A Study Of Initial Public Offer Market (IPO) In India.

Introduction: In recent years Initial Public Offerings (IPOs) have increased tremendously. IPOs provide an easy way to increase initial investor’s wealth and to raise cash for future expansion of The company. This was particularly noticeable in the technology related stocks in 1990s. In many cases there were clear indications that IPOs would not reach profitability in the foreseeable future. However investors, anxious not to miss the boat, would invest in these offerings on the expectation of capital gain as a result of an increase in the stock prices. This euphoria created a hot market condition fuelling an increase in the stock prices until such a time that market sentiment changed. IPOs can be highly volatile and risky for Investors but they can also provide a very higher return if the proper investment strategy is implemented. The IPO risk are two-fold, first is the short-term market fluctuation, second is the risk associated with a change in market perception. Once market perception and investor expectation changes, price would begin to decline precipitously.

2.    What Is An IPO? : An initial public offering (IPO) is the first sale of a corporation's common shares to investors on a public stock exchange. The main purpose of an IPO is to raise capital for the corporation. While IPO’s are effective at raising capital, being listed on a stock exchange imposes heavy regulatory compliance and reporting requirements” An IPO is the first sale of stock by a company to the public. A company can raise money by issuing either debt or equity. If the company has never issued equity to the public, it's known as an IPO. Companies fall into two broad categories: private and public. A privately held company has fewer shareholders and its owners don't have to disclose much information about the company. Anybody can go out and incorporate a company: just put in some money, file the right legal documents and follow the reporting rules of your jurisdiction. Most small businesses are privately held. But large companies can be private too. Did you know that IKEA, Domino’s Pizza and Hallmark Cards are all privately held? It usually isn't possible to buy shares in a private company. You can approach the owners about investing, but they're not obligated to sell you anything. Public companies, on the other hand, have sold at least a portion of themselves to the public and trade on a stock exchange. This is why doing an IPO is also referred to as "going public."Public companies have thousands of shareholders and are subject to strict rules and regulations. They must have a board of directors and they must report financial information every quarter. In the United States, public companies report to the Securities and Exchange Commission (SEC). In other countries, public companies are overseen by governing bodies similar to the SEC. From an investor's standpoint, the most exciting thing about a public company is that the stock is traded in the open market, like any other commodity. If you have the cash, you can invest. The CEO could hate your guts, but there's nothing he or she could do to stop you from buying stock.

Boom and Slump Periods in the Indian:
IPO Market: It has been empirically documented that the IPO market experiences cycles in terms of volumes of new companies, which is referred to in the literature as “hot” and “cold” periods. It is considered to be an empirical anomaly for which no unanimous explanation is yet provided for. The most well known among the sighted explanations is technological innovation or positive productivity shock that changes the prospects of IPOs from particular industry. Empirical studies have found that small and young firms time their offers to use investors’ optimism in their favor and get listed during the booming period. There are evidences of high underpricing1 and industry clustering during the hot periods, though their nature and extent have differed from country to country. Only four countries in the world (namely U.S.A., India, Romania and Canada) 2 have more than three thousand listed companies in their stock exchanges. In India, during 1990s alone,3,537 companies got listed on the Bombay Stock Exchange (BSE).The last decade is also important, since the Indian economy in general and primary capital market, in particular, has undergone Remarkable changes during this period. The liberalization programmed initiated in 1992 along with other changes have enabled large Foreign Direct Investment (FDI) and Foreign Institutional Investment (FII) inflows, giving a ‘big push’ to the capital market. The abolition of the Controller of Capital Issues (CCI) also had major impact on the activities in the Indian primary market. It Witnessed a boom phase (1993-96) when more than 50 companies got listed every month. However, from end 1996 till recently the primary market has witnessed a considerable decline in the number of new issues and the total amount of capital rose.


IPO Market: Under pricing or overpricing? : Extant literature broadly supports the view that IPOs are underpriced. IPO pricing is mostly argued from the point of view of listing gains/ losses. This paper seeks to explain the process and outcomes of IPO pricing in the Indian capital market with the help of a basic model. With the help of certain cases it attempts to show that concept of underpricing is misleading and needs to be revised. According to this paper the extant notion of ‘underpricing’ needs to be termed as ‘overpricing’.

5.    The Price Discovery Process: Corporate may raise capital in the primary market by way of an initial public offer, rights issue or private placement. An Initial Public Offer (IPO) is the selling of securities to the public in the primary market. This Initial Public Offering can be made through the fixed price method, book building method or a combination of both. Difference between shares offered through book building and offer of shares through normal public issue:

Book building
This is the process of price discovery. The company does not come out with a fixed price for its shares; instead, it indicates a price band that mentions the lowest (referred to as the floor) and the highest (the cap) prices at which a share can be sold. Bids are then invited for the shares. Each investor states how many shares s/he wants and what s/he is willing to pay for those shares (depending on the price band). The actual price is then discovered based on these bids. Bids are then invited for the shares. Each investor states how many shares s/he wants and what s/he is willing to pay for those shares (depending on the price band). The actual price is then discovered based on these bids. As we continue with the series, we will explain the process in detail. According to the book building process, four classes of investors can bid for the shares:

1. Retail Individual Investor (RII): In the retail individual investor category, investors cannot apply more than Rs one lakh (Rs 1, 00,000) in an IPO. Retail Individual investors have an allocation of 35% of shares of the total issue size in Book build IPOs. NRI’s who apply with less than Rs 100000/ are also considered as RII category. Retail Individual investor can bid for more than Rs 100000 in an IPO by applying in NON institutional Investors Category. There is no upper limit for bidding amount in ‘NON institutional Investors Category.
2. High Net worth Individual (HNI): If Retail Investor applies for more than Rs 100000 of shares in an IPO, they are considered as HNI.
3. Non Institutional bidders: Individual investors, NRI’s, Companies, trust, etc. who bid for more than Rs 1 lakh are known as Non Institutional bidders. Non-Institutional bidders have an allocation of 15% of shares of the total issue size in Book build IPOs.
4. Qualified Institutional Bidders (QIBs): Financial institutions, banks, FII’s and Mutual funds who are registered with SEBI are called QIB’s. They usually apply in very high quantities. QIBs are mostly representatives of small investors who
Invest through mutual funds, ULIP schemes of insurance companies and pension schemes. QIB have an allocation of 50% of shares of the total issue size in book build IPOs.

6.    The Economics of IPO (and other) Markets: The famous British politician, Benjamin Disraeli once said, “What we learn from history is that we do not learn from history.” Disraeli said this in the context of British politics. He might as well have been talking about the market for initial public offerings (IPOs). Memories are truly short in the IPO market. Having seen scores of people lose their shirts in the IPO bubbles of 1992 and 1994, I now find that it is the same story all over again. IPOs are again the hottest sector in India’s financial markets. The reason is simple: too much money has been made in the IPO market in the last few months. Too much money will be lost in the coming months. What we learn from history . . .
Any kind of rational comparison of long-term returns in the IPO market and the secondary market would show that investors do far better in the latter than in the former. Indeed many such comparisons have been done which cover data taken from several countries spanning over decades. The conclusions are always the same: those IPOs are one of the surest ways of losing money in the long run. But these conclusions are not as interesting to me as an analysis of the reasons thereof. In other words what I find interesting is that there are certain characteristics of the IPO market which makes it unattractive for long-term investors.
To understand how the underlying economics of a market can affect its prospects, let us look at three different markets:
(1) The IPO market;
(2) The market for entire businesses or the mergers and acquisitions market; and
 (3) The secondary market. All the three markets are
Essentially dealing in the same “merchandise” i.e. shares. However, the economics of each
Markets are very different from each other.

7.    The IPO Market: It is only to be expected that in a bull phase of the stock market, there will always be a sector, or a group of sectors which are viewed extremely favorably by the investment community. In the 1992 and 1994 Indian bull markets, financial companies were viewed very favorably by the investment community. In the early 1980s, in the US, biotechnology companies were viewed very favorably by the investment communities. In the 1999-2000Indian bull market it is technology (particularly the software and internet-related) and media companies that are viewed very favorably by the investment community. These favorable
Views of the investment community are expressed by it in the form of high price/earnings, price/book value, price/sales and price/cash flow ratios commanded by the stocks of publicly owned and quoted companies.

At this time, privately-held companies in such sectors find that they possess an unlimited supply of extremely desirable “merchandise” i.e. their own shares. Naturally, merchant bankers scramble to advice these companies on how to raise a large sum of money from the equity markets at inflated prices. (The recent development of book building for IPOs is nothing but an artful form of pitting one bidder against another in an attempt to create a high clearing price for the shares being offered).Four characteristics of the IPO market make it a market where it is far more profitable to be a seller than to be a buyer. First, in the IPO market, there are many buyers and an only a handful of sellers. Second, the sellers, being insiders, always know more about the company whose shares are to be sold, than the buyers. Third, the sellers hold an extremely valuable option of deciding the timing of the sale. Naturally, they would choose to sell only when they get high prices for the shares.
 
Finally, the quantity of shares being offered is flexible and can be “managed” by the merchant bankers to attain the optimum price from the sellers’ viewpoint. But, what is “optimum” from the sellers’ viewpoint is not the “optimum” from the buyers’ viewpoint. This is an important point to note: Companies want to raise capital at the lowest possible cost, which from their viewpoint means issuance of shares at high prices. That is why bull markets are always accompanied by a surge in the issuance of shares. It is true that often hot IPOs list at incredible premiums. The reason is simple: the demands for the shares being there, the merchant bankers ensure that only a limited supply is released to ensure a high price on listing. Super profits are made by those who get shares allotted to them in the IPO, so long as they sell them at, or soon after, the initial listing. This is where the trouble begins. Everyone wants a piece of the hot IPO cakes. Everyone thinks that he will get out at the top. Mathematically speaking, obviously this cannot be true. Moreover as time goes by, the investment quality of the issues tends to deteriorate. Ben Graham put it in these words:
"Somewhere in the middle of a bull market the first new issues make their appearance. These are priced, not unattractively, and some large profits are made by the buyers of the early issues. As the market continues to rise, this brand of financing grows more frequent; the quality of the companies becomes steadily poorer; the prices asked verge on the exorbitant. One fairly dependable sign of the approaching end of a bull swing is the fact that new issues of small and nondescript companies are offered at prices somewhat higher than the current level for many medium-sized companies with a long market history."Because of the above characteristics of the IPO market, it is rare to find shares of companies being offered at bargain prices. History tells that over the long run, it is far better to be a seller in this market than to be a buyer. Indeed, it can be shown that over the long-run, more than 100% of the total wealth created in the IPOmarketaccrues to the sellers. Buyers, on balance, lose money.

8.    The Market for Entire Businesses: The mergers and acquisitions market (M&A) consists of generally well informed buyers dealing with well informed sellers. Like the IPO market, in the M&A market too, it is extremely difficult to find entire businesses being sold at bargain prices. The competitive Nature of corporate acquisition activity almost guarantees the payment of a full - usually more than full price when a company buys the entire ownership of another company. Therefore, while it is easy to find businesses being sold at inflated prices in the M&A market, it is rare to find bargains. Again, history tells us that 80% of all mergers and acquisitions fail to create value because the buyers tend to overpay for the businesses they acquire. Like in the IPO market, it is far better to be a seller than to be a buyer.

9.    The Secondary Market: The secondary market, or the stock market, is like a giant auction house where millions of buyers compete with each other to buy securities offered for sale by millions of sellers. Prices in this market are set at the margin by the most optimistic non owners of stocks and most pessimistic owners of stocks. Because of the auction-like characteristics of the secondary market, prices often diverge far away from the underlying intrinsic values. That is why we have bull markets and bear markets. In bull markets, the most optimistic non owners of stocks are willing to exchange their cash for shares at higher and higher prices. In bear markets, the most pessimistic owners of stocks feel that cash is worth more than the shares they are holding. So they offer them to buyers at lower and lower prices. In bull markets, therefore, prices tend to overshoot underlying intrinsic business values and in bear markets prices fall below the underlying intrinsic business values. Unlike the IPO market, and the M&a market, the secondary market is not necessarily a market where it is better to be a seller than to be a buyer. Depending upon the prices in relation to underlying intrinsic business values, there are times when it is better to be a seller and there are time when it is better to be a buyer. Over the long run, however, it is better to be a buyer than to be a seller in the secondary market. This is because stock prices tend to rise over the long run.
Another interesting characteristic of the secondary market is that it acts as a giant relocation centre where money is moved:
(1) From speculators to investors;
(2) From the active to the patient; and
(3) From the people who buy the most popular stocks to the people
     Who buy the most unloved ones?

10.    Conclusion: In this study we examined the price performance of the IPOs both in the short-run as well as in the long-run where short-run means the behavior of initial returns up on listing. As in other studies on this theme we computed the return realized over the period from the offering of the shares to the first trading day on NSE, called as offer-to-close return. We study the overall under pricing, the delay between issue date and listing date, the time- series of monthly volume of IPO issues and average under pricing in a given month, the cross-section of under pricing across companies, the post-listing trading frequency, the long-run returns to new listings, and price discovery by the market shortly after first listing. There are at present 23 stock exchanges in India and are governed by the Securities Contract (Regulation) Act (SCRA). Among these 23 stock exchanges BSE & NSE are the popular stock exchange and contribute over 75% of the trading.

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