How To Play The IPO Game

In July 2016, Ujjivan Financial Services set the primary market on rocket launchers when it became the first IPO to double in price in a mere two months of listing. The Rs 358 crore IPO in May sold out within hours of its opening at an offer price of Rs 210. As the offer was oversubscribed 41 times, not many investors were lucky to secure an allotment.

But those who were lucky—and who held on—have enjoyed the astronomical ride. The stock listed just 10 per cent higher. But, despite the slow start, in the next few weeks it soared to Rs 527 in no time.

Another stock that took off within a year, though it did not catch the fancy of investors during its IPO, was Manpasand Beverages. Oversubscribed just 1.4 times in July 2015, it listed at just a 2 per cent premium to its offer price. Since then, however, it gained 107 per cent in a year to Rs 670.

When it comes to IPO investing, most IPO investors are looking at listing gains, particularly HNIs and leveraged investors who borrow to invest in IPOs. Says Dharmesh Kant, head, Research — Retail, Motilal Oswal Financials: “Unfortunately, there is a focus on purely listing gains, as in 2008 — and that’s where the problem begins. Most investors want to lock in listing gains, then walk away. That’s not a good sign.”

Gunning for listing gains, investors are also driving up demand that is seeing IPOs create record oversubscription figures. The recent Quess Corp issue saw a whopping 144 times oversubscription, unseen before this in the IPO market. The stock went on to post substantial listing gains though, of 57 per cent, at Rs 500, on its offer price of Rs 317. But its current valuations are astronomical, as experts point out its forward earnings is around 83 times earnings.

In fact, unusual oversubscription is quite common these days. Says Dr Srinivasan Subramanian, MD & Head,Institutional Equities, Axis Capital: “After a long time we find IPOs have given upsides for investors which have been around 20-30 per cent. Most of our transactions were priced at levels which investors appreciated, particularly after what they saw between 2011 and 2014. That is bringing a large number of investors back into the market.”

IPOs have had a better run also because other asset classes such as gold and real estate are not doing particularly well. Says Subramanian: “Gold has just recently fared shade better, but overall returns from the primary market, where retail investors mostly apply, has turned around for the better.”

But oversubscription figures are no guarantee of a good run in the stock markets. The Quick Heal Technologies offer in February, which drew bids of 10.6 times, saw its price flounder. It is now 13 per cent lower than its offer price of Rs 321.

L&T Infotech also attracted scores of bidders, leading to demand exceeding supply nearly 11.7 times. The stock, though, has disappointed investors with returns 4.3 per cent below its offer price of Rs 710. Says Kant: “Some IPOs are priced to perfection. In this case the IT segment is undergoing a shift in business with digitisation; even frontline companies are facing headwinds.”

For investors, it can get difficult to resist the lure of soaring IPOs, particularly because gains can be locked in as soon as a stock is listed. But last year’s statistics show that investors playing purely for short-term gains face disappointment as nearly 40 per cent of listings proved either negative or gave merely low single digit returns. The one problem in the IPO market has been that offers are mostly always priced to perfection; that’s why listing gains are never a certainty.

Luckily, the bull market played its part and drove valuations of the newly-listed companies into the stratosphere. Of 25 IPOs, 15 stocks have listed substantially above their offer prices. Over one-third of them gained 20 per cent or more on listing. Besides, average listing gains were 12.25 per cent last year.

So, on the whole it’s been a great year to invest in the IPO market. If you have been looking for listing gains, then perhaps this is one of the best times to invest in the IPO market.

However, long-term returns in IPOs are just about average. In the last five years, a mere four in ten IPOs have made money for investors over their offer prices. Eighty-four of 144 IPOs are trading below their offer prices. Clearly, this shows that the bulk of the IPOs are in the red, and investors would have been better off not investing in them.

Of course, the latest season that began in January 2016 has been the best for IPO investors. Of 13 IPOs only four listed below offer prices, nine listed above them, all returning 20 per cent or more to investors.

The asking prices for some of these IPOs are stiff though, with some going at about four times the broader market valuations. For instance, two recent companies to hit the markets, Quess Corp and TeamLease, were valued respectively at 45 times and 58 times FY16 earnings. Despite this, Quess Corp received an overwhelming response for its IPO.

The big question then is: At such highly unusual valuations, why are investors lapping up shares in such great quantities? Isn’t the IPO market showing signs of froth? Experts, however, believe that the IPO market is not overheated, and such huge asking prices are due to the higher growth rates of these companies. Says Kant of Motilal Oswal Securities: “Some IPOs are priced at the higher end of the PE band because they have a higher growth trajectory. That’s why some are seeing good listing gains.”

But, while there’s truth to the fundamentals side of the story, there’s no denying that investors have to do due diligence before investing in an IPO. Not many IPOs are going to deliver good returns in the long run as growth can eventually taper off, and valuations can shrink to median levels. When the Infosys IPO first came in 1993, its high growth rates saw the stock command PE levels of over 150 times earnings; these days it trades at about 13 times earnings.

Nevertheless, Dharmesh believes that investors with a long-term vision of three to five years can secure good returns from some IPOs even in this market. Says Kant: “The facts of IPO investing remain. Look at the fundamentals, visibility of earnings, and sustainability of business before investing. For people who have a vision, some IPOs are good to invest over 3-5 years.”

But there’s often an undercurrent of going overboard with IPO investing, as investors are almost always looking for merely listing gains. Loans for IPOs are in great demand, particularly for those IPOs where there is a possibility of listing gains. At around 16 per cent per month for about 15-20 days, many HNIs are not hesitating to borrow to invest in IPOs.

However, all investors are not going to get allotments. Investors borrowing to participate in IPOs will therefore have to bear interest costs from their own pockets. Second, a positive listing is not a certainty and here’s where losses can mount. One not only pays interest costs, but listing losses have to be booked immediately to make good the loan amount due.

However, investors are choosing IPOs quite well, and going in for only those companies that seem to have better prospects. Says Subramanian: “Investors are looking at all IPOs very closely, and only those that have strong fundamentals are seeing a strong demand book.”

And the good thing is that retail investors tend to hold on to IPO investments for a longer time. Says Subramanian: “Anchor and other investors tend to remain. Institutions that don’t receive proper allocations tend to sell, but that selling is absorbed by other institutions. In retail, nearly 50-60 per cent investors tend to stay invested whether the IPO market is good or not so good.”

Nevertheless, while the going is good, investors should not lose sight of the offer price, and apply only if the IPO appears reasonably priced leaving something on the table. No matter how good the offer looks on paper, profits can be made only if prices are right, thus creating a win-win for short-term IPO traders and longer-term investors.

Clifford.alvares@gmail.com