Role of institutional investors in the ‘pop and drop’ saga of India’s IPOs

In the past six months, India has had roughly one initial public offering (IPO) every week. The IPO mania is well and truly here and so is the practice of flipping newly acquired shares soon after a stock lists on the bourses. Most shares issued during an IPO change hands on the first day of trading, with investors looking to profit from the so-called IPO listing pop.

Regulators generally worry about excessive flipping. It puts an ultra-short term approach to investing on display, the exact opposite of the ‘equities are for the long-term’ messaging policy makers are comfortable with.

Some researchers argue that higher allocations to institutional investors results in a check on excessive flipping, as they are long-term investors. However, a study of some recent popular IPOs shows that institutional investors are nearly as inclined to flip their IPO allotments as non-institutional investors.

Shares of Mrs. Bectors Food Specialities Ltd, a packaged foods company, listed on 24 December. Of the 3.75 million shares issued to institutional investors as part of the book-building process, 3.25 million were disposed by end-December. In addition, seven mutual fund firms had been allotted 2.98 million shares as part of the anchor book. By January-end, soon after the one-month lock-in on these shares expired, about half of the shares allotted to the so-called ‘strong hands’ had been sold. By February, three fund houses had disposed of their entire stakes and two others had cut exposure by 55-60%.

Similarly, shortly after the Burger King IPO, six of the eight fund houses who were allotted shares in the anchor book sold 50-80% of their holdings soon after the lock-in was lifted.

“The Burger King and Bectors Food IPOs listed at a premium of more than 100% to the issue price. You can’t blame some institutional investors for booking profits when their price targets were met, though it does look odd for seemingly long-term investors to flip IPO allocations so quickly,” said a fund manager, requesting anonymity.

A moot question here is that if non-institutional and institutional investors are flipping their IPO shares, who is buying and enabling the eye-popping returns on listing. A close look at both IPOs shows that while the majority of institutional investors who were allotted shares were sellers, a handful of them made high purchases as well. The greater the degree to which this happens, the better the chances for listing gains to be sustained.

In the case of Bectors Food, a Franklin India fund absorbed nearly all of the shares sold by other anchor allottees in the mutual fund category. However, there was no additional buying from foreign investors and the stock has fallen over 40% from its listing day price. For Burger King, there was buying from Government of Singapore and Valiant Mauritius Partners, both of which had also been allotted shares during the IPO. On listing day, Valiant bought 2.5 million shares of Burger King at ₹130, according to data on the exchanges. Investors were enthused by the large purchase. However, its average cost of acquisition, including its earlier purchases during the IPO, was only ₹76 apiece, slightly higher than the IPO price of ₹60.

In banking circles, when there is an explicit or implicit agreement by an institutional investor to buy shares after listing as well, the arrangement is known as ‘laddering’. There is no way to say if such arrangements are in place for Indian IPOs, but there is clear evidence of some IPO allottees buying shares soon after listing. Non-institutional investors should keep the aspects of flipping and the possibility of laddering in mind before getting enamored by the large institutional participation in IPOs.

Amid all the mania in the primary markets and the 100% listing pops, venture capital firms and company founders come across as almost unsophisticated. Why do they settle at far lower selling prices in pre-IPO rounds, when the secondary markets seem to be willing to go far higher? In the case of Nazara Technologies, a recent hot IPO, a venture capital firm sold an over 20% stake in the firm at a 25% discount to the IPO price just a few months ahead of the issue. Compared to the expected listing price, Westbridge Capital may have settled for an over 50% discount. But what is pertinent here is the relationship between price and liquidity. A pre-IPO investor is required to wait for a year to sell its shares and there is no certainty where prices would be at that time. So they prefer to settle for the certainty of an exit, even if at a lower price.

As such, to discover the true worth of a firm, it makes sense to wait till about a year after listing, when all lock-ins get lifted and an artificial scarcity in terms of supply ceases. The initial listing pop may just be a mirage.