India is one of the busiest markets in the world for IPOs. More companies have debuted in the past year than China and Japan combined. But if history is any guide, most of them will turn out to be duds in the long run.
Yet the attraction of the “pop” – big returns on trading days – is so great that this fever will not subside.
Something is seriously broken. YK2 Partners, a boutique firm that invests only in Indian public markets, has done the math on two decades of initial fundraising by the country’s companies. Analysts at Mumbai and London-based YK2 considered all of the more than 300 motherboard issues since January 2004 with a ten-year trading history. According to their calculations, the average IPO in this range has returned -3.5% per year, turning a 100 rupee ($1.2) investment into 70 rupees a decade later.
It doesn’t matter whether they were recorded in 2004 or 2013, or any year in between. Indian IPOs have failed miserably in generating excess returns for investors beyond what they would have earned passively by just owning a broad benchmark. Approximately 77% have underperformed the NSE500 Index over a ten-year period, with an average underperformance of more than 14% per year. In other words, the Rs 100 not invested in debutants could have turned into Rs 280 with very little effort.
“We cynically characterize the IPO process as a scheme orchestrated by management, private equity investors, anchor investors, investment bankers, media, etc.,” YK2 co-founders Arun Agarwal and Vinod Nair wrote in a note on their research. “It may make sense for investors looking for an IPO pop, but not for long-term investors like us.”
The regulator’s job is to ensure that companies with reasonably solid prospects come to the public markets and offer shares at a price that allows long-term wealth creation. That the local IPO market falls far short of this ideal is something the Securities and Exchange Board of India has known for a long time. Yet, some steps that SEBI attempted or considered proved too controversial.
One of these was the assessment of IPOs (similar to the credit assessment for bonds). The assessment became mandatory from 2007 and became optional in 2014 due to intensive lobbying. Another idea was to let private investors return their shares to controlling shareholders at the issue price, after three months of significant underperformance. This safety net was considered for years and then dropped.
Indian IPOs are overnight wonders | In the longer term, they perform worse than the benchmark
But it should still be possible to improve the quality of the primary capital market. Clearly, current disclosure-based pricing policies are not up to this challenge. Just a few months ago, Madhabi Puri Buch, the chairman of SEBI, said that the justification companies offered for high IPO valuations was often “nothing but a few meaningless English words.”
There may be a simple reason why the verbiage can so easily masquerade as value: the average IPO returns an average of 25% profit per trading day, and India’s wealthy have a savings surplus. Ben Bernanke, the former chairman of the Federal Reserve, has in the past blamed a “global savings glut” – a pool of capital flowing out of China and oil-producing countries – for low interest rates. In the case of India, it is capital controls that limit how much the affluent class can invest abroad. Any surplus of local savings goes into the hunt for domestic assets, from real estate to IPOs.
There is some inertia built into real estate transactions, but the points are turned around very quickly in IPOs. That explains the average oversubscription of 44 times in recent years. So how do you throw some sand in the wheel? The SEBI chief said on Friday that the regulator is investigating investment banks that artificially inflate share applications to create a false impression of demand.
Cleaning up the market is a good first step, but it won’t be enough. YK2’s Agarwal suggests that SEBI should consider a mandatory lock-in period of one year for all IPO investors so that subscription is driven by fundamentals and not by the lure of a pop. More revelations will be just more words. They cannot break this link between unusual demand and opportunistic supply. Only more skin in the game can do that.
Disclaimer: This is a Bloomberg opinion piece and these are the personal opinions of the writer. They do not reflect the views of www.business-standard.com or the Business Standard newspaper
First print: January 22, 2024 | 6:46 am IST