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Does news of the next big IPO still excite you? - Views on News from Equitymaster

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Does news of the next big IPO still excite you?

Jun 10, 2011

The bigger the hype, the harder the fall, is the case with most Indian IPOs (initial public offerings). Well, a few have created wealth for investors, but a large number have been sure shot wealth destroyers. These are exotic seasonal creatures. In a bull market, they appear like a monsoon deluge. But, when the market takes a turn for the worse, they completely disappear.

For investors, investing in an IPO is like playing cards with the deck stacked against you. The promoters, investment bankers, and brokerages all have vested interest in the successful subscription of an IPO. From rosy financials, to star ratings, and huge media buzz, these IPOs enter the market with all guns blazing. On the listing day they may see huge gains due to propped up volumes. But, sooner or later they falter.

Lower the float, bigger the loot

In 2010, the IPO of Indian travel site, MakeMyTrip was the best IPO in 13 years in the United States. It surged 89% on listing, despite its financials being in the red. Was this the start of a bubble? Maybe not, as its glory of being the best IPO was shortlived.

In 2011, the recent LinkedIn IPO got a lot of people talking about the resurgence of a tech bubble. But, more than a decade later things are a bit different. Most internet companies now have a revenue model in place. After all, over the past few years the internet has been the place to be for marketers and advertisers. Since the potential upside is huge, web-startups are using the 'low-float' strategy. This means that they will reduce the number of shares they offer to the public. High valuations coupled with scarce supply of shares ensure that share prices skyrocket. LinkedIn sold less than 10% of its shares during the IPO, and scare supply, and huge demand for this 'hot stock' ensured that the price doubled in its first trading day. Russian search engine, Yandex followed close on its heels. It took the crown from LinkedIn as the biggest IPO since Google (2004).

Zynga (online games), Pandora (internet radio), and Groupon Inc. (online coupons) also intend to adopt the same low-float strategy now for their offerings. The average float of a US tech IPO over the past year was 24%, and these web companies are offering less than half of this. This strategy counters the negative effects of equity dilution and also leaves the possibility of firms to raise further capital at even higher valuations. But, lower float rather than great fundamentals are actually causing prices to increase phenomenally.

Closer to home, we believe Indian government's decision to make sure that listed companies have a 25% public shareholding is a good policy decision. It helps increase public participation in the affairs of companies and increased liquidity in the stock, preventing manipulation by few parties.

Indian IPOs - few winners, many losers

According to Seasonal Magazine, between January 2006 and May 2011, India witnessed around 330 IPOs and FPOs. Out of these, 70% of these were failures. This means that two out of every three IPO or FPO that hit the market ending up losing money for their investors. You may have more success by throwing darts at the stock section of a newspaper. Some of the more well known wealth destroyers are Future Capital (82% down since IPO), DB Realty (83% down). Reliance Power, if not for its subsequent bonus issue would have been down close to 70%. But, still it would have wiped out 50% of your returns. 2010's most hyped IPO of SKS Microfinance would have also successfully wiped out 70% of your money. In 2011 as well, most of the big IPOs are under water.

A few of multi-baggers, which managed to double or in some cases even increase your wealth five times were IPOs/FPOs of well managed companies Yes Bank, Opto Circuits, Bank of Baroda, Page Industries and Jubilant Foodworks. Mind you, these companies are few and far between.

A few words of caution

So look before you leap when it comes to the next IPO. Remember that the deck is always stacked against you. You have to make a buying decision, armed with the least information, but a thick prospectus. A stellar listing performance should not make you jealous, and neither should figures of over subscription. IPOs play on investor psychology, as they come out only when the market is going up, and is expected to rise even further. It would do you good to remember these caveats next time.

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Dec 10, 2018 03:35 PM