Equity markets have corrected considerably in the past two months. But those in the primary market are acting as if the bull market is alive and kicking. The initial public offerings (IPOs) of ICICI Securities Ltd and Hindustan Aeronautics Ltd (HAL) failed to get enough bids to meet their targeted issue size, and experts have squarely blamed the rich valuations these companies were demanding.
The ICICI Securities issue fared the worst this month, receiving bids for only 88% of the total shares on offer. The pricing was steep, and failed to provide a buffer for investors in case markets fell during the book-building process, pointed out a merchant banker. As it turned out, markets fell late last week owing to heightened fears of a trade war between the US and China, and unsurprisingly, bids for Indian IPOs started to dry up.
Another expert on the primary markets said the brokerage business is cyclical and that it was foolhardy to price the issue at 30-times earnings just when the cycle had begun to turn south. He says that the euphoria in the primary markets isn’t limited to large companies, but is also visible in SME (small and medium enterprise) IPOs. These companies are demanding valuations of 20-25 times earnings, despite the bigger fall in small-cap stocks in the secondary markets. While the BSE 500 index has fallen 9% from its peak in January, the BSE SmallCap index has fallen 14.4%.
A similar trend has been evident in issuances by government-owned firms, where participation by investors has been the weakest. HAL, for instance, was a long-awaited IPO. But after the issue was priced far higher than what the company’s growth rates warranted, it got barely any bids other than from domestic financial institutions led by Life Insurance Corporation of India. Domestic institutional investors or DIIs (excluding domestic mutual funds) accounted for four-fifths of the total bids received, which helped the issue scrape through with a 99% overall subscription. For the two other public sector issuances this month, DIIs accounted for 54% of total bids received cumulatively.
A look at the table alongside shows that participation by high networth and retail investors has been dismal. While the recent correction in the secondary markets has hit sentiment, another reason is that the so-called listing pop has been missing in a significant number of IPOs lately.
In late 2017, when the government divested its stake in two general insurance companies, investors who bid found that they would have been far better off waiting until listing. The shares listed at a huge discount and continue to trade at a large discount to their issue price. From the looks of it, retail investors have taken home the lesson that it’s best to wait until listing before buying shares of public sector units.
A clear outlier in all this is the Bandhan Bank issue, which received a large amount of bids in each investor category. Analysts say its IPO was an outlier simply because its financial metrics also make it an outlier, with high spreads and low non-performing assets. The bank’s shares listed at a 25% premium to its issue price, despite demanding a stiff valuation in the IPO itself.
The success of the Bandhan issue may tempt bankers and issuing companies to continue to demand high valuations even going forward. But hopefully, the under-subscription in the ICICI Securities and HAL IPOs should act as a wake-up call. As it is, FY18—a record year for IPOs—is ending with a bitter aftertaste.