IPOs: All that glittered

Most market players point at grossly over-rated valuations based on earnings projected many years in the future.

The great Indian IPO fallout continues, as the Reliance Power's IPO, priced at Rs 450 per share and which got oversubscribed 73 times, tanked as low as Rs 355.05, after listing at Rs 530 and touching even a high of Rs 599.90.

While the stock finally closed at Rs 372.50 on the Bombay Stock Exchange, investors have been hit hard. Not only have they lost a part of their capital, but those who took a loan to subscribe to the issue have lost a greater amount.

Although Reliance Power, which is the largest initial public offering (Rs 11,700 crore) so far on the Indian bourses, managed to evince spectacular interest, the shift in investor sentiment surfaced when meagre subscriptions to the Emaar MGF Land and Wockhardt Hospitals' IPOs forced them out of the markets last week.

While the overall market sentiment has turned weak and played a big role in this debacle, most market stalwarts point at grossly overrated valuations, based on earnings projected many years in the future.

One may recall that in the case of Reliance Power, the company's plan includes setting up power plants, wherein the major part of the projects would start generating revenues and profits only from year 2013 onwards.

The IPO pricing was also more than aggressive, when compared with existing segment leaders like NTPC and Tata Power. Wockhardt Hospitals' IPO pricing too was equally aggressive.

This conquest of promoters to extract a high price from investors has also contributed. That's not to say that investors haven't been greedy to make quick money from IPO listings.

Another explanation that can be derived is from the correlation between the institutional response to IPOs, vis-à-vis that from retail investors. In Reliance Power's case, the offer was fully subscribed in less than a minute of opening for subscription.

This may be an achievement in itself, but, it is not entirely difficult, considering the fact that institutional bidders need to pay only 10 per cent margin money.

Hence, it becomes easier for them to overbid, and in effect end up creating hype and hubris around an IPO. In Reliance Power's case, they needed to pay Rs 702 crore to subscribe to the 60 per cent portion of institutional allotments worth Rs 7,020 crore reserved for QIBs""-the QIB portion was subscribed nearly 83 times.

Since HNIs and retail investors were also allowed to pay only 25 per cent of the amount upfront and the fact that the grey market premium hovered between Rs 400-500 per share at that time (making it an attractive proposition), the overwhelming response to the Reliance Power IPO was not surprising""the HNI category was subscribed 160 times and retail portion by 14 times, taking the overall subscription to the issue to 73 times.

In short, investors seem to have ended up overbidding, right from the start.

To understand this, one has to go through the fine print of regulations related to subscriptions to IPOs.

In an IPO, a large part of the offer is open to subscriptions from institutional bidders, while the rest is subscribed by high-networth individuals (HNIs) and retail bidders.

Among these, institutional investors have the leeway to subscribe to the issue by making a payment of just ten per cent of the total amount.

A study carried out on the IPO performance in 2007 by Edelweiss Capital (IPO Matrix 2008: A snapshot) hints at a strong correlation between the extent of subscription by qualified institutional bidders (QIBs) and returns on listing.

The extent of QIB subscription in turn, influences decisions of retail investors, who usually place their bids closer to the date of closing of an issue, considering the institutional subscription to an offer.

Although issues like Reliance Power and DLF were exceptions since they allowed part payment of 25 per cent to place their bids, most issues require retail investors to pay the entire amount upfront.

It thus, makes it imperative to question whether institutional investors should be entitled to preferential treatment when it comes to IPO subscription.

On attempting to reason this, A. Balasubramaniam, chief investment officer, Birla Sun Life Asset Management Company says, "Prima facie, institutional investors get this leeway due to the sheer quantum of funds that they commit.

Besides, the chances of individual investors not meeting their commitments are high, which is not the case with institutional bidders."

He further adds, "Earlier, institutional investors were not required to pay any margin money at all," hinting at changes in regulations.

While the regulator may make it tad stricter for institutional investors to apply for IPOs going forward, it is the retail investors who are more vulnerable to the market risk, as is the case with Reliance Power.