By Aakash Sinha
Initial public offer (IPO) is the new trend amongst finance investors. Each one prays to get his hands on the allotment of shares and have a successful listing.
Decoding IPOs
Initial Public Offering, or simply known as an IPO, is a means to raise funds from the public in exchange for a part of the ownership of the company, in the form of equity. IPOs serve a wide range of purposes: Raising funds for debt repayments, funding expansion plans, working capital requirements, and exit strategy by private equity investors.
Luck is an important part of an IPO for Retail Institutional investors (RII). One might have experienced a situation where people who have applied for more lots of the same IPO didnt receive any whereas someone who invested for a minimum lot (for instance, just 1 lot) received his allotment of shares. Let us see how this happens.
Cochin shipyard IPO example
When a company issues an IPO, they have to break up their allotment of shares for different types of investors. For retail investors, the maximum amount they can invest is ?2,00,000.
Let’s take an example of a Cochin IPO. The amount that is required to be raised is ?1,468.11 crore. In this, the portion that is reserved for RIIs is 35%, amounting to 1.16 crore shares. The price band ranges from ?424 to ?432 per share. The minimum quantity, i.e. one lot, that can be ordered comprises of 30 shares. After allowing for a 5% discount on the issue, the price per share comes out to be ?402.8. Hence, one lot would cost ?12,048 (402.8*30) to the investor. This would further give us the maximum number of lots that can be purchased by an RII: ?2,00,000/?12,084 = 16 lots. Hence, the total numbers of shares purchased in such a case are 480 shares (16*30). A total of 19.42 lakh applications for RII category were received under various lot sizes. 16.87 lakh applications were received for a single lot size or 30 shares, and 18,000 applications were received for the maximum lot size of 480 shares.
Much to do with luck
Now, as discussed earlier, the limit for retail investors is ?2,00,000 and companies have to reserve 35% for the RII segment. However, there exists a wide range of investors within RIIs itself. It was observed that proportional allotment of shares is a huge disadvantage to small-time traders (who have a lower budget) due to which Securities and Exchange Board of India (SEBI) changed the allotment procedure to ensure maximum investors in RII category get the allotment. Hence, whenever an IPO takes place, shares are distributed on the basis of the minimum bid of shares received to ensure allotment of shares to maximum people.
To further clarify, in the Cochin Shipyard IPO example, if the RII segment was oversubscribed by 7.51 times and the minimum bid for shares was 30, then 30 shares would be allotted to each applicant, selected on the basis of a lucky draw.
Also, 1.18 crore shares were allotted to the RII category from the unsubscribed portion of employee investors category. The minimum bid, i.e. 30 shares were allotted to 3.94 lakh applicants. The applicants had a probability of 1:5 (3.94 lakh/19.42 lakh) of being selected. Hence, it doesn’t matter whether you invest for 1 lot or 16 lots, as the allotment is based on the minimum bid. So, it is always ideal to purchase a single lot whenever the issue is expected to be oversubscribed by a good margin.
Growth of a recent boom
IPO market was almost non-existent in India since 2010 (?37,534 crore raised from the public by 64 companies), with only three IPOs worth ?1283 crore in 2013 and five IPOs worth ?1200 crore in 2014, floated. However, 2017 witnessed over 33 IPOs worth ?70,000 crores. This bull-run of IPOs is being led by insurance companies such as SBI Life Insurance, with shares worth ?8400 crore being oversubscribed by 3.58 times. It was followed by New Life Assurance with shares worth ?9600 crore being oversubscribed by 1.19 times. Insurance companies have come up with mammoth-sized IPOs based on valuations, and their offerings are running into thousands of crores now.
The reasons for the insurance companies entry into the IPO segment are manifold. Firstly, in August 2016, Insurance Regulatory and Development Authority of India (IRDAI) allowed insurance companies to raise money from the capital markets. Moreover, reduction in dependency on promoters for capital and on Ministry of Finance for funding public health insurance companies facilitated this spur.
Secondary markets’ contribution
The major reason for the boom in the IPO market is accounted by the phenomenal performance by the secondary markets in 2017, which has successfully attracted significant foreign investments. Foreign investors have poured in over ?42,000 crore in equity markets and over ?1,31,000 crore in the debt market. Along with FIIs, domestic mutual funds and equity-linked savings scheme have also been pouring in money in the secondary markets due to which there is abundant liquidity in the market. However, the IPO boom might be solely dependent on the performance of the secondary markets bullish run and as soon as the bull-run ends, the IPO market will start to dry up and reiterate the 2013-14 scenario when Indian equity markets weren’t performing well and the IPOs were dormant.
Comparison with Brazil
Another comparison can be made with the Brazilian markets. The IPO market peaks in 2007-08 along with the secondary stock index and repeats the same pattern during 2010-13 and 2016-17 as well. The Equity offerings peak and dive in line with the IBOVESPA (Brazilian Stock Index), thereby further strengthening the argument made for the Indian markets.
However, secondary markets are also dependent on various factors such as economic and political reforms, and public sentiments. Recently, Brazil and Argentinian secondary markets have been heavily influenced by the political elections to be held in 2018 and corruption scandals, such as the car-wash probe which has resulted in investigations of around 83 politicians.
Takeaways
Hence, the IPO market, as mentioned above, will continue to boom and perform well as long as there are bullish secondary market performance and high liquidity in the markets. The IPO market will tend to slow down or even halt if the secondary markets initiate a bearish run and/or the liquidity starts drying up from the markets.
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