The IPO Deep Freeze

Reliance Power's poor listing was the last straw. The domestic IPO market has slipped into a deep freeze and is unlikely to see a revival soon. But, investors have only themselves to blame! By Vivek Sharma

The new issues frenzy, built on the excellent returns made by IPO investors last year, peaked last month when the Reliance Power issue opened. At nearly $3 billion, it was the biggest ever IPO by an Indian company and the biggest global IPO so far in 2008. The massive marketing effort to promote the issue was unprecedented and resulted in lakhs of new retail investors opening demat accounts, in the hope of making quick profits. Institutional investors, both domestic and foreign, also briefly suspended their self-proclaimed ability for sane judgment and jumped in.

The issue was fully sold within a minute of opening and by the time it closed, had generated demand of nearly Rs7.5 lakh crore and was subscribed a massive 73 times. Grey market trading in the stock had taken off in right earnest even before the issue opened. Premiums of over Rs450 per share in the grey market definitely boosted investor demand for the IPO. Business television channels fuelled the frenzy by providing regular updates of grey market price changes.

When the IPO opened, market pundits were confident that investors would double their money. All they had to do was place a bid and pray for an allotment. If only, making money was all so easy!

Markets started tanking the day the Reliance Power IPO opened and the indices have now retraced most of the up-move made late last year. Even though the grey market premium continued to lighten, most analysts were expecting some gains for the stock on listing. But, that was not to be as Reliance Power became the first stock from either Reliance groups to close lower on debut.The large IPOs - Wockardt Hospitals and Emaar MGF - that followed Reliance Power suffered from the weakened market sentiment. Both issuers cut their offer price bands and extended the offer period, but to no avail. Investor interest had vanished and the issues were withdrawn. Other issuers who were set to hit the market are unlikely to go ahead. What a change in fortunes this has been for the IPO market, in barely over a month!

Big gains of 2007 can no longer sustain investor interest
Most IPOs that hit the market last year did generate good returns for investors. Though the sharp market rally towards the end of the year helped, last year's IPOs were generally of better quality with established businesses and were more reasonably priced.

Even after this year's correction, most of last year's bigger IPOs are trading higher than their issue prices. Television broadcaster GBN is among the best performers, now trading more than three times its issue price. Credit rating company ICRA and retailer Vishal Retail have also given similar returns to investors. Indian Bank is trading well over double its issue price while telecom major Idea Cellular is quoting 40 per cent above issue price, even after the recent correction.

Last year saw two large infrastructure developers hitting the market. Stocks of both Mundra Ports and Maytas have appreciated substantially since their listing. Among the issuers from the financial services sector, Religare has appreciated sharply while Motilal Oswal has offered more modest returns. Even Future Capital, which completed its issue just ahead of Reliance Power, had a good listing and continues to trade above its issue price.

Real estate developer DLF was easily the most high profile IPO of last year. Even though there were concerns of high valuations about the much delayed issue, the stock has offered good returns since listing. Among other builders that offered shares last year, Aakruti Nirman has doubled from its issue price while HDIL has offered more modest returns. ICICI Bank mopped up more than $2 billion in a follow-on offer and the stock is still in the money.

Past gains have been the main factor driving the IPO market towards the end of last year and early this year. But, as the markets came under pressure, part of the gains in recently listed stocks vanished. Startled by the suddenness of the recent market fall, most investors have been scared-off new IPOs. But, issuers still tried their best to push their offers.

Big fat dreams to get cancelled or delayed
Rs75,000 crore - that is the kind of money that was expected to be mopped up by companies from the primary market this calendar year. That would have easily been a record, almost double of what was raised in 2007 and three times the 2006 figure. It would still not have taken us anywhere close to the Chinese, as a single Chinese issuer - Ping An Insurance - is planning a $22 billion IPO this year!

Of course, a majority of the issuers in the IPO pipeline are from the infrastructure and realty sectors that are most fancied in the markets these days. Issuers planning the biggest floats were power generation companies with 'ultra-mega' ambitions, property developers who were determined to 'build a new India' and the few who are into building roads and bridges.

Encouraged by the Reliance Power 'mania', many other established business groups have ventured into power generation. JSW Energy from the JSW Steel group, Sterlite Energy, which is a part of Vedanta group and Jaiprakash Power Ventures, were among the early birds with billion-dollar IPO plans. Others like Hinduja, Essar and Ispat were also rumoured to be interested in joining the fray.

After all, power generation had become a once in a lifetime opportunity to own companies valued at tens of billions of dollars - even before going through the trouble of actually building a business. All an entrepreneur had to do was float a company, finalise the details of a few large power projects, get preliminary approvals from the government and sell a minority stake to the public.

Once the stock gets listed on the exchanges, the promoter is a shoo-in to next year's Forbes list of billionaires.

Preliminary approvals are easy to come by, as power generation is a priority for the central government. State governments are ready to do anything to attract mega industrial investments. Questions on business models and valuations were, till now, being brushed aside. How long will it take to acquire sufficient land and start construction? Doesn't matter! Can these power companies build adequate fuel linkages, especially when fuel prices are soaring? Again, doesn't matter! Aren't the state electricity boards, who will be the major customers, already bankrupt? Who cares? Look at the projections, instead.

Dreams of real estate developers were no less impressive and the pedigree of some of them was even better. Emaar, co-promoter of Emaar MGF, is one of the biggest builders in the Middle East and is now building the world's tallest building - Burj Dubai. Future plans of some of these developers are like that incredible structure coming up in the Arabian Desert, the final planned height of which has not yet been disclosed!

None of the builders will accept that the property market is cooling off and prices are correcting. Even if that is the case, they argue, this is only temporary blip. The great Indian middle class will buy homes, even if they have to indebt themselves for life. And demand for commercial space will rise forever, irrespective of rising supplies, as economic growth shifts to double digits. These are some of the impressive stories that were being sold to investors!

After the Reliance Power and Emaar MGF fiascos, all these planned big issues will be postponed indefinitely. Given the cloudy market outlook, it will be quite a while before they can think of peddling the big dreams once again.

The only potential big issuer outside the infrastructure-realty space is SBI, which is planning a follow-on issue to shore up its capital base. Given its lower valuation when compared to its private sector peers, the issue would not have been excessively priced anyway. Interestingly, SBI - if its issue goes through - will be the only mega issuer this year with an established business!

Investors have only themselves to blame
Early signs of the IPO market topping out were visible from the second half of last year itself. Encouraged by the success of the early real estate IPO's like DLF, Akruti and HDIL, the subsequent issuers from the sector priced their IPOs higher. Interestingly, all the four property stocks that were offered during the second half - Brigade, Puravankara, IVR Prime and Omaxe - are all trading well below their offer prices, with IVR Prime having more than halved from its issue price!

This is not the first time bunching of excessively priced IPO's has happened just before a market decline. The worst was probably in the mid-nineties when thousands of companies just vanished after raising money through public subscriptions.

The promoters disappeared and a never-ending probe by the ministry of company affairs has not yet found any of them. This won't be the last either, as there will be a long queue of issuers to offer shares at the highest possible valuations whenever market sentiment improves.

It is easy to blame issuers and their merchant bankers for pricing these IPO's way above any kind of justifiable valuations. When markets are on a high, selling a mega IPO is easier than selling chilled soda in a desert - like the kids do in an old Pepsi commercial. Promoters and investment bankers will only be too happy to do so.

Promoters, without any track record in a new sector, cannot be blamed for taking immature businesses public when they are allowed to do so, particularly during a friendly market phase. It is in the promoters' interest to raise capital at the least possible cost. That means demanding the highest possible price multiple on projected earnings, which in turn requires them to promote dreams and promises to support that price.

It is the job of investment bankers to help the issuer get the highest valuation possible. It is not their business to protect the investors' interests. After all, they get paid by the issuers - not by investors! Yes, there is the risk of an odd high-price IPO being cancelled when the markets turn weak. But, investment bankers are smart enough to know that investors' memories are extremely short. When the market improves and after a couple of IPOs make money, investors rush in - whatever the price may be.

Investors who get carried away by market frenzy and are ready to believe any improbable investment story will eventually lose money. It is sad to see even institutional investors ignoring their fiduciary responsibility and making extremely risky short term bets. All these have happened before and will happen again!