Hollow gains

IPOs are back in fashion, and how. Snowman Logistics, a subsidiary of Gateway Distriparks and the latest IPO entrant on the bourses, made a dashing debut earlier this month, with gains of an astounding 68% on day one of listing. With that kind of return, Snowman comes second only to PG Electroplast, which listed in 2011 at ₹412 for a 96% premium. Of course, it’s another story that the founders of PG Electroplast have since been banned from the markets for manipulating stock prices.

Snowman’s share listed at ₹79 against its issue price of ₹47. In other words, had an investor invested ₹1 lakh in the IPO and sold on the day it listed, he or she would have made a cool ₹68,000. However, those gains are only on paper. No one would have really been able to pocket those kinds of gains, as the issue was grossly oversubscribed, making it impossible for people to get the number of shares they applied for. For those who did not borrow any funds and applied for the IPO with their own money, there is the opportunity cost of the money to contend with. 

But the ones left with the worst return were those who borrowed money. For an investor who had applied for 5,000 shares with an equity to debt ratio of 1:4 (that is, for every rupee of the investor’s own contribution, the loan amount was ₹4), the return on investment would have been a paltry 3.3%, against the 68% premium at which the scrip got listed. Even if one borrowed money through an application supported by blocked amount (ASBA) account, the return would have been only a shade better at 4.5%. The ASBA facility was introduced to eliminate the hassle of waiting for application money to be refunded post allotment. For example, if an investor bids for 100 shares for ₹20 each and the issue is subscribed ten times, he or she will receive 10 shares and only the cost of that chunk, that is, ₹200, will be debited. This way, the applicant only pays for the shares allotted and is saved the trouble of blocking the entire amount.

In fact, brokerages and some non-banking financial companies (NBFCs) are now financing margin money through ASBA at low interest rates of 7-8%, compared with 12-14% for normal margin funding. Market expert Ambareesh Baliga says, “ASBA allows brokerages to cut down on interest rates. The financier opens an account in the name of the borrower to utilise funds deposited for ASBA applications. The borrower will earn interest on those funds, and assuming he or she earns 6% interest and the financier charges 13%, the cost of funds comes down to 7%.” However, a cheaper mode of leverage is no guarantee for higher returns for investors, and that’s what has ended up disappointing them big time. The contrast in absolute listing gains and what the applicant actually ended up making is a result of the oversubscription numbers.

In Snowman’s case, a large section of investors — mostly high net worth individuals (HNI) — leveraged their applications through the ASBA facility. The issue was subscribed 60 times, receiving 195 crore bids for an issue size of 3.25 crore shares at a price band of ₹44-47. The retail segment of the Snowman IPO — the second one to hit the capital markets in FY15 after amusement park operator Wonderla Holidays — was subscribed 41 times, while the non-institutional investor segment, comprising sophisticated investors such as corporates and HNIs, was subscribed a whopping 218 times.

This meant that an investor who had applied for 100 Snowman shares received only 1.6 shares, which severely impacted his or her return. In IPOs that are oversubscribed several times, investors have little room to make money, given the negligible allotment of shares compared with what they had applied for. 

The risk for investors is only compounded when a public offer does not see a strong listing. Consider this: Wonderla, which listed at a 26% premium, is among the top 10 IPOs since 2009 to have delivered record first-day gains. In this case, given that the oversubscription was 38 times, an investor using the ASBA facility would have earned 2.3%, and an investor relying on normal margin funding would have made just 1.1%.

Still, investors are not getting any wiser. Investment bankers like B Madhuprasad, non-executive chairman of Keynote Corporate Services, feel that investors are increasingly looking at making a quick buck in IPOs. “Almost everyone who is investing in new issues is looking for short-term listing gains. A typical investor encashes on the day of listing and re-enters the stock once the price falls.” That’s typically the case with all bullish markets.

Given the backdrop of negative payoffs or dismal risk-adjusted return, most primary market pundits advise investors to stay away from leveraging. Prithvi Haldea, founder chairman of Prime Database, which tracks the primary market, is dead against IPO financing, which is encouraging the retail investor population to turn into speculators.

“The primary market should be a long-term and vibrant place for needy corporates to access low cost of funding. But today, it is a punter’s paradise, with leveraged investors happy to make money till such a time as it covers their interest costs. The HNI portions of both Shemaroo and Snowman were oversubscribed by more than 200 times. This sends wrong signals to small investors, who perceive the stock as a reliable investment with good fundamentals. Regulators should come down heavily on this,” he says. 

Investors should be wary of assuming oversubscriptions to be an indication of strong listing. Though it may mean high demand and a strong listing, oversubscription may end up diminishing return if an investor fails to get decent allotments to make large enough gains to offset the interest cost, in case of margin funding. There have been several issues over the past few years that have listed at a discount to their issue prices. For instance, Va Tech Wabag and Godrej Properties listed at around 50% discount to their issue price. An investor who applied for 5,000 shares — borrowing 80% of the funds required — in Va Tech Wabag at an issue price of ₹1,310 would have lost ₹1.2 lakh (including interest cost) on an investment of ₹2.2 lakh. 

But investor memory is short. Right now, the strong listing of Snowman and Wonderla has sparked hope among investors that there could be a repeat performance with other IPOs as well. HCC is looking to list its subsidiary, Lavasa, and others, such as GVK Airport — a subsidiary of infrastructure company GVK — are waiting in the wings. But experts urge investors to be cautious. 

However, it is still too early to call this a revival. In fact, so far, 2014 is turning out to be one of the worst years for the primary markets; till the end of September, two floats managed to raise only ₹378 crore, compared with over ₹37,000 crore in 2010. “When Justdial entered the market last year, people started claiming that the IPO market has been revived. But there were no new issues for a year after that,” says Haldea.

He believes that during a boom and bust cycle, strong firms with reasonable valuations get oversubscribed, followed by bad ones raising money at attractive valuations; the vicious circle is complete when bad companies go public at exorbitant valuations. The last time the IPO market peaked was FY08, when any and every company with terrible fundamentals managed to raise money. History may not repeat itself but it does rhyme for sure.