IPO/OFS – It’s seller vs buyer, with advantage seller

Initial Public Offer.  IPO. The magic term that brings forward so many emotions…and probably all falling into the bucket of ‘greed’ or ‘fear’.  Nothing in between. 

Our investors are truly a capricious lot. The retail investor is driven by his quick profit on a single lot. The HNI tries to multiply his gain by leveraging.  And the institutional investors, who seem to be an important link in this whole business, act in a very strange manner, mimicking the behaviour of the masses. After all, behind the professional tag, hides a human with emotions like me and you.

Public issues – then and now

I have seen this system of public issues change over time. We moved from ‘controlled’ pricing to ‘free’ pricing, from “public” issues to class-segregated issues where allotment limits are specified for each class of investors. In the old days, there was a pro-rata system and today there is a lottery system. And in the old days, one had to put in money along with the application and the allotment and refund process could take three to six weeks! Which meant that your money was stuck and you could not ‘rotate’ your money enough when the IPO calendar shows thirty and more issues in a month! 

Yes, things are better today.

But the PayTM listing has been a kind of a shock to the system. Years ago, it was the IPO of Reliance Power which hit the pause button on stock markets. When people make money, there is never a noise. It is happiness. However, when people lose money, there is hue and cry about the perils that the ‘retail investor’ has to suffer, lax price controls by SEBI on new issuances of shares and so on and so forth. It is as if the investor has to be guaranteed a positive return on everything he buys! And the call has to be taken based on one day’s price!

Book-building is not price discovery

Most IPOs today are priced in a ‘price band’, and this band is finalized only a week or before the issue hits the market. When the draft prospectus is filed, there is no indication of price. This pricing band system is named as ‘book building’ route. In essence, it means that during the dates that the issue is open, based on the bids, the final price is determined. 

But does it genuinely work like that? In a bull market, everyone bids at the top of the band and in a bear market, at the lower end of the price band, if at all.

In reality, the investment bankers have already agreed on a price with the issuing promoter. In fact, I can say that in many cases, the mandate is given to a banker who promises the highest price per share. Of course, no one will admit to this. The official reason will be because a particular banker ‘understood’ the company very well and thus will be able to sell the issue well.

This system works fine as long as there are listing gains, or the issue is a small one, or one that hasn’t received much by way of investor or media attention. 

But when an IPO like a Reliance Power or a PayTM bursts this happy bubble, it raises age-old debates. Has the book-building system failed us? Are we better off with a ‘fixed price’ system, where the price of the share is inked into the draft prospectus that is filed with the regulators? 

The answer depends on whether you are an issuer or an investor. The issuer will not like a ‘fixed price’ offering because he would like to play it by the ear. Depending on when the approval comes and the market conditions, he is trying to maximise the price.  Often, bull markets are chosen for launching issues, because that is when the seller can extract the maximum. The investor is always at a disadvantage, because the seller chooses the time and the price. 

The other thing to realise is that ‘book building’ is generally a misnomer. What happens is that before the price band is fixed, the banker has done the rounds with key investors and has given ‘indicative pricing’.  Based on the actual market conditions at the launch, the price band is suitably stretched. In a sense, it is a fixed price already but within a range.  It is the institutional investors who set the price. 

The retail investor, by and large, is playing for the flip on listing. And so is the leveraged HNI who has borrowed to invest in a big way. And then we have the hand of the grey market or the ‘GMP’ which whispers of a ‘premium’. This is the reason we see the huge volumes on the listing date. All kinds of adjustments and deals are made to square off bets made and to take home what is on the table. Thanks to technology, the money on allotment is locked in just for three to five days. And a listing pop of, say, 10% is a huge return for a seven-to-ten-day ‘investment’.

Fixed or book-built?

I still support free pricing as opposed to controls on prices. Price controls will stifle business besides conferring unnatural powers to the government, which neither understands market moods nor valuations.

So, the options before us are whether we adopt a fixed-price approach or a book-building one.  A fixed price is what my choice would be. It is only fair that the promoter decides his selling price beforehand and skip playing around based on market conditions.

Yes, on his approval, he could be given an option to revise his price once should there be any material developments since the filing and approval of the offer documents. Apart from this, nothing else would have happened. Market conditions keep changing. That is something the promoter has to learn to live with. 

A book building exercise generally is a function of camaraderie between market players and the bankers. Generally, all it does in the end is to take the issue price higher and higher.

But fixed or book-built, the gap in IPOs that should be addressed, in my opinion, is the lack of information. SEBI has to pay attention to this. The RHP (red herring prospectus) is hardly read by anyone in time for an issue’s opening (incidentally, I have written on how to read an IPO document, if you’re interested in knowing what to look for). 

The statutory ad, for instance, is one that needs drastic changes. Today, the “statutory ad” has meaningless information. What is the point in knowing that the promoter is a holding company? I do not even know what the market cap of the company at the issue price would be! What are the latest sales and profit numbers?

These are information that are basic to understanding the company issuing the IPO rather than pointless sentences that run into four lines and cannot be read in a single breath! I want to know simple things – what is the business? How and why will it make money? Who are the customers? Who is the promoter?  I will be happy to sit with SEBI and design a simple one pager. 

And if I were SEBI, I would also put some language restrictions. Not to have a sentence longer than twenty-five words. Yes, we could think of other restrictions such as having anchor investors (mutual funds, for sure) not sell for a year at least. When these funds have exit loads and sell the product as a long-term investment, this should be easy. Surely, they are professionals, who study everything and then invest for the ‘long’ term.

Investor behaviour

Finally, let us turn to the investor. You apply for two or three lots. What is your intent? 

This signifies that you are happy to buy everything you applied for at the price on offer. Now, if you are allotted only one lot and the listing price is below the IPO price, should you be buying more or selling? In less than a week since you filled in that application, neither the company nor its prospects have changed. 

But, then, you will say that you are only applying to sell on listing. If so, you should study probability. A simple one which tells you that for any possibility, there are at least two outcomes. Listing gains are not guaranteed. And on the day of listing, if everyone rushes to the exit gate, who are you going to sell it to? 

Do not blame the promoter. They did what they had to do. When you get listing gains like you did in the case of Nykaa, did you shed a tear for the promoter who so underpriced the IPO and lost out?

Other problem points

For me, an investor’s loss or gain, whether large or small, cannot be a reason for changing something. The reasons have to be beyond that. In that context, I have a preference for a fixed price offering, so that I have time to dig deep and do my homework. Surely, the promoter cannot keep changing his mind depending on how the index behaves in the week before his IPO opens! 

I also dislike leveraged applications, because they inflate the demand and lead to a temporary price imbalance that can be very misleading.  And of course, this famous acronym of GMP. Will our regulators ever be able to touch these players? GMP is openly shouted and even leading newspapers now seem to be using it as a reference point when they ‘review’ an IPO.

I am also against the offer-for-sale being clubbed with an IPO. An IPO should be a new sale of shares where proceeds go into the company. OFS by promoters or other investors can follow a month later by simple selling in the secondary markets. If there is to be a listing without an IPO and only through OFS, then let there be a separate process and pricing for it. Maybe take the last twelve months of share issuances by the company and benchmark the issue price to that issuance price/s.

Personally, I am happy to ignore the IPO process and carry on with my investing. I always believe that the secondary markets offer me enough choice, with price history and business track records. I do not have to debate on the possibility of profitability in forty years hence!

Is there a superior process for price discovery that is better than the existing system? When everything is fixed in advance, with the active collaboration of bankers and institutional investors, it is tough. How do you have a trade on a share before listing? 

It will not be deep enough to have a fair price. It would be easy to fix such trades and will open a new vista. Buying a new company share is always a risk. Not enough knowledge, not enough track record (even the past accounts are ‘re-stated’) and no research report, no forecasts! In the past, we would have ‘forecasts’, but then, which management does not know how to use an Excel sheet? 

No amount of tinkering with the process and laws can curb the outcome of the IPO battle between the issuer and the investor. Rare are those IPOs which ‘leave something on the table’ for the investor. An IPO, for an investor, is a miniscule part of his asset allocation. Unfortunately, it blooms in a bull market only. And somewhere, someone like R Power or PayTM comes and reminds the investor that it is possible to lose money also.