Should IPO Reservations go?

The mega DLF Ltd and ICICI Bank Ltd public issues have both sailed through because of strong institutional demand. Retail investors have barely been able to cough up enough funds to subscribe to the portion allotted for them.

Nearly 35% of ICICI Bank’s Rs10,063 crore issue and 30% of DLF’s Rs9,188 crore issue were reserved for retail investors. In sum, retail investors have had to come up with Rs6,278 crore in a short span of time to subscribe to the allotted portion.

It’s no wonder the response was lukewarm, despite an enticing Rs50 discount (about 5.5% of the issue price) that ICICI Bank gave retail subscribers and part-payment options.

For the issuer, it doesn’t really matter if the retail portion goes undersubscribed as long as the institutional portion is oversubscribed. In fact, it’s critical that the institutional portion (typically 50-60% of an issue) is fully subscribed—otherwise, the issue devolves.

In case the retail portion doesn’t have enough bids, the spillover from the institutional portion can take care of the shortfall. But it does affect market sentiment if the retail portion of an initial public offering (IPO) doesn’t get enough bids.

With bankers heaving a sigh of relief now that the two mega issues are out of the way, the question is: Do we need to revisit the rules that require mandatory retail allotment?

This question isn’t a new one, but the experience with two large issues makes an emphatic case for a revisit, at least in the case of large issues and certainly in the case of follow-on ones, where retail investors can easily buy from the open market.

Without a specified retail quota, not only could institutional demand have been better met, but even the retail section of the market would not have come under pressure. From an issuer perspective, it could avoid discounts to retail subscribers, resulting in raising the best possible amount from the market. In any case, the retail portion, with most investors applying at the cut-off price, contributes nothing towards price discovery.

ICICI Bank pricing

ICICI Bank’s pricing of its follow-on public offer (FPO) has been a coup of sorts. The stock traded at Rs908.70 when the bank announced its price band of Rs885-950, moving up to Rs954.55 by the end of trading on Friday.

The strong demand from institutional investors for the bank’s FPO seems to have pushed up the stock in the secondary market.

In fact, the stock traded at an average of around Rs900 in the preceding six months and the price band for the issue went against the conventional wisdom that follow-on offers should be priced at a discount to the traded price. Why else would investors block funds for about three weeks? They’d rather buy from the open market.

But ICICI Bank faced no such problem—its IPO was oversubscribed by 11.5 times, with the vast majority of the bids coming from institutional investors. Also, it’s not just the ICICI Bank scrip that did well last week—National Stock Exchange’s Bank Nifty moved up by even more than ICICI Bank last week. Whether FPO benefited from the surge in bank stocks or whether some of the sheen of the issue rubbed off on other bank stocks is a moot question.

Essentially, ICICI Bank has taken advantage of strong institutional appetite for Indian banking stocks, which remains unsatisfied because of low foreign holding limits, especially for state-owned banks. (State-owned banks account for 50% of the total market value of all listed banks).

The strong demand was visible in massive oversubscription for the institutional part of the issue. Retail investors, of course, weren’t expected to share the fervour, which explains the upfront Rs50 discount.

Via Mint