IPOs Coming Up, How Should You Think About Them?
The stock market is doing well, hitting all-time highs. A number of companies want to make the most of this by launching their Initial Public Offerings. In 2021 we have 15–20 IPOs lined up on Indian bourses. The big ones like Zomato, Nykaa, LIC are already making headlines.
It is an opportune time to consider our IPO strategy as a whole.
IPOs provide an opportunity for an investor to get engaged with a company for the first time. In cases such as LIC, these are companies we are familiar with and might have an interest in. For retailers like Nykaa, we might have used their service. There are other companies we will only get to know from the Red Herring prospectus they file. All of them offer the retail investor (Mr. Joe Public) an opportunity to invest in and benefit from their growth.
IPOs are also an opportunity for the founders, employees, initial investors to unlock the value created by their risk and hard work.
Ideally, it looks like a win-win scenario. Every party gains when a good business comes to the fore. Why then, should we even bother to have an IPO strategy, should we not just go out and subscribe to every IPO that comes up.
Unfortunately, no that is not the case.
It is not really a case of win-win every time.
One key ingredient here is information asymmetry. The company’s investors and founders know everything about the company the rest of us do not. We have not had the chance to analyze their performance over a long enough period. We have not been given an opportunity to scrutinize their financials through economic ups and downs.
Therefore, it is always speculative to invest in a company where there isn’t enough information available.
“you should buy a stock, only if you are investing in it for 10 years”
It is useful to ask, who benefits the most from the IPO. Is it only the VC divesting his stake or is the company getting the funds for business growth?
In the case of the former, it is a win for the VC but does not serve the company’s long-term interests and consequently the retail investor’s.
All of these details are contained in the Red Herring prospectus. Joe Public will need to take the effort to read up and find out.
Just to illustrate, let us look at the recent IPO of Sona Comstar. The issue was for Rs. 555 Bn , of this only 30 Bn was for corporate use and the balance of 525 Bn was to retire the debt from Blackstone, the initial investor.
Basically, for every 100 rupees invested by the retail investor, 95 was to the VC and 5 to the company to use for growth purposes.
This might be good or bad, that is for the individual retail investor to decide. It is important to dig in and be aware of this information to make a decision.
Retail Investors and the over-subscription trend
IPOs tend to be over-subscribed. Of the 257 IPOs from Feb 2010 to March 2021, 200 were over-subscribed in the retail investor quota. This is the quota for Joe Public to invest.
Retail investors can invest up to Rs. 200,000. High Networth Individuals (HNIs) can invest more than Rs. 200,000.
In the HNI quota, 195 IPOs were over-subscribed.
The level of over-subscription is seen as an indication of how well the company is going to perform on the stock markets.
But, data does not necessarily reflect this
Of the 132 companies which were oversubscribed by retail investors between 2010 to 2017, a whopping 89 have their current market price lower than the list price, and 83 of these have dipped below the issue price.
Listing gains, the holy grail of IPOs
This is one enthusiastic reason why a lot of people want to invest in IPOs. Listing gains is the money you make if the company lists at a price higher than the issue price.
This is akin to trading in IPOs.
My approach is — “you should buy a stock, only if you are investing in it for 10 years”. I think it is not worth my time to go after listing gains. But that is just me.
Let me present the math as I see it
Assuming you are a retail investor, you will be constrained by the 200,000 limit. How stocks actually get allocated in the case of over-subscription remains a mystery.
I am taking allocation in proportion to the over-subscription of the issue for a retail investor quota.
Looking at the issues of the last 3 years, the top 10 retail investors over-subscribed IPOs would have given you a best case of Rs. 7,200. for Bector Foods and Rs. 3,800 for Burger King.
Consider the effort: i. set aside Rs 200,000, ii. subscribe to the IPO, iii. track allocation (agonize over it) and then iv. rush to sell on listing day. Finally, v. make sure you got back the unutilised part of your Rs. 200,000. All of that seems too much effort for the gains available.
Of course, if you have time on your hands, it is not a bad pursuit at all. (Note to self: Side gig idea post-retirement)
Applying for IPOs as an HNI by taking a loan
One area I would definitely steer clear of is taking a loan to invest in an IPO.
Your broker or even your bank will lend you money to invest in an IPO. The assumption here is that you will make enough money on Listing day to make up for the transaction costs and interest. This is an unnecessary risk in my book.
Consider the two cases of SBI Cards and the Ali Pay IPOs, both were sure-shot successes in waiting.
SBI cards IPO was over-subscribed. Just before the stock was listed, we went into the Covid market crash. The stock was listed at 100 rupees lower than the issue and stayed below the issue price for a good few weeks.
The Ali Pay IPO was a case of global euphoria — a $37 billion issue with more than $3 trillion from retail investors, many of whom had taken a loan to invest in the IPO. The issue got pulled at the last minute due to regulatory issues.
So, leveraging to invest in IPOs is not something I would recommend at all.
One final point to round off the post
Of the 252 IPOs between Feb 2010 to March 2021, 143 are trading below list price and 137 are trading below their issue price. So more than half the companies from the IPOs of the last 10 years have lost value.
What is the possibility that you will be able to pick the winners based only on the Red Herring prospectus and a few media articles?
I don’t rate my ability to see the future as very high.
So, given my predilection to passive investing, I think I will steer clear of IPOs for now. I will still prefer index investing or even if it is individual stocks, I would like to see a few years of solid performance track record.
Before we end, I would suggest reading this article about the IPO Scam, which forever changed how the primary market operates in India. A nice little story of ingenuity, greed, and the desire for free stuff.
Finally, a shout out to Money Control for this compilation of stats on IPOs since 2010.
Takeaways:
- An IPO has asymmetry of information, the retail investor will need to research well to understand the company
- More than half the IPOs since 2010 are trading at below their issue price. Of the issues that were oversubscribed more than half are trading below their list price.
- Listing gains sound great but for the passive investor the effort is not worth the returns
My recommendation for the long-term investor is to stick to fundamentals and investigate a company thoroughly before investing. An IPO company should be treated no differently from one that is listed when considering for investment.