Earlier, we would see a stock list even higher than its issue even if its pricing was aggressive. The mis-pricing would get corrected over weeks or even months, as investors realigned valuations to actual performance
Investing in an early-stage business that has tremendous growth potential, and ample visibility of future potential, is a no-brainer. Investors know this only too well. Investment bankers who manage the issue know it even better.
Take the recent initial public offering (IPO) of ICICI Prudential Life Insurance Co. Ltd. Being at a nascent level, the business of life insurance offers tremendous potential in India.
And being the first major IPO in this space, ICICI Prudential Life’s issue, which premiered in September, saw huge demand and was subscribed 10.48 times. Evidently, there was latent investor demand for an insurance stock and this translated into a blockbuster IPO.
But listing trade turned turtle. Over 7 days, what seemed to the markets like a sound investment idea with a proven pedigree, strong market position and great long-term prospects; turned out to be wobbly listing trade. All it took was an eventful listing day (the unexpected ‘surgical attack’ by India).
Investment bankers had clearly priced the issue to perfection from an issuer’s standpoint. And, we all know what such an issue would turn out to be for a subscriber.
That it happened on listing day and exposed the structural weakness of IPO pricing, speaks volumes for our market’s astute sense of fair value.
Earlier, we would see a stock list even higher than its issue even if its pricing was aggressive. The mis-pricing would get corrected over weeks or even months, as investors realigned valuations to actual performance. Investment bankers no longer enjoy the currency to perpetuate mis-pricing for even a single day. Price discovery is fast maturing in our markets and that is the good news from this IPO.
That demand could correct so sharply within a week also raises a question around the nature of demand for new issues, and the source of their funding.
The worst-kept secret of Indian investment banking is that an issue can be mobilised using the banking and lending system itself. There is a huge running arbitrage trade financed by non-banking finance companies (NBFCs) and fronted by high net-worth individuals (HNIs). They borrow huge sums of money for a week from financiers and try their luck with promising IPOs. Meanwhile, companies with greater financial muscle use their regular credit limits with banks for a quick trade. So, if investment bankers create enough hype to ensure participation, the retail segment would not want to miss out.
The market regulator’s move to shorten the IPO cycle has come in handy for those running this trade. Arbitrageurs see lower risk in a shorter time trade. The Securities and Exchange Board of India’s (Sebi’s) proposed move to further shorten the IPO cycle to 4 days will only further fuel speculation in IPOs.
Clearly, investment bankers are playing on the arbitrage industry run by lenders and the IPO speculation industry, which has grown multi-fold with the availability of big money. But the regulator will and should find ways to further shorten the IPO cycle to just one day and create a more transparent price discovery process.
Only if the IPO trade is ended, will the conditions for the evolution of a strong and transparent IPO price discovery mechanism emerge.
While Sebi means well to encourage investors to participate in IPOs, it needs to seriously take a re-look at how it can eliminate the investment banking industry's manipulation.
Could investors have anticipated this listing move and stayed away? Though ICICI Pru Life IPO was a fresh listing, there has been a silent price discovery going on in the company's shares.
This listing day price move was not unexpected, to those closely tracking the private trade in the company’s shares over the past year. Insiders were selling their employee stock options in the range of Rs200-250. While many of these trades are private and not available for verification, it was evident that those selling the stocks were informed investors who knew its fair value.
Unlike lay investors, insiders know the fair value of their stock and usually holders of employee stock options are savvy, well-informed professionals. That even their smaller lots traded at lower rates, was clearly a valuation marker one simply could not ignore.
A sharp 33% jump in pricing, which investment bankers gave the issue over the prevalent private trade, was a clear case of pricing overkill. What we see now is a correction of that pricing excess.
This brings us back to what investors must do with pricey IPOs. Investors must learn to stay away from them and await listing.
On listing, investors must allow prices to correct and enter the stock at different levels. Position sizing is important and sharp price-drops must be effectively used to raise the size of one’s investment position. If one has already participated in the IPO and got a fractional allotment, this sharp fall can be an opportunity to increase position.
Progressively, exchange trading in the stock will discover its fair value and investors must keep resizing their position as valuations stabilise. Performance reporting will further provide investors the opportunity to evaluate prospects and revise their estimates. Investors in IPOs must give themselves room to respond in such situations, and positions must be scaled up with ample due-diligence.
An IPO is a week’s job. But investing effectively into an IPO could well run into 6 months.
Shyam Sekhar is chief ideator, ithought
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