Demystifying IPOs

Brands need a lot of trust to get themselves established in the market. Trust plays a very important role in all. To make a successful brand, a lot of things come into the picture: right investor, better sales, good marketing heads, and many other things. But other than running a brand, to grow successfully with trust, brands need you to invest and trust them the most. Here IPOs come into the picture.

In simple terms, when a privately-held company looks to grow or expand, it either taps into raising more debt or raising capital in equity in primary markets, called Initial Public Offering.

Reasons why IPOs comes into the market:

• To raise capital from the market.
• Investors are ready to pay a fancy price for anything new coming to the market
• Exit strategy for initial investors and venture capitalists
• To have public awareness about the company and its products

Myths surrounding IPOs in India

It’s important to remember that not all initial public offerings (IPOs) are bad. The risk is in assuming that IPOs are inherently good investment opportunities. Some are riskier than others, while others have a greater potential for higher rewards. Companies filing for an initial public offering can benefit from relatively simple evaluation methods. When companies are filtered through this evaluation, it is clear that many of them are poor performers. On the other hand, some companies, such as D-Mart (DMART), are objectively good from a financial standpoint, and they would have been great IPOs to participate in, both because of their financial performance and their reasonable valuation at the time of IPO.

Some Myths about IPO:

• IPOs are supposedly the earliest way to invest in an ever-growing business
• It must be a wonderful investment since everyone is enthused about an IPO in India
• If a corporation wants to go public, it must be financially sound

Factors Influencing IPO Pricing

Pricing of IPO depends on some of the important factors such as Absolute Valuation of the company. Usually, Investment bankers use DCF (Discounted Cash Flow) to determine the future performance of the company, how the company has performed financially over the past years, what is the potential growth rate of the particular segment and industry in the upcoming years.

Usually, companies come up with IPOs in a Bullish market. The reason for choosing this time is the market sentiments. Bullish markets are the period when the market is filled with enthusiasm and intrigue. One of the true reason is also to ensure that the company stocks are oversubscribed, which basically means the investor will have a holding instead of making listing gains. So one of the factors that affect the pricing of the IPO is the trend of the market.

Reasons why IPO investments are a huge success

In India, investors enjoy the mysteries around IPOs in the capital market. Profits are always connected with an initial public offering (IPO). Several investors and management behavioral oddities are contributing to this. So let’s get this straight.

Investors are continually looking for unique investing ideas and dumping the old. Typically, every IPO introduces something fresh to the market and people are fascinated by it.

Secondly, an IPO investment has no track record, and investors often believe in the value of mystery because they assume something different will happen, perhaps some form of adventure. It’s mostly about the new industry’s expansion.

People begin to follow the pied piper. When consumers begin to follow a large brand or a notable merchant banker who is launching an IPO, they tend to buy it. This is an IPO psychology blunder.

Reliance Power

The underlying stock logic that an infrastructure is always a safe option is not a guarantee of high profits.

It’s time to wipe old wounds, but for good, for reviewing the lessons the frenzy-filled infrastructure IPO — Reliance Power — taught us all, a decade after it made holes in many investors’ pockets.

This IPO was sold between January 15 and January 18, 2008, and it received 73.04 times subscription. Before Coal India, this IPO held the title of “biggest IPO ever”, the Rs 11,560 crore issue, on the other hand, was notable for another reason. It was fully subscribed within the first few minutes of its launch.

In fact, by the end of Day 1 of the bidding process, the issue had been subscribed to more than ten times. Over 5 million bids were received across all categories, with a total commitment of over Rs 7,50,000 crore. Reliance Power also had the largest shareholder base among all listed companies, with approximately 42 lakh shareholders.

While many firms on Dalal Street have gone out of favor, Reliance Power stands out because of the high level of euphoria around the IPO at the time of its introduction. People came in droves to invest in the IPO, from auto wallahs and rickshawala to HNIs and foreign investors. During that time, a record number of Demat accounts were opened. Some people liquidated their entire portfolios, while others borrowed money to buy IPO units, but it was all in vain!!

People bet blindly on any issue and made a killing on listing day. However, the treasure appears to have degraded following the Reliance Power incident.

Some of the missteps taken by people are:

GREED

Many Reliance Power investors expected big returns on the first day of trading and hoped to sell their stock on the first day. Their greed led them to disregard the notion that the issue was maybe overpriced when accounting for the company’s growth till 2009–10. There must be a buyer for every seller. Most investors wanted to sell on the day of the IPO, but there weren’t enough purchasers. According to a Wharton School article, investors’ “irrational exuberance” caused them to overlook the fundamentals.

SLOTH

Before investing, the majority of investors did not conduct their homework. They may have gained a better understanding of the valuation and the company’s predictions if they had spent some time researching Reliance Power and its competitors, such as Tata Power and NTPC. They simply wanted to generate money without having to do the necessary legwork.

Investors who looked into similar issues would have discovered that NTPC and Tata Power were significantly less expensive than Reliance Power.

GLUTTONY

The desire to own a Reliance Power share was so strong that even before the IPO, the shares were being traded in the grey market for anywhere between Rs 600 and Rs 900. Even though such off-market transactions are illegal, the media has made much ado about them, adding to investors’ frenzy.

IPO grey market

When a company wants to obtain money to fund its expansion, it usually sells a portion of its stock on the stock market. An initial public offering, or IPO, is the name for this procedure.

An IPO grey market, on the other hand, is an unofficial market where IPO shares or applications are bought and sold before being accessible for trading on the stock exchange.

It’s also known as an over-the-counter market or a parallel market.

The real reason why investors trade in the grey market is:

• Investors find this an opportunity to buy shares even before it is listed if they feel the stock price may rise in the future.
• Sometimes investors miss the deadline and in that case, they can approach the grey market to buy more shares.

Companies benefit from the grey market as they may gauge the market conditions and estimate the future of the demand of the share in the market.

The main concern behind the IPO grey market is that the IPO grey market is an unauthorized market that operates outside of the jurisdiction of SEBI. As a result, there are no assurances. All transactions are conducted based on trust and involve the risk of a counterparty.

As a result, if the stock crashed, parties would have no legal redress.

What to keep in mind before investing in IPOs in India?

Know the firm thoroughly: Before applying for an IPO in India, make sure you read the prospectus. This document offers extensive information about the company’s financials, market performance, and the goal of the IPO in India. The prospectus can be found on the company’s website or on the SEBI website. Also, see if the promoter or the company is involved in any substantial litigation. At all costs, stay away from repeat offenders.

Keep an eye out for oversubscription: Each IPO has a pre-determined, limited number of shares that are proportionately allotted to each investment category. If there is a lot of demand for a particular IPO in India, the number of applications may outnumber the number of shares listed. This means that shares are distributed proportionately, and you may receive fewer shares than you applied for.

Shift your attention away from listing gains While listing gains are appealing, if the firm is fundamentally good and short-term, the share price will continue to rise long after the company’s initial public offering in India.

Written by Vaishali Bhatt (vaishali.bhatt@xumitcapital.com)

References:

7 IPO sins — BusinessToday, https://www.morningstar.in/posts/39729/the-psychology-of-ipo-investing.aspx, https://blog.finology.in/market-news/psychology-of-ipo-investment.