Sucheta Dalal :Killing the initial public offering market again
Sucheta Dalal

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Killing the initial public offering market again  

Sep 27, 2004



 

If a newspaper report of last week is to be believed, the investment banking community may be getting ready to distort the primary market, mislead investors with false hype and pave the way for killing recently reawakened investor interest in Initial Public Offerings (IPO).

 

Although the report quotes a senior investment banker, it is doubtful that investment bankers will succeed this time, by pushing for the emulation of bad global practices in a vastly different Indian situation. Here is what the report says. The Securities and Exchange Board of India (Sebi) is examining the feasibility of doing away with the system of asking for upfront payment from non-institutional investors in primary issues.

 

What it means is that just as Qualified Institutional Buyers (QIBs) don’t have to pay any money until allotment, investors too can apply for shares without coughing up any money. The report suggests that investment bankers are lobbying for such a change after the Securities Market Infrastructure Leveraging Expert task force (SMILE) recommended a 10 per cent margin on QIBs.

 

Now consider the situation if investment bankers had their way. Initially, small investors as well as high networth individuals would rejoice. Dr Poonawala from Pune will not have to block up over Rs 120 crore for weeks on end and Dr Punwani from Mumbai won’t have to write endless emails to the regulator to get his refunds. The same applies to thousands of investors who are frustrated at frequent primary market mess-ups. Bankers will also rejoice. Instead of lending money to investors to gamble on allotment, they will lend on a sure thing — they would merely lend the application money in the expectation that the investor will flip the shares after listing and repay them with interest.

 

This is a bonanza for manipulators since it will build up enormous pressure to ensure that the listing is at a substantial premium to the offer price and will open up a shady business opportunity for them.

 

But let’s also not forget all the action that will take place during the issuance process. Just recollect the early 1990s to get a clear picture. Between issuers, lead managers and the media, every IPO will be desperately hyped up to ensure a massive rush of applications. After all, you cannot create a post-listing premium until investors see a goldmine in every IPO. Chequebook journalism will be back with a bang and now that some large media companies openly sell editorial space, it may legitimately form part of issue expenses.

 

A host of dubious listed companies and shady corporate groups will also add to the noise by drumming up expansion plans and rights issues. Inevitably, the bubble will burst in a few months and the primary market will probably die out for another decade.

 

This is the likely scenario if Sebi listens to preposterous suggestions that retail investors be exempted from paying upfront. For the record, this is not the first Sebi committee to recommend a small margin for institutional investors; it is the third. Each committee was aware of the international practice and made its recommendation after detailed deliberation.

 

In fact, SMILE made the recommendation even though the SEBI board had rejected the recommendation of the Y.H. Malegam Committee and the Primary Market Advisory Committee to levy a margin on institutional investors.

 

Investment bankers make three points. First, that institutional investors may not be willing to pay a margin on application. Secondly, that it would be more ‘‘judicious’’ to eliminate it for retail investors rather than impose a margin on QIBs. And that IPOs will not be subscribed if QIBs stay away and prefer to buy in the secondary market.

 

All three arguments are misleading. There are plenty of examples where Lead Managers deliberately hyped up issues (even an excellent issue like Maruti Udyog was hyped to show oversubscription in under 10 minutes); or as the SMILE committee has said, QIBs ‘‘influence pricing by showing an inflated book in the early stages of the issue, thereby luring unsuspecting retail investors who are impressed by the response’’. Secondly, as discussed earlier, it would be disastrous rather than judicious to eliminate margins for retail investors. And thirdly, the TCS issue shows that the market acumen of institutional investors is hugely over-rated.

 

In case of TCS, all institutional applicants were only willing to pay between Rs 800 to Rs 850 per share while retail applicants bid at Rs 900 or cut-off. In fact, had it not been for the 60 per cent mandatory reservation for QIBs, retail investors would have got a greater share of the allotment and TCS could have collected more money.

 

If there is any change that is warranted, it is that the buckets for QIBs, high networth individuals and retail investors (currently at 60:15:25) should be allowed to be reset to allow greater retail participation whenever possible. Also, the allotments to institutional investors must either be proportionate or as per a declared formula in order to free them from the clutches of Lead Managers. Finally, as the TCS issue proves, it may not be such a bad thing if institutional investors go to the secondary market. Curiously, the news report attributes many complaints to investor associations, which are not strictly correct. Sebi-registered investor bodies represented on these committees have supported margins for institutional investors. In fact, they only protested against delays and debacles in the allotment process.

 

Investment bankers were also adequately represented on SMILE but seem to have missed its excellent proposals to automate the primary market processes to speed up listing and allotment; and to eliminate mistakes caused due to multiple manual entries of application details. The SMILE committee proposals will also ensure that refunds are accurate and made directly to investors’ bank account. These changes are far more important to investors.

 

In fact, eliminating application money will only bring in gamblers and speculators and reduce the chances of genuine investors coming into the market. This is neither in the interest of investors nor the corporate sector, although it will enrich the investment banking community. In fact, at a time when the Google IPO dared to defy international conventions, why should they bind Indian regulators?

 

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http://www.indianexpress.com/full_story.php?content_id=55884


-- Sucheta Dalal



 



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