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Primary markets are not always a golden goose

Monday, August 01, 2016
By Jayant Pai

Jayant Pai CFP and Head - Marketing, PPFAS Mutual Fund

The primary market largely comprises of two segments: 1. Initial Public Offerings (IPO) 2. Follow On Public Offerings Worldwide, they are often viewed as a lottery, wherein successful allottees are able to sell their holdings at a huge premium on listing. This belief may still hold good in some countries, but in India this arbitrage has faded over time. This is due to:

Free pricing of IPOs: Today's newbies may find the old 'war-stories' of fabulous gains from IPOs very alluring. However, sadly for them, times have changed over the past decade or so. Prior to 1992, IPOs were priced as per an ultra-conservative formula, which invariably resulted in allottees enjoying super-normal gains. However, since 1992, this formula has been dispensed with and promoters are free to price their IPOs as per market demand.
Hence, a lot of value is appropriated by the promoter at the IPO stage itself. Since it is a zero-sum game, the promoter's gain is the allottee's loss (albeit notional). Hence, while it may happen once in a while, it is unrealistic to treat supernormal gains as "Par-For-The-Course".

The dice is loaded against you: Promoters have access to the best investment bankers. It is their job to please their client (in this case, the promoter) and ensure that they get the biggest bang for the buck. Obviously, this means that your interest as an investor is rarely, if ever, taken into account.

Despite these factors, investing in IPOs can be reasonably fruitful if one approaches them as 'investments' rather than lotteries. Conduct the requisite due diligence by:

Looking at valuations and not 'values': This may sound strange, but many retail investors actually make decisions based on the nominal value of the shares being offered, rather than the valuations. Hence, concentrate on the right intrinsic and peer valuation metrics (Say, P/E ratio, P/B Ratio, EBITDA/Sales) to assess the Offering.

In fact, many a times, IPOs which are made during bear markets turn out to be much better investments as the valuations are usually at sensible levels. Also, the chances of allotment are higher due to the general apathy in the market.

Undertaking peer comparisons: Today, it is rare to come across any IPO where peer comparisons are difficult. Hence, an investor should always compare the company making the offer, with other listed peers. Only then will one know whether applying for the IPO is worthwhile or not.

If the new company is not markedly different from its peers, it may make sense to apply only if it is offering its shares at a reasonable valuation discount.
Investing in Follow-On Public Offerings (FPOs): This pertains to further equity issuances made by listed entities. Here, the decision whether to apply or not, is slightly easier, as comparisons between the FPO price and the current market price can be made on a continuous basis. Sometimes, poor market conditions may result in the offer price being higher than the market price, due to the time lag between the offer price being announced and the issue opening. In such cases, you could purchase the shares from the secondary market, rather than applying in the FPO, in case you are bullish about the company's prospects.

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