SBI Cards IPO: This one's for high net-worth individuals, but has its risks

Listing gains may be limited, if the issue is subscribed multiple times

When an initial public offering (IPO) like that of SBI Cards, which is expected to evoke a good response, takes place, expectations of listing day gains run high. High net worth individuals (HNIs) often borrow money from non-banking financial companies (NBFCs) to apply for such IPOs. Such leveraged bets, however, carry high risks that HNIs need to be cognizant of.

If a person’s application is for more than Rs 2 lakh, he falls in the HNI category. Allotments in this category happen as follows: If the HNI portion gets oversubscribed x times, then each HNI is allotted 1/x of what he has applied for. HNIs often borrow to enhance the number of shares they are allotted. “Suppose an HNI wants to buy shares worth Rs 1 crore. If the oversubscription is 10 times and he applies using only his own money, he could end up with an allotment of Rs 10 lakh worth of shares only,” says Shankar Vailaya, chief executive officer, Sharekhan BNP Paribas Financial Services.

HNIs must take into account the probability of listing gain before applying. “Listing gain should be adequate so that the applicant is able to make a profit even after deducting interest cost,” adds Vailaya.

Two key risks exist in taking such a loan. Instead of a listing day gain, there can be a loss. Even in case of a high-quality company, sometimes market sentiment can change between the time of applying and the time of listing. Even extraneous factors (say, like the Coronavirus epidemic) can affect sentiment.

The other risk is the amount of allotment the HNI gets. “If the level of oversubscription is higher than expected, the HNI will end up with a smaller allotment. But he will have to pay interest on the entire borrowed amount, which could result in losses,” says Deepesh Raghaw, founder, PersonalFinancePlan.in, a Sebi-registered investment advisor. He adds that as the level of allotment reduces, the listing gain has to be higher for the investor to make a profit. Guessing in advance how much the level of oversubscription will be is not easy as HNI applicants mostly apply on the last day.  

 

 

The interest rate on these loans also has a bearing on the investor’s profitability. NBFCs raise money from mutual funds. In case of more popular IPOs, the latter agree to lend only at a higher rate. 

NBFCs add a spread of 2-3 percentage points to the borrowing rate before lending. (Note that if the NBFC charges 12 per cent, the investor will pay a rate that is lower by 3-4 per cent. The interest earned while the money is blocked in ASBA offsets a part of the investor’s cost.)

The most favourable scenario for leveraged HNIs is if the listing gain is good but the level of oversubscription is not very high. Though this can happen, these are intrinsically conflicting outcomes. If an IPO is popular, the likelihood of listing gain is high, but such an IPO is also likely to be oversubscribed. The probability of getting the optimal mix of listing gain and allotment is not easy.

Any investment where leverage is high—it can go as high as 99 times the amount put up by the investor—carries high risk. “Investing in an IPO via IPO funding is a high-risk high-reward investment. It could result in massive losses if things go wrong,” says Adhil Shetty, CEO, BankBazaar.com.

Finally, beware of over-leveraging. “Restrict yourself to your risk-taking ability. If you have one crore of your own, then don’t try to get allotment for more than that amount,” says Vailaya. Shetty suggests that IPO funding should be considered only after carefully analysing the IPO, issue price, market and industry trends, and cost of borrowing.