»5 Minute Wrap Up by Equitymaster

On This Day - 5 JANUARY 2015
Beware of the upcoming IPO boom!

In this issue:
» Should investors worry about slowdown in FII equity inflows?
» New banking reforms offer little reason to cheer
» Black money menace gets bigger, takes GDR route
» ....and more!

  Chart of the day
Few days back, we wrote on how 2014 was a limp year from the perspective of IPOs. Unlike the rising activity in the secondary markets, the primary markets seemed to be largely untouched by the Modi frenzy. The year 2014 witnessed lowest amount of money raised in a decade! However, the lackluster trends in the primary market can largely be attributed to the time taken in IPO formalities. As the reform expectations bring retail investors back to the markets, a new wave of confidence has taken over the companies that are ready to raise money this year. As such, 2015 will be a different story for IPO market it seems.

As per an article in Firstpost, IPOs worth at least Rs 80 bn are lined up to flood the markets in 2015. Further with SEBI likely to notify new norms for e IPOs, the primary markets may witness a heightened activity.

However, before you bet your hard earned money on these, allow us to share some statistics with you. Taking a look at the long term trend, in the last seven years, 63% the total 178 IPOs issued are currently loss making. Six of these companies were suspended. It needs to be highlighted that all of these IPOs have been analyzed considering their prices in 2014, a year when the Sensex reached new life time highs. The performance could be worse if seen in any year prior to 2014. And it is not just the IPOs of small firms that have disappointed. Reliance Power and DLF Ltd were some of the biggest failures, both eroding over 70% of investors' capital since their IPOs hit the markets!

But have the retail investors learnt any lessons from the past? We don't think so.

Of the six IPOs in FY15 so far, most of which were in small and medium cap space, five were oversubscribed. With limited track record of financials or management performance and integrity, what is it that's driving the investors to these stocks? It is unlikely to be the attractive valuations. As aptly put by the investing legend Warren Buffett - "It's almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors)."

It is certainly greed playing the dominant factor, both for the issuers and the subscribers. And while it may serve the former as bullish sentiments rule, the long term retail investors are likely to get the short end of the stick.

We hope the lessons learnt from past experience will not be lost as a slew of IPOs hits the markets. As everyone around seems to be greedy, it is time for retail investors to exercise caution. While this does not mean that you should avoid IPOs lock, stock and barrel; make sure you do not end up paying higher valuations for a company that is yet to establish its worth.

Do you think retail investors are likely to be the most vulnerable participants in the upcoming IPO boom? Let us know your comments or share your views in the Equitymaster Club.

Around 2/3rd of the IPOs since 2008 have eroded wealth

While it is the new Government that has reversed the trend in the markets, the role of FIIs in driving this rally can hardly be overstated. FIIs have pumped in amounts over Rs 980 bn in 2014 itself. Huge influence of FIIs has made the Indian equity markets and retail investors quite vulnerable. India was the relatively preferred market for FIIs this year as the developed economies faced a slowdown and offered low returns.

However, with US expected to raise Fed rates, we will not be surprised if some of this money makes a smooth exit, leaving significant turbulence back home. Another reason to worry is the falling oil prices. One must note that a significant chunk of this inflow comes from oil producing countries. As crude prices decline, these flows are likely to slow down, putting a brake on this rally.

Infact, a slowdown in the FII inflows already seems to be here now. At Rs 21 bn, the FII equity inflows in the month of December have been the lowest in the last 10 months. So should investors worry about this trend? We do not think so. With reform story playing out in the economy, any likely correction should be seen as an opportunity to buy companies with strong fundamentals and attractive valuations.

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The black money menace in India is far too deep rooted for the government and regulators to sweep out within months. The SEBI is realizing this as it tries to probe companies who have laundered money through capital markets. We wrote to you earlier as to how the capital markets regulator is probing companies suspected to be raising funds in the names of fictitious entities. Such practices also involve inflating the size of business transactions without making any real profits, simply to transfer illicit funds.

It now appears that such activities are not restricted to domestic shores. In fact companies have also been tapping the GDR (Global Depository Receipt) route for round-tripping of funds in the name of capital-raising activities. SEBI suspects that companies route funds through Switzerland, Hong Kong, Singapore, Mauritius, Dubai and Canada for multi-layered transfers before bringing them back to India. Now, there is an urgent need for the government to ensure that regulatory loopholes do not encourage such practices. But it is also important for investors to be watchful about companies that have too many subsidiaries and intercompany fund transfers, without relevant business interests. Such suspicious cues should be a warning signal about the quality of management.

One area that the government is looking to reform urgently is banking. And the bulging bad loan portfolio of PSU banks is playing no small role in forcing the government to do so. Now, as we wrote to you, we are not terribly excited about the sky high valuations that some entities in the financial sector are fetching currently. And going by the nature of upcoming 'reforms' that the government has proposed, it will be a while before any improvement is witnessed in banks' fundamentals.

To begin with, the government has asked PSU banks to form a separate holding company. This holding entity will have stakes in the parent entity as well its various subsidiaries. This will de-risk the parent from being directly exposed to the functioning of various subsidiaries. Plus it will allow the holding company to adopt different ways of raising capital such as issue of shares with differential voting rights. In doing so the banks'capital requirements will be met without diluting the government's stake. These proposals may help the government to get the burden of recapitalizing PSU banks year after year, off its back. However, this does not solve the problem of poor management of the entities. And without that investors have very little reason to cheer!

Meanwhile, Indian stock markets slipped into the negative territory after opening the day on a positive note. At the time of writing, the benchmark BSE Sensex was down by 24 points (0.1%). The sectoral indices were trading mixed with the stocks in the power and software space leading the losses. However, stocks in the consumer durables and auto space were trading firm. Barring China, the Asian equity markets were trading mainly in the red with markets in Singapore and Malaysia leading the losers. The major European markets opened on a weak note as well.

 Today's investing mantra
"Be fearful when others are greedy, and be greedy when others are fearful."- Warren Buffett

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