IPOs: Have a 'stag' strategy

Higher secondary market prices often translate into primary market buoyancy as well. This has been one of the best calendar years ever for initial public offerings (IPOs). By mid-October, IPOs had raised over Rs 41,000 crore and there are issues lined up for the next two months as well. According to Prime Database, this is the best year in the last decade — even better than the bumper 2007 (Rs 34,000 crore) and 2010 (Rs 37,500 crore).

The insurance sector has tapped the markets most effectively. ICICI Lombard, SBI Life and GIC-Re have already completed big issues and New India Assurance’s IPO is in progress at the time of writing. But, all sorts of businesses have raised funds, many at eye-watering valuations. Several high-value IPOs have gained on listing as well. 

SBI Life and ICICI Lombard are trading at price-to-earnings (PE) of 70x and 45x, respectively. If that’s high for insurance companies, what sort of discount would you award a fast-moving consumer goods company specialising in snacks? Prataap Snacks (Yellow Diamond) was subscribed 47 times. The issue price of Rs 938 was equivalent to PE 202x on 2016-17 earnings. It’s trading at over PE 250x now. 

GTPL Hathway, a cable distributor, is trading below its issue price of Rs 170. Investors subscribed to the issue at PE 88x and it’s now trading at Rs 140 — that’s PE of 72x. Avenue Supermart (D-Mart) was sold at PE of 36x at the issue price of Rs 299 and it listed at 100 per cent premium in March. It’s zoomed higher since, and is currently priced at Rs 1,151. It’s natural for promoters to seek to raise money during a bull-run. Investors are fired up due to gains in the secondary market and ample liquidity is available.  Given a market where major indices like the Nifty are trading at PE of 27x, it’s possible for issues to be priced very aggressively and find buyers. 

Equity is the cheapest form of financing. There are no hard and fast servicing obligations unlike with debt. If the company pays dividend fine, if it doesn’t, okay. Most investors are happy with the prospect of capital gains. Everyone hopes that issues will list at a premium and continue gaining. 

However, playing the IPO market is, in more senses than one, a lottery. Apart from the allotment ratio of course, there are never guarantees a stock will list at a premium. Even less is there a guarantee that it will then continue to register capital gains. Investors with long-term perspectives undertake serious risks if they buy into ‘hot’, highly-priced IPOs. 

Many ‘hot’ issues — Idea, RPower, DLF, IndiaBulls Power (later Rattanindia Power) experienced strong primary market responses, despite being priced at higher valuations. Each of these has proved to be a wealth destroyer in the long term for original allotment holders. Of course, other hot issues such as Maruti have done quite well for those who got allotment and stuck it out through thick and thin. 

Investors like punting on new things and markets are usually over-optimistic about new concept businesses. The classic example would be the internet. But, if a business has peers, buying it at high valuations compared to the peers is a dangerous game.  Even if primary and secondary prices are all inflated, a higher IPO valuation than that of listed peers needs to be justified by some competitive advantage that the business possesses. 

For example, FMCG blue-chips get discounts of PE 45-50x. A small player like Prataap Snacks might grow faster due to base effects but will it be able to sustain a PE at five times the industry’s average levels?  Why? 

D-Mart listed at a decent valuation compared to its peers. Most supermarket chains are high-valuation, low-profitability plays, and D-Mart has better financials than most of its peers.  But, is it worth the current PE of 135-plus? Global giants like Whole Foods and Kroger tend to trade at PEs of between 20x and 40x. 

There are several things a primary market investor can do in a big bull market. One strategy is to go ‘stag’. Be prepared to take profits and sell out quickly if the stock lists at a premium. Another strategy is to not buy overpriced issues at all. Wait for listing. Buy only if stock lists at a premium and the momentum seems strong. The one thing you probably should not do is buy an overvalued issue and hold it for the long term if the price starts falling after it lists.


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