend thy ways

Barking up the wrong tree?

One view among experts is that the entire debate has been framed incorrectly. Typically,analysts take the IPOs for a particular period,compare the IPO price with the current price,and then declare that IPOs were overpriced or under priced. This,say experts,is an incorrect way of assessing the performance of IPOs. Says Prithvi Haldea,managing director,Prime Database: How can you pick up the IPOs for a given period,say 2005 or 2006,and compare their prices with todays? Market conditions vary and with it the prices of companies that had their IPOs. Besides,he says,IPOs cease to be IPOs and become listed stocks on the day of listing. Numerous secondary markets stocks have also fallen from their highs,but nobody makes an issue of those stocks,he says. Why pick on companies that have recently had IPOs?

The fallacy of deriving conclusions based on point-to-point comparisons is brought home further by an example that Haldea cites. RECs IPO price was Rs 105. At that time,some analysts said that the company was overpriced. However,it got a good response,listed at a slight premium and rose to Rs 120. Now that a gain was available,analysts declared that the IPO was under priced. Over the next one year its share prices started falling and went as low as Rs 50. Now analysts turned around and started saying that the IPO was overpriced. Now the same company has gone up to Rs 205 and analysts are saying that the IPO was under priced. How can the same IPO be branded as under priced as well as overpriced?

Haldea further adds: If the companys share quotes above the offer price,we give credit to the issuer for having left money on the table. If it goes below the offer price,we brand the promoters as greedy. In recent times,would you call the government greedy when NHPC quotes below the offer price and magnanimous when OIL trades above the offer price?

Greed at play

Even if one were to accept the premise that promoters offer IPOs at high prices,what makes this possible is the greed that overwhelms all the parties involved,especially in bullish market conditions. Says Ashish Kapur,chief executive officer,Invest Shoppe India: Typically,more IPOs come into the market during bullish times because promoters know they can get a higher valuation then. Even if the investment banker feels that the IPO is overpriced,he dare not say so lest the promoter goes over to a rival,more accommodating,firm. Retail investors are to blame because few of them bother to assess the company on its fundamentals. All they are looking for is listing gains. They basically pay the price for their greed and lack of due diligence.

Improving the price-setting process

All the experts we spoke to vehemently opposed any attempt by the government or the regulator to control the price-setting process too closely. But they felt that there are other facets of IPOs that need to be reformed. They,for instance,believe that the manner in which the IPO price is fixed can be improved.

Haldea says that the current process is efficient neither for the issuer nor for any investor class. In his opinion,it is a myth that book building results in price discovery. Instead of one fixed price,the promoter gives a price band. But that band comes from the promoter,and is not discovered by the market. At best,price discovery takes place within the 20 per cent price band set by the promoter. Maybe the company deserves much more than that price band. If investors are willing to pay beyond it,why should they be denied the opportunity to pay a higher price and get those shares? And why should the company be denied the opportunity of getting a higher price? he says.

Haldea proposes that the institutional portion of IPOs should be auctioned. Allocation should be done to institutional investors on a top-down basis. This method,he says,will get the company the price it deserves,so there will be no complaints of under pricing. Institutional investors will be happy because they will get the number of shares that they want,and at the price that they are willing to pay. Right now they have to stand in a queue and get a proportional allotment.

The lowest price that the auction fetches,Haldea suggests,should be converted into the fixed price for the retail investor. If you dont want to take the lowest price,take the average of the lowest five auction prices, he says. Further,the promoter could give a sealed envelope with a floor price to the regulator. If his issue does not sell at or above the floor price,he should have the option either to accept the lower bids or to cancel the issue.

Greater oversight

According to experts,instead of focusing on fixing the price of IPOs,the government should,one,make the existing regulations more stringent; two,enforce them better; and three,enhance the level of investor education.

Kapur suggests that if information in the offer document is found to be false or if there is over-statement,the punishment for both the investment bankers and the promoters should be more severe. At present,the promoter is debarred from the capital markets for a certain number of years and usually the investment banker is fined and his licence taken away. Kapur believes that punishment should extend to imprisonment. Only such harsh measures will deter potential fraudsters.

Haldea suggests that specialist agencies should be set up to examine offer documents and point out errors and cases of under-disclosure and overstatement. In his view,the abridged prospectus should be made more readable for small investors. Further,he says,the government should check insider trading and manipulation of prices on listing date and beyond,and punish grey market operators.

Pune-based financial planner Veer Sardesai suggests imposing a period of silence before the offer opens akin to what we have before elections to temper the advertising and media hype that accompanies IPOs. Further,as the IPO progresses the investment bankers announce the number of times it has been oversubscribed. This makes investors think there will be large listing gains. More applications pour in,pushing the price to the upper end of the price band. Sardesai suggests doing away with these announcements until the issue closes.

Stop gambling

At present,a large number of retail investors gamble on IPOs. They dont try to understand the fundamentals of the company but bet on them purely for listing gains. Some even borrow money at an interest rate of around 15 per cent for this purpose. This is highly risky for two reasons. One,as Kapur says,even if the stock lists at a premium you may not reap the benefits if you are not allotted enough shares. Two,listing gains depend on market sentiments. As Sardesai points out,There is a gap of 15-20 days between the closing of the issue and its listing date. Sentiments could turn during the interim period.

Finally,as Sardesai suggests,investors should treat IPOs as genuine long-term minimum three years investment opportunities and should invest in them only after taking into account the companys fundamentals see box: Primer on IPO investing.

sk.singh expressindia.com