Rules of IPOs

How swiftly the mood of the markets can swing from sunny optimism to extreme scepticism! The withdrawal of two big-ticket initial public offers (IPOs) by Wockhardt Hospitals and Emaar MGF this week underline how fragile the all-important factor called ‘investor sentiment’ really is. Barely three weeks ago, IPOs from Reliance Power and Future Capital Holdings sported record subscription figures, having garnered runaway response from every class of investor. The n, those rushing to hop on to the IPO bandwagon were hardly deterred by the stiff asking price or ‘execution’ challenges that faced these companies, both of whom rolled out their IPO at a rather nascent stage of their business. Yet, it is precisely these reasons that are now being cited for the unenthusiastic response to the Wockhardt and Emaar offerings.
Institutional appetite waning

It is not merely individual investors, bruised by the recent blows to their net worth, who seem to have lost their appetite for IPOs in three short weeks.

Retail investors, in any case, tend to take their cues from the larger institutions; which is why IPO subscriptions tend to bunch up on the last days of the offer period.

The larger worry for Indian investors, and the markets in general, should be the extremely tepid response from QIBs (qualified institutional bidders).

That institutional investors cold-shouldered a globally recognised name such as Emaar in the hot real-estate sector, after lavishing their attention on a slew of lesser-known names in 2007, is disturbing.

This suggests a genuine waning of liquidity and appetite for risk, at the global level. A recent report from Thomson Financial states that globally a total of 21 IPOs, worth $6.3 billion, were withdrawn in January. India, until recently, was an exception to this trend; but no longer.

‘Superior’ growth prospects or not, liquidity remains the engine that powers stock markets. When it comes to liquidity, India’s primary market, much like its secondary market, depends heavily on the favour of global investors.

A good number of retail investors, in any case, were in the game mainly for listing gains. With present secondary market conditions making huge listings difficult, those on the speculative fringe may remain on the sidelines until the frenzy starts all over again.
Structural shift

This being the case, the failed IPOs may flag off two key trends for the stock markets in the months ahead. One, the flow in the IPO pipeline may dwindle as those with a limited track record rethink IPO plans.

Two, with global investors in a risk-averse mood, markets may no longer be willing to pay any price for a new business idea. Valuations, whether for new offers or already listed companies, may moderate. In the buoyant markets of the past few months, businesses and stocks that captured the imagination were able to justify sky-high values, on the strength of fancy “valuations” assigned to nascent businesses that were still on the drawing board.

These developments may also require retail investors in IPOs to make some changes in their investment strategy for the months ahead. The key takeaways for them from the turbulence of the last week are:

Listing gains are no longer a certainty. This means that investors cannot bank on flipping a stock on listing to recoup high funding costs incurred to bid for the IPO. Investors may be better off avoiding leveraged bets on IPOs, no matter how attractive the business or the “grey market” buzz on the stock is.

Investors should go back to evaluating every IPO much as they would a stock in the secondary market. Businesses that have alternatives in the listed space may no longer be able to command huge valuation premia, just because they are garnering funds through an IPO. Newly listed stocks may no longer remain islands of high valuation, with large trading volumes, in current market conditions.

Finally, while making their decision, investors should factor in the opportunity loss involved in taking the IPO route. Quite a few retail applicants to the Reliance Power IPO probably sacrificed attractive opportunities to buy into blue-chips of their choice when they were available at rock-bottom prices in the recent market correction.

A significant part of their funds was locked into the offer. Allocating only a portion of your overall equity portfolio to IPOs and participating only in high conviction ones may be the best way forward.

Via Businlessline