With a slew of IPOs poised for 2019, it makes sense to study why new issues have suffered in the years since 2008
If you have even a nodding acquaintance with the business pages of your daily newspaper, you would know by now that the much-talked-of IPOs from ride-sharing companies Uber and Lyft have flopped.
Uber went public in May 2019 with a $82.4-billion valuation, with the stock priced $45. However, despite the hype surrounding its market entry, the Uber stock registered the worst first-day dollar loss in US IPO history, notching a 7.6% loss on debut.
Lyft, with a $24-billion valuation, also disappointed investors on its debut two months earlier. Pegged at $72, the stock spiralled to $88.60 on opening day, only to quickly plummet below the IPO price. The swarm of retail investors who rushed in to make a killing was left in the lurch.
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Why IPOs Fail?
Both Uber and Lyft are American businesses and the IPOs were on US bourses, but there is a lesson here for Indian investors as well; it is this: businesses have to have a sustainable and profitable model to succeed.
Companies take the IPO route to raise capital, maybe for expansion or squaring off their debts, with private investors, if any, divesting or diluting their stake. However, if the market does not find the business viable in the long run, or if the company’s debts outstrip earnings or show similar negative indicators, the IPO will very likely fail.
For instance, while Uber and Lyft have huge potentials, their intense price wars – hence their operations – were also heavily subsidised. This has also pushed them deeper into the red, making analysts unconvinced about their valuations or profitability.
Kathleen Smith, principal at investment banker of Renaissance Capital, identified over-valuation as the root issue. “The problem is these companies have been valued privately at levels that have not followed through in the public market,” she was quoted by CNN as saying.
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Reliance Power Flops
Notably, as a uber-brand like Uber has shown, brand recall may not always work with investors if fundamentals are weak, or if there is a disconnect between private placements and public markets.
This is true of all markets, not the US alone; the story of IPO flops in India is best reflected in the IPO of Reliance Power way back in January 2008.
When the company debuted in the capital market, it seemed to have depended more on external factors to ride on – the Reliance brand and the appeal of the energy sector – rather than strong fundamentals.
Thus, despite profits of only Rs 16 lakh, it had a price band of Rs 405-450. Retail investors too were initially blinded by the brand name and the performance of other energy companies (Tata Power, NTPC), and the IPO traded at 80% premium in the grey market.
Yet, in the end, the Reliance magic failed – a first in the history of the Indian stock markets. On the opening day, the stock spiralled up 19% to trade at Rs 538 for all of four minutes before plunging to Rs 355 and never recovering enough to even close to the issue price. By the close of trading, investors’ wealth in hundreds of crores had been eroded.
So what went wrong? The first reason was, of course, it was its aggressive pricing in comparison to its peers, whose financials were stronger than that of Reliance Power. Another reason was the overhang of the US subprime crisis.
The Management Accountant, the journal of the Institute of Cost Accountants of India, noted in a case study later that between January 4, when Reliance Power announced the issue, and its listing on February 11, the benchmark Sensex fell over 4,000 points, or almost 20%. “The IPO was not helped by a souring in global market mood,” the journal noted.
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Is Reliance Power the biggest destroyer of wealth among Indian IPOs in the past decade or so? Not really; there have been a host of them that have disappointed, and Reliance Power is just one of them – though arguably the biggest among them as a brand, though the list does include a few well-known names.
A recent analysis published by The Economic Times shows that almost 61% of IPOs from 2008 – 100 out of 164 – are trading below their debut price in April 2019. Of this, six infrastructure and real estate stocks – Gammon Infra, Shriram EPC, DB Realty, Reliance Power, Jaypee Infratech and KSK Energy Ventures – have witnessed their share value erode by over 90%; in fact, the ‘big 3’ – Reliance, Jaypee and Gammon – lost over 98%.
While many prominent stocks have lost over half the share value in this period (S Chand and ICICI Securities, among several others), only 44 have registered double-digit returns even as the Sensex doubled during this period.
What has been more disappointing has been the performance of most state-owned undertakings. This includes the high-profile IPO of Coal India, which is still valued at about the same level nine years down the line; Hindustan Aeronauticals and Cochin Shipyard have also floundered.
For most of these stocks, analysts attributed the same reasons as had been cited for the Uber and Lyft debacles: over-valuation and weak fundamentals.
2018 Déjà vu
The story of the decade played out prominently in the year gone by, with seven of the 10 biggest IPOs of the year trading at levels below their debut prices.
This has, in turn, rubbed off on the IPO Index of the Bombay Stock Exchange, which fell nearly 15% between the beginning the year and end-September.
Interestingly, 80% of the Rs 27,900 crore raised by 69 IPOs in 2018 was accounted for by these 10 companies; by the year-end, only three were trading over the IPO price – Bandhan Bank, HDFC Mutual and Lemon Tree Hotels.
Economic Times analysis of trading performance shows that 60% of the 47 regularly traded stocks (of 69 that entered the primary market during the year) were trading below their IPO prices. The biggest loser was Ashoka Metcast, which lost some 75% of its issue value.
The underperformance has wiped off investors’ wealth to the tune of some Rs 4,700 crore.
The DMart Story
But it would be wrong to assume that the years since 2008 have been a decade-long story of gloom and doom for IPOs. Stocks of companies with strong business fundamentals have fared well in the markets.
From last year’s lot, the surprise has come from Inflame Appliances, which manufactures LPG gas stoves, with an issue size of Rs 6.48 crore; it yielded returns of 76% for investors.
But it is Indian retail chain DMart that has shown that if the business model is strong, the strength of a brand does not matter. DMart’s 112 stores in some 41 cities was known to its loyal customer base for offering quality at affordable prices when its IPO came out in March 2017.
So though low-profile compared to Big Bazar (the rival in the brick-and-mortar world), and Flipkart or Snapdeal (competitors from the e-commerce space), DMart made history of sorts when its maiden market offering was oversubscribed 104 times.
The shares issued for qualified institutional buyers were oversubscribed 144 times, that for non-institutional investors 277 times, and retail investors seven times. Moreover, the stock debuted at Rs 600, more than double the issue price of Rs 299.
Its IPO clicked because of a host of reasons, the foremost being the impression that the promoters were focused on building the business, keeping the profit margins low so they could keep shelf price affordable.
Since we started the story of disappointing IPOs with that of Uber and Lyft, let us see what US billionaire investor Warren Buffett has to say about those two or any other IPOs for that matter.
In an interview to CNBC before Uber made its maiden issue, Buffett explained why he had decided to pass it; it was because he had never bought an initial stock offering.
He was also critical of investors who fell the hype around an IPO, and said they were lured into buying into it mainly because they did not want to fall behind in getting rich. “That’s not a sound basis for an investment,” Buffett told CNBC.
However, people who invested in Reliance Industries shares way back in 1977 may differ with Buffett on the question of IPOs; the stock has more than doubled shareholders’ wealth every 2.5 years since its debut, and anyone who had invested Rs 10,000 back then would be a crorepati today.
So what are the important points one should consider before investing in an IPO? There are several:
* First, there is the promoter’s stake post-issue: a holding on the higher side reflects the management’s commitment to the company and bigger vision for it;
* Second, the promoter’s background is very important, as it reflects his/her capabilities: the DMart issue is a case in point;
*Third, the number of projects in the pipeline and their size also speaks volumes about the company’s scalability going forward, and,
*Finally, speculative gains should be avoided, with the focus being on long-term wealth creation.
A host of IPOs are in the pipeline this year: keep your wits about you so you don’t get swept away by the hype, weigh the pros and cons and you will be fine. Clueless about investing in stock markets? Here are some options.