“The more dependent the valuation becomes on anticipations of the future - and the less it is tied to a figure demonstrated by past performance - the more vulnerable it becomes to possible miscalculation and serious error.”

- Benjamin Graham

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The observation by the legendary investor, in a lot of ways, captures the essence of the Indian IPO (initial public offer) market, which has been a notable victim of price abuse. The incestuous relationship shared by investment bankers and promoters has made a mockery of the so-called price discovery mechanism. A frenzied bull market also acted as a stimulant. For proof, consider this: Of the 286 IPOs from 2004 to September 2009, 184 issues are still in the red. In fact, had things not turned nasty on the global front, the Indian primary markets would have probably ended up raising more than the record Rs 52,219 crore mopped up by 90 IPOs in FY08.

While the last fiscal was a complete washout with only 21 issues managing to mop up Rs 2,034 crore, the inexplicable turnaround since March this year has put the IPO gravy train back on track. Eleven issues have raked in Rs 13,035 crore and, not surprisingly, five issues are already trading below their issue prices. Continuing with the tradition of aggressive pricing, Mahindra Holidays & Resorts was the first off the block in the current fiscal to raise money at 30x its 12-month trailing earnings. Having seen that the world is flush with funds and global investors are continuing to buy the India growth story pumping in over $12 billion since March, the pipeline for new issues is getting longer with every passing day.

As on date, 53 issues worth Rs 31,112 crore are waiting to hit the markets. A majority of these issues are from the realty, power and construction sectors, which have been the biggest gainers in the rally thus far. The list also features smaller companies driven by “first-generation entrepreneurs” looking for capital to “grow their businesses”. For those who are looking for a “gem” of an IPO, the list has also some jewellery makers.

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Pricing pressure

IPOs launched in 2009 have failed to perform on the bourses because of aggressive pricing and low retail interest

Name of the issue	Amount invested (Rs cr)	Current value (Rs cr)	Current MTM return (%)	Profit	Loss
Mahindra Holiday	278	321	15	Profit
Excel Infoways	48	39	-18		Loss
Raj Oil Mills	114	71	-38		Loss
Adani Power	3,017	3,078	2	Profit
NHPC	6,039	5,535	-8		Loss
Jindal Cotex	84	98	16	Profit
Globus Spirits	75	60	-20		Loss
Oil India	2,777	3,158	14	Profit
Pipavav Shipyard	496	487	-2		Loss
Total	12,927	12,847	-1	4	5

Source: SMC Capitals

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If you are not looking to be a long-term investor, and instead want to make a quick buck by participating in IPOs, the recent listings should be an eye-opener. You would be better off doling out money in charity. For investors looking to invest in fundamentally sound companies, there are just a handful of issues worth ‘talking’ about. Investing in these issues would be subject to the valuations that the bankers finally arrive at. From the looks of it, investors are not going to come across any generously priced IPOs that will leave good money on the table. Nor are there companies that look like must buys for your portfolio.

Great expectations

The performance of the new listings is far from impressive. The three large IPOs launched in recent times, namely Adani Power, National Hydroelectric Power Corporation (NHPC) and Oil India saw a lukewarm response to their issuances. Adani Power fell below its issue price of Rs 100 on the day of listing, disappointing market watchers who were expecting the secondary market listing to be at a 10-15 per cent premium to the issue price. Even now the stock is trading at levels close to Rs 100, and has not seen much action.

Similarly, NHPC rose 1.9 per cent on the listing day and is now trading at Rs 34.55, below its issue price of Rs 36. The only exception was OIL India, the country’s second-biggest oil exploration firm, which rose as much as 10 per cent above its issue price of Rs 1,050 on listing on September 30 hitting a day’s high of Rs 1,156 in early trade. Currently the stock trades at Rs 1,195.

Arun Kejriwal, director of research firm KRIS, says that despite having good fundamentals all of these companies received a tepid response because they were overpriced. “Both promoters and merchant bankers have unrealistic price expectations, reminiscent of the pre-crisis period,” adds Kejriwal. S. Subramaniam, head of investment banking at Enam Financial Consultants, does not agree. He says that the recessionary phase has made companies wiser, and there are a number of them waiting to raise money with reasonable valuation expectations. In defense of the recently listed companies he says, “Investors are looking at the very short term. These companies should be looked at a medium to long term investment avenues, to give decent returns,” he says.

But after a series of flop shows, bankers and promoters may well revisit their pricing strategy. Avdhoot Deshpande, an investment banker, believes that there is a consensus among promoters that there should be some amount of discount to the listed peers to create goodwill among investors, but that does not necessarily mean that all issues will be at a discount. “The issue pricing has to be realistic and if the company has a good pedigree, the issue will see good appetite, whether or not it is at a discount to its listed peers,” says Deshpande.

That is precisely the question. Is the pipeline good enough to ensure that companies can command a premium and yet deliver decent returns to shareholders? We will answer that in just a bit. Before that will this momentum in primary issuances continue? Prithvi Haldea, chairman and managing director of Prime Database, the primary market tracking firm, says, the flurry of primary issuances one has seen in the past few months does not really mean a revival in the primary market. That is still some time away because of the current uncertainty and increased volatility. “What we have seen so far is just the first phase, that is, the firming up of plans by corporations to raise money through IPOs. But approvals can take anything from a couple of weeks to around four months. Also, post-approval, the market condition too will determine the timing of the issue. Thus, how many of these companies actually list is yet to be seen,” says Haldea.

There is a lot of liquidity in the market, companies with robust business models and reasonable valuation, will undoubtedly see good appetiteRavi Kapoor, MD and head, equity capital markets, Citigroup

Haldea is skeptical also because the so-called pipeline of primary issuances is three to four years old. Most of these companies, had initially planned to raise money in calendar 2008, but could not because of the adverse market conditions. “One has to wait and see if the secondary market is able to sustain the current momentum till the end of the year. It is only after December, that some issuances may see the light of the day.”

But investment bankers still like to go with the flow. Ravi Kapoor, managing director and head, equity capital markets at Citigroup, says that the revival in the primary market has begun pointing to the long list of companies in the pipeline. Unfazed by the poor show of new listings on the bourses, he says, “There is a lot of liquidity in the market, so good companies that are coming out with adequately sized issuances and have robust business models, a management with a good track record of execution, and reasonable valuation, will undoubtedly see good appetite.” The operative word here is liquidity. The abundance of liquidity and desperation among institutional investors to make a quick buck because of a feeling of having missed out the surprise rally since March has resulted in active participation in new issues. The QIB portions have been substantially subscribed several time over in prominent issues like Adani Power (39 times), NHPC (29), Oil India (54), Pipavav Shipyard (11). But the retail portion in none of these issues was subscribed more than three times. Clearly, the weak retail sentiment and mispricing has resulted in poor listing.

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Listing gains

The hit rate for listing gains was the best in the initial years of the bull rally when issues were better priced

IPO launch year	CY2000	2001	2002	2003	2004	2005	2006	2007	2008	2009
Average return	-0.2	19.7	-3.8	17.8	3.6	30.4	33.5	28.4	14.9	12.6
Total count of IPOs launched	8	3	2	3	14	30	60	87	37	12
Positive count	3	1	-	3	6	24	47	56	21	7
Negative count	5	2	2	-	8	6	13	31	16	5
Proportion of companies that gave listing gains	37.5	33.3		100	42.8	80	78.3	64.4	56.7	58.3

Source: SMC Capitals

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That is probably one reason Nilesh Shah, chief operating officer of Prudential ICICI AMC, too believes it is early days to conclude that there is a revival in the primary market. “It is just another means by which a promoter raises funds.” Till there is money available, issues will hit the market, but poor listing will ultimately result in tepid response from institutions too. Shah says the only way investors can guard their interest is by looking at company fundamentals carefully before deciding whether it is a go or no-go. Shah’s views are further corroborated if one were to take a look at the IPO pipeline.

Post-approval, the market condition will determine the timing of the issue. Thus, how many of these companies actually list is yet to be seenPrithvi Haldea, Chairman and MD, Prime Database

How they stack up

The IPO pipeline is far from exciting. Jagganadham Thunuguntla, head of equity at SMC Capital, expresses his disappointment when he says, “Though there are good issuances that are expected from the likes of MCX, the country’s largest commodity exchange, SKS Microfinance, the country’s largest microfinance institution, these companies have to file their DRHPs yet.” There are a handful of companies with great fundamentals that have re-filed their DRHPs such as Cox and Kings, but here indications are that valuations are going to be stretched, adds Thunuguntla.

Topping the list of companies waiting to hit the Street is real estate. If the QIP rush helped to resurrect the fortunes of the beleaguered listed real estate players, it has given unlisted developers enough confidence to fancy their chances in the primary market. Of Rs 31,112 crore worth of IPOs in the pipeline, nearly 50 per cent is being accounted for by nine realty companies. At least five major real estate companies – Emaar MGF Land, Lodha Developers, Sahara Prime City, Godrej Properties and DB Realty – are looking to raise over Rs 12,500 crore either to complete ongoing projects or to reduce debt. Emaar MGF, which is planning to raise around Rs 3,850 crore, had scrapped its IPO last year. Experts say these companies are waiting for the “right time” to launch their IPOs in anticipation of higher valuations.

A handful of companies with great fundamentals have re-filed their DRHPs, but indications are that valuations are going to be stretchedJagganadham Thunuguntla, Head of equity at SMC Capital

Haldea, however, believes that companies should price issues at a substantial discount to their peer group to make them a success. “If the pricing is not good, investors will not touch the issues,” he says. “Real estate companies saw a dream run in 2006, where all and sundry listed, without investors looking for real credentials. This time round, investors will look at the track record of the company, before deciding to invest in it.”

In fact, Deepak Parekh, chairman of HDFC, the country’s biggest home loan player, has already raised the red flag. “If a large real estate IPO fails, it could have a serious repercussion on the secondary market,” Parekh said in a PE meet recently. For a sector that is inching its way to recovery, valuations have already reached obscene levels of 28.63 one-year forward earnings.

If realty firms were the initial gainers in the rally, subsequent inflows made their way into infrastructure and construction stocks. As a result, 75 per cent of the infrastructure stocks are trading close to their 52-week highs. The BSE Capital Goods index is trading at 35.15 times compared with 21.27 times for the benchmark Sensex.

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The same old story

The current IPO pipeline is dominated by companies from the real estate and infrastructure space

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No wonder then that companies from these two sectors have been quick to file their DRHPs with the regulator. Hogging the space along with JSW Energy (Rs 3,000 core) and Reliance Infratel (Rs 5,000 crore) are smaller companies such as MBL Infrastructures, AMR constructions and ARSS Infrastructure Projects that have lined up issuances in the Rs 50-100 crore range.

Avadhoot Deshpande, who is working on a few infrastructure issuances among others, insists that investors will not be disappointed if they don’t look at primary market issuances in terms of making a quick buck on listing, and focus instead on the company fundamentals and execution capabilities. “Primary market issuances are a reflection of the state of the economy, thus infrastructure being the need of the hour, it is not surprising that companies in power, road construction and telecom tower providers are in the capital raising mode,” he says. Deshpande feels that these companies will give good returns to investors despite the long gestation period of their projects, but investor expectations should also be realistic. “One must understand, that gone are the days when a company’s stock price doubled or tripled within six months of listing,” he says. “Companies that will list hereon may not give such high returns, but still have the potential of giving an average of 20-25 per cent annualised returns.”

The fact of the matter is that the IPO pipeline does not boast of any companies that have unparalleled credentials or any unique proposition that the secondary market does not offer currently. Considering the risks associated with companies that do not have a listing track record, the issues will make sense for buyers only if the price is really attractive.
Something Kapoor agrees with. “Infrastructure and real estate issuances will have to be at a discount to the listed peers to attract investors in the first place, but then again their growth profile and scalability also needs to be built in the valuation,” he adds.

Analysts on the buy side (whose job is not to sell stock ideas but to help fund managers take decisions on stocks) are skeptical about the quality of issues and the timing. They feel that the companies that are knocking at the door now are a bit late to the party, and that the cash flows of many of these companies are suspect.

In fact, rating agency Crisil has assigned a grade of one on five to the issuance of MBL Infrastructure owing to the weak competitive position of the company in the road construction industry. “The company’s management has been a late mover in capturing business opportunities in its area of operation. Also, returns from the BOT segment will be subject to a lead time of 4-5 years,” the agency said.

Concurs Harish HV, partner at Grant Thronton, a consultancy firm, who feels the problem in the infrastructure space is the increasing gestation period of around 10-15 years. Given that infrastructure spending is yet to gather steam, the opportunities will be far and few in between.

Media and entertainment is another sector that is looking to grab investors’ eye balls. Harish, however, feels a lack of transparency, undercutting and poor governance have been plaguing the sector for long. “It is still a nascent industry in India that has to come of age, to give investors sustainable benefits over the long term” he says.