Is this the end of the IPO dream run?

Nov 27, 2010

In this issue:
» India's industrial production has taken a step back
» Dubai's economy is all but healthy
» Projects feel the heat of the environmental ministry
» Correction in real estate prices? Not very soon.
» ...and more!!

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The IPO dream run seems to have fizzled out. Just like it came to an end in early 2008. At that time what pricked the IPO bubble were the global financial crisis and the subsequent meltdown in global stockmarkets. What has now stopped the IPO juggernaut in its tracks are a slew of scams and scandals. And the last straw has been the bribery-for-loans scam involving several real estate players and banks.

As has been the case with bull runs in the past, companies in recent times announced IPOs by the dozen as they wanted to ride the wave of euphoria in the stockmarkets. After all, the developed world was struggling to keep its head above water. And foreign investors in their quest for higher returns were pouring into emerging markets including India to capitalise on the faster growth prospects of these economies. The general perception was that as long as the US and Europe struggled to recover, foreign money would keep flowing into India. This, despite the prices of many stocks having reached exorbitant levels. This enthusiasm spilled over to IPOs as well and the feeling was that as long as there was enough liquidity, IPOs would get oversubscribed. Even if the valuations were on the higher side.

Ironically, the global scenario has not changed. But the recent spate of scams in India has meant that Indian stockmarkets have suffered. Little wonder then that IPOs have also begun to see a slow down. Real estate companies, especially, are likely to face the maximum brunt. These companies had come out with a plethora of issues before the scandals came to light. And many more were slated to come with issues, which may not see the light of day. That said, the investment rationale for IPOs is no different from investing in already listed companies. At the end of the day, the business fundamentals have to be sound, the management strong and the valuations reasonable. Without them the IPOs do little favour to the markets.

 Chart of the day
Industrial production in September 2010 painted an interesting picture. As the chart shows, India's production considerably lagged not that of not only emerging countries but also of the developed world. This, despite the country being one of the fastest growing economies currently along with China. A single month's production number is certainly not a good indicator of an economy's health. A realistic judgment could be drawn on the basis of trend over several months. However, overcapacity and high input prices do seem to be impacting some sectors in India reasonably hard.

Data Source: The Economist

As the fate of real estate in India remains clouded under issues of legality, the prospects in other parts of the world are not very bright either. Take Dubai for instance. The economy relied squarely on development of extravagant real estate projects until a few months ago. However, it came crumbling down as reports of excessive debt burden on the government backed projects became public. Investor confidence in the emirate plummeted and several ongoing projects were stalled. Since then the economy has managed to get on to the crutches. Help from oil rich neighbour Abu Dhabi and sale of US$ 1.25 bn of bonds aided the recovery. But with government debt of US$ 100 bn due for repayment in coming fiscals, the Dubai economy is all but healthy.

The real estate bubble has taught the Dubai government two set of lessons. That building an economy purely through borrowings is unsustainable. And that the growth of an economy needs to be broader based. Concentrating on just one aspect could have disastrous fallouts in times of distress. We hope the lessons are taken more seriously by other economies as well.

The reports of Indian real estate being caught in liquidity trap came in as good news to some. Prospective home buyers who have failed to fetch a reasonable bargain thought that this would be an ideal opportunity. Reports of banks likely to refuse loans to the real estate sector led to speculations of a correction in home prices. Builders hoarding inventory thanks to availability of debt were seen giving in to liquidity pressures. And buyers hoped to see their dream houses coming within their budgets. But top bankers have sought to underplay the reports of bribery in real estate loans. In fact they have reaffirmed their willingness to lend to housing projects. On one hand this will save a massive slump in the sector. But on the other it may keep home prices beyond the reach of the common man.

The environmental ministry in India is raising the red flag on all projects that are considered to be harmful to the environment. The reason cited is India's active commitment towards minimizing climate risk. In the most recent reports, the ministry has questioned the operations of major projects of a construction company as well as a power company. If the companies are unable to satisfy the ministry, they stand to lose their licenses for these projects which could result in massive losses. The ministry has also requested for the ban of SUVs (Sports Utility Vehicles) in India terming them as 'socially useless'.

It is good to see the ministry taking a stance on climate risk. However, we wonder if they are addressing the correct issues. It is important to remember that the same ministry had increased the mining reserves for Coal India just before the IPO. Going after infrastructure development by private companies only and ignoring the public run companies is definitely not the ideal solution.

China is beginning to feel the jitters of steep rise in commodity prices. Inflation in the economy last month rose to a two-year high and food costs jumped 10.1%. This has forced the Chinese government to spell out some quick measures. All with the aim to deter excessive speculation and to tame inflation. One of the measures is to raise costs of trading farm-product and metals futures. Major Chinese commodity exchanges intend to scrap measures such as discounts for same-day trading. These were introduced in the past to strengthen volumes. However, the government has now pledged to use price controls. It may even consider raising interest rates a second time this year to curb inflation. Several US and European commodity exchanges are also charging more to trade some raw materials after prices jumped.

According to experts, raising fees to be active on the exchange is a predictable move to try to calm down speculative investment. But high futures prices also point towards fundamental demand -supply factors. The world's four biggest agricultural contracts are traded in China. However, the Chinese exchanges' steps may have little effect on world commodities prices. Partly because trading is closed to outside investors.

The week gone by was largely lackluster with most of the global markets closing in the red. This was a result of European debt worries and tough talk from North Korea regarding the situation in the Korean Peninsula. Japan was the top gainer for the week (up 0.2%) followed closely by Germany, up 0.1%. The biggest loser of the week was Brazil (down 3.8%). In Asia, Hong Kong was the biggest loser (down 3.1%) followed by India (down 2.3%). The US was also down by 1% during the week. Meanwhile, gold and crude prices continued to gain.

Data Source: Kitco, Yahoo Finance

 Weekend investing mantra
"Price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to...the operating results of his companies." - Ben Graham

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2 Responses to "Is this the end of the IPO dream run?"

Agnel Pereira

Nov 27, 2010

Three points on today's items in your Wrapup.

One, the Industrial Production. Please note many of the countries mentioned (incl US) had dropped down heavily last year whereas India didnt. So when you analyse the growth over the same month last year, you are bound to see improvements for those countries with low production last year.
Second point about Dubai. More than the debt, the main problem in Dubai was over supply of exotic real estate for a city with 95% foreign people living, out of which a vast majority are low wage labourers. They aimed at rich foreigners to buy exotic RE, but when the federal UAE government failed to provide the long term Permanent Residential status, the Dubai bandwagon got derailed. What the ruler embarked on there was much bigger dream than what could be achieved realistically. He is a visionary no doubt, but he wanted around 4 large artificial yet exotic island projects and then to replicate each of the world cities within one Dubai. Great plan, but for whom?
Thirdly, IPOs in India will never have a successful long run. This is because, the issuers are too greedy all of the time. Rarely you get an IPO where the offer price is reasonably discounted to the intrinsic value of the company (like Coal India). And also, the fortunes of IPO market lags the success of the secondary market and very rarely the latter has a long run of success, so IPOs timing has to be so perfect to reap success. Coal India was good in that respect too. Thankfully the secondary market has corrected, so we will be relieved from some greedy issuers for the time being.
There is always a logic to buy stocks in the secondary market on listing (or little later) whether they list at a premium or discount.



Nov 27, 2010

My subcription has started coming in only from today,with less time among my biz schedule it is nice to go thru the crisp biz news around the markets

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