IPO: An Easy Way to Generate Wealth?
Initial Public Offering (IPO), as we mentioned in one of our previous posts, is the process followed by a company to get listed on the stock exchanges for the first time. This allows retail and institutional public market participants to own a part of the company, while also providing the company with an opportunity to raise fresh capital from the public market.
In the Financial Year 2020–21, we have had 30 firms raising INR 31,277 crores, and as per an article in the Economic Times, 28 companies are holding an approval from the market regulator, the Securities and Exchange Board of India, for raising nearly INR 28,710 crores going forward. This is in addition to companies like LIC, HDB Financial Services and NCDEX who are expected to come out with IPOs come FY 21–22, but are yet to receive approvals.
IPOs see a lot of interest, with many offerings, like that of Mrs. Bector’s Foods (198.02x), Mazagon Dock Shipbuilders (157.41x) and Burger King India (156.65x), seeing massive over-subscriptions, i.e. the ratio of the demand of the shares to the number of shares on offer.
And this interest, more often than not, is completely justified. In 2020, we had companies like Chemcon Speciality, Happiest Minds Technologies and Route Mobile generating over 100% in listing gains (the returns generated over the issue price on listing in the stock exchange — If an investor bought a share of a company for 100 during the IPO, and owing to the high demand, the price of each share shot up to Rs. 200, then the listing gain is of Rs. 100 or 100%). And we also had other companies like Burger King India and Rossari Biotech generating 92.25% and 58% returns. In fact, as per another article in the Economic Times, public listings in the 2020 had an average listing gain of 35.61%, while in 2019 had an average listing gain of 18.72%.
This must make us wonder — Are IPOs the easiest and most predictable way to make money? 35.61% of returns generated in a single day, must be, right? Not really. While IPOs in 2019 and 2020 have generated significant returns for its investors, IPOs have also seen years like 2011–13, when the average listing day gains were only 0.78%, 4.23% and 5.68%. Additionally, in the current year 2021, of the 16 IPOs, 6 IPOs listed on the exchanges at a loss.
While there are certain ways to predict the returns that can be generated on listing, which includes looking at the total oversubscription and also on the grey-market premium (GMP-The price of the share being exchanged in the grey market minus the price of the share during an IPO), there have been instances in the past and in 2021 when companies with high oversubscription and GMP have been listed at a loss. Additionally, if no shares of a company are being traded in the Grey Market, then the GMP will also not be available. And if the number of shares being traded is extremely small, then the same will not be reliable.
In 2021, while we did have companies like Indigo Paints and MTAR Technologies which generated listing gains of 109.31% and 88.22% respectively, both these issues were extremely oversubscribed (117.02x and 200.79x respectively) and hence the chance of allotment extremely small.
Which brings us to the second issue with IPOs: massive demand. Even if you apply to all the IPOs in a year, there is a significantly high chance of you not getting an allotment in any of the IPOs which have a potential of generating a higher return due to the high demand in these IPOs. The retail portion (Every issue has reserved portions for Institutional Investors, HNIs and Retail, and in some cases, Employees) of MTAR Technologies itself was oversubscribed by 28.40x. And until the process of allotment is complete, the money of all investors continues to remain with the company, post which the refunds are made to investors to whom no shares were allotted. This also brings forward the issue of the opportunity cost being completely missed out on, as the money is locked and can’t be invested elsewhere, and the refund process can take some time as well.
Thirdly, to participate in an IPO, a retail investor needs to apply for lots (a bundle of shares), and each lot is usually worth over INR 15,000. And to apply for a larger number of shares, an investor would need to shell out another ~INR 15,000, and only up to INR 2,00,000. If an investor has to apply for shares worth more than INR 2,00,000, they need to apply under the shares reserved under High-Networth Individuals (HNI) bracket.
In some cases, the HNI bracket is much less subscribed than the Retail bracket. However, in cases like the IPO of MTAR Technologies, the HNI segment saw an oversubscription of over 650 times, making it even more difficult than the retail segment to get a subscription.
Due to this, many institutional investors also follow a policy of not being very active in the IPO market. While there are some issues that generate significant returns, the allotment of institutional investors is also so small that the impact of the high returns on the returns of the overall corpus continues to be very minor. Additionally, to participate in an IPO, these institutional investors need to sell their holdings while sitting on cash until the allotment happens, which, as already mentioned, might end up being much smaller than the amount that they apply for. Hence losing out on the opportunity cost of the money.
However, the returns on the money invested did outweigh the issues that any IPO brings with it for retail investors in 2020, and the investors who were allotted shares during any of the blockbuster IPOs were able to generate significant returns on their money invested. Hence, to conclude, while IPOs are not an easy way to generate wealth, they, definitely, can help generate high returns for their investors.
Disclaimer: The views expressed in this article are personal, and are not to be associated with the organisations we are a part of.
