Pricing pressure: Sebi should avoid over-regulation

The idea of asking independent directors to justify pricing does not make sense

The Securities and Exchange Board of India’s (Sebi’s) attitude to initial public offerings (IPOs) appears to have swung from being liberal to over-regulatory within the space of two years, going by recommendations adopted at the last board meeting. While some new requirements involve additional disclosures that could help investors and issuers, others cannot be termed market-friendly. For instance, the regulator has proposed a committee of independent directors (IDs) justify the IPO-pricing band, using quantitative means. The pricing band will then be compared with the weighted average cost of acquisition of prior primary issuances and secondary transactions in the share. The IPO-pricing band has to be adopted and approved by the board of directors anyhow. Thus, it is unclear how much value IDs could add to the process. This also puts a heavy burden of responsibility on IDs, who may not all be qualified to make such financial valuations. IDs are often chosen for their professional expertise in some sphere relevant to the company’s business rather than for their financial acumen. Forcing an engineer or bio-scientist to justify IPO pricing may not be useful.

In other IPO-related measures, Sebi has approved an alternative five-stage filing mechanism. The current four-stage process consists of filing a draft red herring prospectus (DRHP) with Sebi, making it available for public comments for 21 days, followed by confidentially filing an updated DRHP. After Sebi’s clearance, the approved RHP is filed with the Registrar of Companies (RoC) and exchanges. The final stage is filing a prospectus after setting the price band. Under the proposed optional five-stage process, an issuer can file a DRHP confidentially with Sebi and stock exchanges for in-principle approval. Once Sebi’s observations are incorporated, an updated DRHP may be made available for public comment. This may be followed by confidential filing of a second updated DRHP and, upon approval, the issuer may file the RHP.

In this five-stage process, sensitive business data and competitive advantages would be kept confidential until all the approvals are done. The issuer may also be able to receive feedback from institutional investors to gauge demand and possible pricing without revealing details to the public at large. However, this five-stage process will perhaps extend IPO timelines. Sebi has also mandated that key performance indicators (KPIs) are to be disclosed in the prospectus. The price per share of the issuer based on primary issuances and secondary sale/acquisition, if any, in the 18 months preceding the IPO must also be disclosed. In the event of no transactions in the past 18 months, the last five transactions in the preceding three years are to be disclosed, along with the weighted average cost of acquisition. The intent is to justify IPO pricing through additional disclosures.

Issuers have generally disclosed KPIs in offer documents for marketing purposes but they will now have to mandatorily state them in the “Basis for Issue Price”. This additional requirement is perhaps due to the bearish performance of new-age tech companies (NATCs). NATCs are usually loss-making and backed by private equity and venture capital investors. While much of this is sensible, the idea of asking IDs to justify pricing does not make sense. IPO pricing, or any equity valuation for that matter, will always have subjective elements. If there are adequate disclosures, the principle of “caveat emptor” should apply.