CIRCUIT BREAKER. We don’t need no reservation

The primary market seems to be coming back to life, with long-awaited IPOs from Syngene International, Coffee Day Enterprises and Interglobe Aviation sailing through to a rousing reception from institutional investors.

But retail investors are missing in action. Despite their highly visible brands, both the Coffee Day Enterprises and Interglobe Aviation IPOs saw their retail quotas get only partially subscribed, even as there was a scramble for institutional allocations. These IPOs triggered no rush to open new demat accounts either, unlike IPOs from Reliance Power and Coal India in 2007-08, which marked the influx of legions of first-time investors into equities.

This lack of retail appetite for IPOs will no doubt cause some market commentators to fret about small investors lacking faith in equities and to call upon SEBI to do something about it. But small investors’ decision to stay away from the current crop of IPOs is very sensible, and the regulator should do nothing to ‘fix’ this.

There are at least three sound reasons for retail investors to stay away.

For starters, the notion that IPOs are a great vehicle for first-time investors to dip their toes into equities is plain wrong. Given that IPOs, especially of the book-built variety, usually come from companies that lack a regular dividend or even profit record, the average IPO is far riskier for the investing public, than the average secondary market investment.

When choosing stocks in the secondary market, the investor has a track record to go by. She can evaluate the company’s performance over business cycles, changes in shareholding pattern and historical governance record. But in an IPO, there are only snapshot financials and hypothetical ‘risk factors’ outlined in the prospectus. Assessing prospects for an entirely new business based on these one-shot disclosures is tough.

In some recent IPOs, matters have been further complicated by the business itself. The Coffee Day IPO, for instance, was not simply an IPO from a coffee retail chain. It was an IPO from a holding company with stakes in a veritable supermarket of unrelated businesses — a coffee retail chain, a mid-sized software firm (via Mindtree), logistics (via Sical Logistics) and an IT park, for good measure. Assigning a value to each of these businesses and then pricing the offer was not easy. That the business was loss-making at the net level also made conventional metrics like the price earnings ratio redundant in valuing it.

Interglobe Aviation seemed like a straightforward business to start with, though investors may think twice about owning an airline business. But then, the firm’s promoters complicated matters by paying themselves extra-generous dividends just ahead of the IPO, leaving the company bereft of reserves.

It can be argued that there is really no corporate governance worry if a privately held company distributes accumulated profits to its private shareholders. But the bottomline is that Interglobe Aviation, despite being a consistently profitable company, did carry negative networth on its balance sheet during its IPO, befuddling investors.

If there were company-related challenges with these two businesses, you must admit that it is no cakewalk for lay investors to assess the prospects for a Syngene International, which is into drug research, or a Navkar Corporation, which operates container freight stations.

With hardly any listed peers to compare with, how would retail investors know if the stiff earnings multiples of 28 times or so, demanded by these offers, were justified?

The truth is that a fair number of IPOs nowadays are neither designed nor priced to meet the capital needs of the firm. They are intended to give private equity investors a reasonable exit, which automatically sets a high bar on valuations and raises the asking price for public market investors.

But why should retail investors pore over offer documents or try to value a business, when they can simply sit back and take their cues from those omnipotent entities — the QIBs (qualified institutional buyers) or anchor investors? Isn’t this why book-built offers were mandated to reserve 50 per cent for QIBs and rope in anchor investors?

Well, the truth is that retail investor faith in institutions has taken a beating after their bitter experiences in the past.

Many of the large and much-hyped IPOs in the last 10 years have had QIBs queuing up for allotments. But that didn’t prevent the stock from crash-landing within the next couple of years.

It’s hard to forget that institutional investors were so gung-ho about the Reliance Power IPO at the fag end of the last bull market, that its QIB portion was over-subscribed 83 times. But the stock languishes 80 per cent below its IPO price (even adjusted for bonus), with the firm’s business plans going awry. DLF, which has been in trouble with SEBI for inadequate offer disclosures, also attracted a much bigger response from QIBs (over 5 times) than from retail investors during its IPO. With the business hit by the real estate slowdown as well as leverage problems, that stock today trades 77 per cent below the offer price.

In fact, looking at subscription patterns to IPOs over the last 10 years, it is clear that QIBs are susceptible to the same forces of greed and fear that prove to be the undoing of small investors.

QIBs have also flocked to IPOs from fancied sectors in over-heated markets. Nor are the QIBs or anchor investors who jostle for allotments in book-built offers, all long-term. Many are in the game for flipping the stock. Given this scenario, you cannot blame retail investors for keeping their own counsel.

Empirical data also conclusively proves that IPOs are a highly risky route for first-time investors looking to create wealth through equities. An analysis of Bloomberg data on over 500 domestic IPOs in the last 10 years shows that fully half these IPOs have delivered losses to their investors, with 160 trading 50 to 90 per cent below their offer prices.

The first-time investors who bet on these IPOs would have had a far better shot at creating wealth had they invested in large-cap equity funds or even exchange traded funds tracking the Nifty or the Sensex. With this kind of return experience, can you blame investors for sticking with funds or secondary market investments this time around?

Indian policymakers should really try to get away from this mindset of wooing small investors into IPOs by reserving special quotas for them or offering retail discounts. Far from being short-sighted, retail investors are displaying great prudence in staying away from IPOs they perceive to be risky. Vehicles such as the NPS, exchange traded funds and diversified mutual funds are far better avenues for retail investors to create wealth through equities.