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Hard lessons from the primary market fiasco financial scene

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Directors of Emaar MGF at a press conference to announce the company’s IPO in Mumbai recently. The issue, however, was withdrawn due to lukewarm response.
Directors of Emaar MGF at a press conference to announce the company’s IPO in Mumbai recently. The issue, however, was withdrawn due to lukewarm response.

Withdrawal of IPOs can queer debt-equity gearing of projects

Highly experienced merchant bankers should guide their clients more diligently on the pricing as well as timing of their IPOs.

The significance of certain recent happenings in the primary market can hardly be overemphasised. The withdrawal in quick succession of two initial public offerings — those of Emaar MGF and Wockhardt Hospitals — marks a definite phase in the recent history of the primary capital market.

Both offerings are from promoters with a good degree of visibility.

The projects they were implementing are also in businesses whose potential is well recognised by the markets. In fact, Emaar is in a business that until recently was hugely favoured by investors.

It is a telling sign of the times that when many companies with far less reputations could mobilise large sums, these two issues had to be shelved and that too after testing the markets. Their subscription lists were kept open for a few days but there was simply no adequate investor response.

Other companies are bound to take their cues and pull out their issues before their scheduled openings, thereby saving themselves the mortification of massive undersubscriptions.

Severe impact

There are numerous consequences of withdrawing or shelving a planned public issue. If the proceeds of the issue are earmarked for funding a specific project, then there could be a delay in its implementation.

Considering that the company may have to fill in the void by raising a loan there would be major implications on its debt-equity gearing and consequently its profitability.

Needless to add that the IPO route is one of the most recognised forms of raising long term capital and a setback to the plans of a few high profile companies will have major consequences for capital formation. Individual companies will also have to reckon with the consequences of the pull out from a marketing sense.

Although not fully exploited in India (except by a few IT companies) there is a positive correlation between stock prices and the company’s brand visibility.

In the aftermath of the deferment, however, such issues do not seem to matter as much as those that are directly affecting the capital market, especially its primary segment. All of a sudden, in a matter of weeks, investor sentiment has turned for the worse drastically.

Reliance Power fiasco

This was demonstrated even more poignantly by the episode of Reliance Power. The company had floated the biggest public issue ever (Rs. 11,500 crore) in India and secured a massive oversubscription.

However, its much hyped debut on February 11 ended in a fiasco, with the stock closing 17 per cent lower than its issue price.

The discount widened the next day but more importantly it proved that even the Reliance group is not invincible.

Looking at it another way, the cry for realistic pricing of IPOs was growing louder by the day.

Aggressive pricing of issues — certainly in the case of Reliance Power— carries a high degree of risk which naturally increases manifold when market sentiment is hit drastically. A related risk has been the launching of IPOs much before the business plans of the company have made reasonable progress.

To project, in the offer document, earnings over a five or seven year period and still hope for record subscriptions certainly calls for some audacious, if unrealistic, assumptions while marketing an IPO.

Sobering experience

Most certainly, in all cases — that include Reliance Power as well as Emaar MGF and Wockhardt Hospitals — the merchant bankers and other advisers are either complicit or lax.

Now they will have plenty to answer for. Irrespective of whether the secondary market picks up or not, getting an issue subscribed at the discovered price is going to be a challenge. Investors, especially the retail ones, would have had a sobering experience. In the light of the Reliance Power experience, it would be naïve to expect quick gains on listing hereafter.

New IPOs will come under intense scrutiny. Investors will have to be guided by fundamentals and not by expectations of immediate returns.

Flawed timing

It is wrong to attribute the recent fiascos in the IPO market to the massive secondary market correction alone. It is true that market valuations are down by 20 - 25 per cent since January. Yet timing an IPO is a decision to be made by professionals, people with long experience in the capital market.

Some of India’s top investment bankers have been associated with Reliance Power and the other two IPOs. Surely it was not beyond them to anticipate a shift in investor preferences.

Rating exercise

Finally, a word on the rating exercise. Reliance Power’s equity issue secured a high rating — 4 on 5 — from Crisil.

The rating exercise for equity issues has been controversial ever since it was made compulsory for all IPOs. It is meant to provide an independent, expert appraisal of the project for which the IPO is made. In any case, it is not by itself meant to influence an investment decision.

For a long time to come, it seems that the purpose of rating an equity share issue will be misunderstood.

C. R. L. NARASIMHAN


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