Analysing An IPO: A Different Strategy

The year 2015 is turning out to be a runaway success for the primary equity capital market. The money raised so far (October 2015) through this route has exceeded what has been raised cumulatively in the last three years (refer table of issues in 2015). This is despite the first two months of the year remaining dry with no public issue of shares. Looking at the DRHP filed by companies with the SEBI and clearances, we believe that we will see more issues in the coming two months (refer table of expected issues). This year, till date, 18 companies have hit the primary capital market and raised Rs 10,862.47 crore, the highest over the past five years. 

Nonetheless, as an investor wouldn’t you be interested in knowing how these IPOs have performed in terms of yielding returns? There are different sets of investors with different objectives who approach the primary capital market. Someone might be interested only in listing gains and want to make quick buck, considering that IPOs are generally under-priced and provide room for good appreciation on the listing day. Then there are investors who subscribe to the issue with a long-term horizon and remain invested despite fluctuations. Therefore, performance also needs to be measured accordingly. For the former class of investors, the listing day’s performance is important whereas for the latter class of investors, a long-term performance is essential.

Out of the 18 IPOs that have hit the market this year, 16 have been listed so far. Of these, eight companies yielded listing gains while the rest were a disappointment, closing lower than the issue price on opening day. The best performer on listing day was VRL Logistics that closed 43per cent higher than its issue price while Coffee Day Enterprises turned out to be the worst performer.
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An attempt to discover a trend for the opening day listing will not provide any concrete results. So what is it that distinguishes a performing IPO from a non-performing one and more importantly, what are the things you should look before applying for an IPO that suits your objectives? To answer this question, we have extended our study beyond the current year to include all the IPOs that have hit the market since 2009 and our analysis also encompasses factors other than the financial performance of the companies and valuation.

A Historical Perspective

Since 2009, there were altogether 158 companies that tapped the primary capital market for the first time to raise funds to the tune of Rs 83,227 crore (refer table:1). Nonetheless, there were 13 other follow-on issues too, mainly from the government stable. If we add those issues too, the total amount works out to Rs 1,29,475 crore. Of the companies that got listed, the average return on listing day was around 9 per cent. Almost 60 per cent of the issues yielded listing gain, whereas 40 per cent failed to give any positive returns. Since every issue was of a different quantum, the average return does not reveal whether an investor made money post the listing. This is because many small issues would have performed well while one big issue would have spoiled the entire party. 

Therefore, we analysed the gain in rupee terms that an investor would have earned on listing day. This turns out to be positive and the gain totals Rs 9,826 crore. The IPO of Coal India, which was of  Rs 15,199 crore, played a crucial role in this return and generated opening day profit of Rs 6,148 crore for its investors. In terms of sectors, construction, engineering and finance represent those from where the largest number of companies tapped the primary market to raise funds, and in that order. Nevertheless, when it comes to the quantum of amount raised from the market, power generation and supply tops the chart followed by mining / minerals / metals, finance, and construction respectively. In terms of returns, mining / minerals / metals with four issues provided the best average returns. This was followed by steel and construction.

One of the reasons for such a performance by the commodity companies is that most of them had hit the market in 2010 at a time when the commodity cycle was on a high. Therefore, they could demand good premium from investors, and hence better returns. Any company from this sector that approached the market after that - when the commodity cycle was caught in a downturn - could not evoke the same level of interest from investors. A case in point is the recent listing of Pennar Engineered Building Systems, which closed 12 per cent below its issue price on listing day. Therefore, it’s clear from historical data that if a company from a sector which is in vogue comes up with an issue, chances are high that it would provide listing gains.
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This shows that besides the financial parameters and valuations, there are other factors too that definitely impact the listing performance, which in turn may or may not depend upon the financial parameters. Therefore, if you want to skip the usual analysis of financial performance before subscribing to the IPO, these factors might help you in making your up mind to invest for listing gains. We will study some of them in detail and figure out if they can help in predicting the future returns, be it listing or long-term. We are consciously not considering the financial analysis and valuation of companies because as and when any IPO is announced we undertake a detailed analysis, either published in our magazine or posted online depending on the opening and closing dates of the issue.

Issue Size

It is believed that larger the size of an issue, higher will be the listing gain because larger issues are followed and analysed by a large set of analysts and any under-pricing will be discovered easily. These issues draw more investors and this may lead to a higher demand. Since the number of shares is limited and the demand is not fully met, upon listing there may be listing gain.

Listing Gains and Issue Size

We studied the impact of issue size of all the IPOs in our study period and plotted listing gains against each issue size. We find that there is positive correlation between issue size and listing gains. As issue size increases, listing gains also increase; however, after a certain point it stabilizes and then reduces slightly. To understand things better, we went a step further and placed all the IPOs into five different buckets or quintiles on the basis of their issue size. We found that the median difference of the listing day return between the top 20 percentile issues and bottom 20 percentile issues is 2 per cent.

You may find this too narrow to consider it important but if we take into account the variation of performance, it is too high in case of lower-sized issues. For example, the difference between best performer and worst performer in the top percentile is 58 per cent while for the bottom percentile it is as high as 198 per cent. The top 20 percentile issue sizes comprise issues between Rs 700-15,199 crore while the lowest percentile comprises issues between Rs 23-60 crore. We also studied the statistical significance of the issue size using regression analysis and found it to be an important factor in determining the listing day gains and almost 9 per cent of the total issue gains can be attributed to the issue size. Therefore, if an IPO had listing gain of 10 per cent, 0.9 per cent is contributed by issue size, and higher the issue size higher will be gain.

The Demand Factor

Our study shows that there exists statistically significant correlation between subscription and the listing gains. These significant correlations indicate that there exists high correlation between the market demand and the listing day return. This is due to the fact that in case of an oversubscribed issue, the demand for shares issued by the company is more than the supply and investors who do not get shares in the allotment process try to buy on the listing day. This leads to over and above market gains on the listing day.

Investors in India who apply for IPOs are broadly classified into three categories: Qualified Institutional Buyer (QIB), Non-Institutional Investor (NII), and Retail Individual Investor (RII) along with employee reservations, if any. In an IPO, QIBs have a quota of 50 per cent, retail investors 35 per cent, and HNIs 15 per cent. We studied the IPO performance on listing day and the subscription level for all these three categories combined together.

Graph 2: Listing gains and Sub Times

First of all, the relation between total subscription and IPO performance is considered (refer graph). The graph indicates that as the subscription level goes up, the probability of listing gains rises. Once again, we divided the entire data of total subscription into five quintiles and found that companies that lie in the top 20 percentile in terms of total subscription (average total subscription was 40 times) gave better average returns compared to companies in the lower 20 percentile (average total subscription was 0.88 times).

Graph 3

Therefore, it is clear that subscription levels do play an important role in first day gains of IPOs. We ran a regression analysis on listing gains and subscription levels and found that there exists a positive relationship between them and a one-time increase in subscription level has the probability of increasing the listing day returns by 0.6 per cent. We investigated further to check if only the total subscription matters or whether the level of participation of QIB is also important. The accompanying graph clearly shows that as subscription increases, returns increase too even if there is no one-to-one relation. We again carried out the same exercise and concluded that the top 20 percentile in terms of subscription saw better returns than issues that saw lower subscription levels. For the top 20 percentiles, the average return was 25 per cent compared to negative 1.64 per cent for the bottom 20 percentiles.  Therefore, QIB and their level of interest too play an important role in determining the IPO listing gains.
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The relation between retail interest and listing gain returns also shows the same trend. In some of the cases, we see that despite good appetite from institutional investors and overall investors, the IPO fails to yield listing gains, but these cases are few and far between. In our study, we have observed that in the top 20 percentiles, only a single such instance has occurred. IndiaBulls Power, now know as RattanIndia Power, saw total subscription of 21 times, which was led by 40 times’ subscription by QIBs, and yet closed 12.78 per cent below its offer price on listing day. Moreover, in the last six years, any issue that has been oversubscribed by more than 22 times has never given a negative listing day return.

Application Strategy for Oversubscribed IPOs

You may be tempted to apply for an IPO in big lots where you have witnessed a good amount of institutional investors as this may provide better allotment and higher listing gains. However, with the norms having been changed by the Securities Exchange Board of India (SEBI) a couple of years ago regarding the procedure of allotment of shares, many retail investors haven’t quite understood the changes and are still beating around the bush as far as IPO investment is concerned. SEBI has declared transparent and investor-friendly guidelines for IPOs, which gives every investor an equal chance of getting shares in an IPO irrespective of the lots he has applied for in an oversubscribed issue. Even if he has applied for a minimum permissible lot, he may get a minimum number of stocks as allotted to shareholders. Considering this, it seems much wiser to apply via smaller lots than unnecessary blocking your amount in big lots.

Book Running Lead Managers

Our analysis cannot be complete without analysing the role book running lead managers (BRLMs) play in determining listing day gains, if any. BRLMs are involved with the complete process of an IPO. They have to get the pricing of the IPO right and ensure compliance as well as success of the issue. According to a statement by the SEBI chief, “If the merchant banker fails to act diligently and comply strictly with the letter and spirit of the regulations, the investors are put to grave danger, which may not be in the interest of the capital market.”

We have seen in the past that BRLMs have been prohibited from participating in the securities’ market. For example, PNB Investment Services, which was the book running lead manager for the IPO of Taksheel Solutions, and Almondz Global Securities, that acted as the BRLM for Electroplast and Bhartiya Global Infomedia, were prohibited for not complying with the disclosure norms in their IPO prospectus.

As mentioned earlier, they play an important role in determining the offer price range. Our analysis will try to understand if any BRLM has displayed a consistent tendency of leaving something on the table for investors. In order to study this, we identified 15 prominent BRLMs that altogether have managed more than 353 issues with a time period beyond 2009. We have kept the minimum number of IPOs managed by any BRLM to six to get in our study. Although there is a vast difference between the average returns provided on listing day by IPOs managed by any two BRLMs, statistically we could not find any significance of BRLMs in determining listing day gains. We carried out a regression analysis between the returns provided by IPO and BRLMs that have managed these issues and could not find any relation between them.

Table 4

Market players say investors should wait for at least a quarter or more days if they are investing in an IPO. This is because anchor investors cannot exit before one month, things would take two to three months to settle down, and many times an IPO’s performance after three months reflects the true picture. One quarter also allows most of the companies to announce their quarterly results, which throws good light on how they have been doing, thus acting as a trigger for the movement of their shares.

Hence, we checked the performance of these IPOs after 90 days. We excluded FPOs and a company like Aqua Logistics that got suspended due to procedural reasons. It is crucial to note that most of the companies showed a negative return post their listing and 90 days’ thereafter. Out of a total of 160 companies, 107 companies’ scrip performance, after adjusting for any corporate action such as rights and bonus, was found to have dipped 90 days after they debuted in the primary market

From the above discussion it becomes clear that if you want to invest for long-term in any stock, you can pick that stock even after listing and awaiting at least the quarterly result. Further, for listing gains, one should look at sectors that are trending, along with issue size and oversubscription figure. This is not to say you should ignore financials and valuation for which we are always there to guide you.

IPO Guidelines

Dos

·         Read the prospectus/abridged prospectus and pay special attention to outstanding litigations and defaults, if any.

·         Study the objectives, financials, and company history of the issue.

·         Take into account the background of the promoters.

·         Use the ASBA (application supported by blocked amount) process for applying to the scrip.

Don’ts

·         Don’t follow rumours or illusory advertisements. High return in short time is impossible.

·         Don’t go by any implicit/explicit promise made by the issuer or anyone else.

·         Don’t invest based on the prevailing Bull Run of the market index or of scrips of other companies in the same industry or scrips of the issuer company/group companies.

·         Don’t necessarily bank on the price of the shares of the issuer company going up.