This is why IPOs hardly make money

Jan 8, 2011

In this issue:
» Oil prices raging upwards
» Australian floods spell trouble for Indian steel cos
» Rare earth metals the next big thing: Jim Rogers
» India to be the third largest by 2050?
» ...and more!!

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Year 2010 was one of the best for IPOs. Not in terms of their performance but in terms of the amount of money that the companies could raise through the primary market route. But by the time the year came to a close, most of the companies who had IPOed in 2010, were trading at huge discounts to their issue prices. As per a study conducted by a leading business daily, 6 out of 10 of the companies ended the year below their issue prices.

The interesting question here is why don't the IPOs do well? Barring a few, most tend to underperform. The reason behind this is that most IPOs in India are mostly marketing exercises. The companies tend to paint a rosy picture to lure investors. The best part is that most of them tend to decide their offerings as per the investor sentiment. So if the investors are not favoring their companies at the moment, then the companies prefer to delay the IPO rather than facing fallout.

The worst part is that even the government controlled companies do this. Just before the blockbuster issue of Coal India, the management came onto the tabloids to talk about how the IPO would be one of the best ever. Now oil major, Indian Oil has decided to delay its public offering. The reason the investor sentiment for the company is depressed in the light of the higher crude prices.

Well, no wonder IPOs don't do well. They are just a marketing exercise for the companies to raise huge amounts of money. And once the companies secure their funds, reality starts to raise its ugly head. But by that time, the innocent investors are stuck with bad investments in their hands. This is why we advise investors to be cautious and look deeper into the businesses before investing in them. Go beyond the flashy marketing messages and judge the business for what it is.

Do you do your own research before investing in IPOs? Share your views with us or post them on our Facebook page.

 Chart of the day
Today's chart of the day shows how oil has fared over the last decade. Clearly, the prices peaked in 2008 at the height of the crisis. But by the end of 2008, oil prices fell almost 70% from their peaks. However, constrained supply and harsher weather conditions have forced oil prices to start trending upwards. Though the prices are still not as high as the peak in 2008, but they have gone up by almost 130% from their 2008 lows. Unfortunately, unless supply constraints are removed, the prices are most likely to go higher in times to come.

Data source: WTI prices from US Energy Information Admin

Oil is not the only fuel whose prices are going up. Prices of coking coal, one of the key ingredients for making steel, increased substantially in the recent past. This led to an overall increase in steel prices as manufacturers decided to pass on the escalating cost to evade margin pressures. However, we believe there are no signs of steel prices cooling off in the near term. In fact, the situation is about to get worse. Recently, Australia's Queensland province, one of the major coal exporting regions in the world, has been hit by severe floods. This has damaged the transport and infrastructure facilities in the city. Now, it may be noted that India predominantly imports its coking coal requirements from the Australian market. Thus, the supply shortage created due to logistic issues could further increase coking coal prices from current levels. Further, frigid temperatures in most parts of Europe and China are also likely to keep the coal prices at elevated levels. We believe absorbing the ever rising input cost will not be sustainable for the steel companies. And thus, you could well see another round of hike in steel prices the near term.

Interestingly, despite higher prices in most commodities, PIMCO does not expect this trend to continue. As per a leading fund manager at the company, commodity prices would not come down, but at the same time he does not see much upside in them either. This is despite the significantly better forecast for the US economy in 2011.

Reason - The US does not drive commodity demand and prices anymore. After all, it is the growing emerging markets, India and China that were driving the demand growth. However, the worrying high inflation will force the emerging market governments to contain demand. Predictions are that oil will peak at $100 and food prices would come down as Governments are hell-bent to control the latter. While we do pray that PIMCO is right, as higher prices are eating away everyone's incomes. However, we still don't see any signs of commodity prices easing off in the near future.

There are some commodities that are set to see their prices spike going forward. No, we are not talking about gold or silver or for that matter agricultural commodities. What we are talking about are rare earth metals. These metals are used in a variety of scientific and industrial processes and because of supply concerns, are set to witness a big jump in prices. Or so commodities guru Jim Rogers believes. Interestingly, China has a monopoly as it controls more than 97% of the world's rare earth metals. Some of these metals include dysprosium, terbium and europium. Of course, what goes up has to come down and sometime in the future, new mines will come on stream which will bring the prices of these metals down. Which is why now seems the right time to lap up these metals.

Let us turn the clock back a bit. In fact, quite a way back. Imagine the global economy of the 1970s. What do you see? The world dominated by US, Japan and the European block. From that vantage point, would it have been possible to conclude that some 40 years later, the very same economic powers would weaken considerably in terms of economic influence. That countries like Japan would suffer a lost decade or that the US would drown so much in debt that the status of US dollar as a reserve currency could come under severe scrutiny? Above all, would it have been possible to conclude that countries like China and India would take huge strides in their development, especially the former. If your answer to these questions is no, then perhaps you should not take the latest prediction by the famous accounting and consultancy firm PwC that much seriously.

The firm has gone ahead and given us a prediction for the year 2050. It believes that by the time we complete the first fifty years of the current century, China would have become the world's biggest economy whereas USA and India would occupy the second and third position respectively. Of course, when one is predicting so far out, there have to be caveats. And what are the caveats in India's case? They are the usual suspects like infrastructure, education, fiscal policy etc. Well, there is no chance that one can take any meaningful decision based on such a prediction, even if it turns out to be correct. Give us a 3-5 year prediction any time!

The first week into the New Year was a good one for all the key global stock markets, barring India. As you can see from the chart displayed below, the Indian markets were the sole losers this week with its benchmark index, the BSE-Sensex, posting a loss of 4%. Most of the losses in the Indian markets occurred on the last trading day of the week. This was largely on the back of concerns relating to the high inflation numbers and a possible hike in interest rates going forward.

Coming to the rest of the world, Asian stocks led the pack of gainers this week with Japan, Hong Kong and Singapore recording gains of about 2 to 3%. The UK, Chinese and US markets recorded gains of about 1% each.

Source: Yahoo Finance

 Weekend investing mantra
"Owning stocks is like having children - don't get involved with more than you can handle." - Peter Lynch

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12 Responses to "This is why IPOs hardly make money"

Ravi Katari

Jan 10, 2011

We come back to the issue of irresponsible bankers, valuation assessors and stock brokers. The fact is that once these guys certify a fair value the average citizen believes them. There needs to be a system for punishing them severely for wrong guidance.



Jan 10, 2011

Can you re-visit the ipo recommendations that you have provided. Mainly the ones which were avoided because of valuations? I think lot of them have fallen by 40% which might make it a good buy!



Jan 9, 2011

Dear Sirs,
How can an Indian investor invest in rare earth metals? What are the avenues available? Kindly enlighten me. Thanks



Jan 9, 2011

I do endorse your views; it is especially lamentable to see PSUs doing cosmetics for IPOs, eg. NMDC, NHPC, etc. The investor, however, has no direct means to know the truth; he has to go by the ratings given by certain Agencies authorised to do so; they are the real culprits. If the so called rating Agencies can be made accountable for any repeated down slides on listing,things may improve, but it requires corporate legislation which requires a committed political will; but alas, all governments, whether right, left or centre, aim only one thing - make an 'Inda Lncorp', domestic saving, investors money in other words, is the best way. This happens when MPs are corporate millionaires. This will end in the existing corporate law regime, if only the shareholders 'handle' things and people in the so called General Meeting; in short,India requires a corporate revolution.

You are to free to use this idea but you are not expected to indulge in plagiarism; publish with proper acknowledgement;copy right laws may apply.


Sunil Kumar

Jan 9, 2011

As long as the IPO is a marketing exercise, none of these IPOs will do well. You are right in saying that after getting hold of people's money, the reality corrects the pricing. The investment banker, on whose credibility the mass janata puts their money, is the sole culprit behind this. The janata should now wake up and start making all investment bankers behind this 'day light robbery' responsible behind the janata loosing their hard earned money. The investment bankers, who are robbing the promoters and the investment community for long time and is also responsible for unjustified real estate pricing in Mumbai and other parts of the world. They are investing their kitty of money which is swelled out of robbery. The Janata has now declared a war against corrupt politicians. All investors now should declar a war against the investment bankers and hold them responsible for all losses. The investmenet bankers cannot hide behind the small print allowed by SEBI and continue to rob public of their hard earned money. Let us together declare a war against investment bankers. In recent press news, the promoters have accepted the fact that they know much more about their businesses than these investment bankers and have began doing deals with their internal staff. The war has just began.


sarat palat

Jan 9, 2011

It is better to have your own way of research and studies. What is mentioned in the article is 100% true. The promotors wants to make the maximum during the IPO. One of the method we could adopt is avoid IPO's. When it opens up for trading, watch the movement for a few weeks and then come to a decision.



Jan 9, 2011

Make hay while the sun shines. That adage is well utilized by IPOs as well.
When the going is good, even the "Bad" gets the best and when the going is bad, even the "Good" gets the worst.
Coal India was basically good and the going was good and no wonder they mopped up enormous money.
Generally, I don't do any research on any IPO; I go by the Prospectus statements. Sometimes the Brokerage Houses advise on the issue and if a cluster of issues come out, they give opinion on the different issues. I follow them.
Of course, I cannot apply for all the issues.
Fortunately, Coal India and Power Grid have not failed so far.



Jan 8, 2011

Your article is excellent. There is no news I read about the Australian flood in the coal mines. You had given a valuable information. It is said that coal india holds the largest coal mines in the world and I am surprised to see that we import the coal from Australia. Is that mines leased by coal India for mining? Every investment analyst opined that the coal India shares are worth to keep for longterm. Do you mean that it is misleading to keep up the share prices? I think the coal mines are yielding like gold comparing with other industries in India and will certainly yield good dividend and the price fixed is fair as it is reported that the employees union who boycotted the issue had asked the company to issue shares again to the emplyees alone for giving a chance to participate in getting stake in the company


Saroj Singh

Jan 8, 2011

Yes you guys are right. But you are not different from others all you money maker guy come out all kind of idea after train leave the station. You all cheating the investors. Unlucky investors because know no one cant stop you bad guys.

thank you.



Jan 8, 2011

It is easy and comfortable for firms like PWC to project for a period with a gap of 40 years.because no one is going to remember and ask any embarassing questions.But if they have to make projections for next 3 to 5 year period they will be caught and would face ebrassing questions from various corners.So the best thing is if some one makes such 40 year + projections one should not even look at them

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