Friday, 11 December 2009

Expensive IPOs failed due to overpricing

Expensive IPOs failed due to overpricing

3 Nov 2009, 1045 hrs IST, Supriya Verma Mishra, ET Bureau

Initial public offerings are back, so are investors who have not learnt their lessons. There is nothing more disturbing for an investor than missing More Pictures
out on potentially high returns IPO, which can be flipped in a few weeks. Some have made millions that way, but most seem to have lost money.

Most share sales since 2004 failed to deliver, thanks to robber barons and bankers who took every penny possible out of investors’ pockets, shows an ET Investor’s Guide analysis. Not that those investors were naive. It was greed, when they queued up to shell out hundreds of rupees for a share in companies with no revenues even!

The frenzy among retail investors is not back to where it was in January 2008, but is rearing its head. A risk-return analysis of past IPO’s suggested that investors need caution in a market, which is to see a flood of IPOs. About 20 companies are set to raise Rs 20,000 crores in the next 2-6 months (depending on SEBI clearance).

Legendary investor Warren Buffett is wary of IPOs. Shouldn’t retail investors walk his path? “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 to a less-knowledgeable buyer,” Buffett reportedly said on IPOs.

Check out the IPOs that failed to deliver


Out of the 277 odd companies that raised funds through an IPO since 2004, we short-listed those that raised more than Rs 100 crore. It led to choosing 114 companies. We then calculated the returns from these investments at IPO price and their current market price. We compared with the returns the Sensex provided from the date the stock listed till Friday. Having done this, we worked out the shortfall, or gains in the returns posted by stock vis-àvis the Sensex starting from the period the stock began trading.

Out of the 114 companies; a little over one-fourth (30) bettered the Sensex return during the period and another half a dozen were in line with the broader market. In a majority of the IPOs, however, investors lost their capital, leave alone getting returns. About two-thirds of all IPO companies (65) are trading below their offer price out of which nearly 60% of them are at half their initial sale price. Investors might have been better off with bank deposits.

The analysis

But why did majority of the IPOs fail to deliver? The usual answer from the companies and bankers will be “that’s the way market is”. Although there’s no single reason, a dominant one is the pricing as sellers try to get the maximum, which, at times may be even higher than their traded peers by sugar-coating prospects. Broadly speaking, the companies that debuted with high valuations compared to their listed peers failed miserably.

A company which has a nascent business and asking for a valuation 60-100 times its latest annual earnings is almost robbery, but have happened. In order to support such a pricing, it will have to more than double its earnings every year on consistent basis. This is well nigh impossible in best of circumstances, not surprisingly most of these high fliers fail to deliver.

Most of the IPOs in our sample however failed to deliver simply because they were priced too aggressively. This includes initial public offers of Suzlon Energy (priced 55 times its preceding year’s earnings), jewellery maker Gitanjali Gems (112x), and multiplex operator PVR (140x) among others. Besides the company specific reasons, the common factor among them was their high price to earnings (P/E) multiple that they were asking.

At a P/E of 140x, PVR would have to grow at least 70-80% to justify such rich valuations. However given the unreasonable valuations and too much expectation built into the price, these stocks were the first ones to be slaughtered at the hint of first trouble in the market.

Other cases of irrational exuberance include Reliance Power and Mundra Port. In Jan’ 08, Reliance Power raised Rs 11,700 crore from the market at More Pictures
five digit earnings multiple and no revenue from operations. It is yet to generate any revenues form electricity. For the year ended March’ 09 it had other income of Rs 360 crore.

The company’s gross block remains at a miniscule Rs 295 crore (on consolidated basis) and the market capitalisation it still has is Rs 38,000 crore, a far cry from the more than 84,000 crore at the IPO price. Similarly for Mundra Port, out of Rs 1,770 crore raised, close to half of the funds still remain unutilised after two years.

Financial services were the worst hit during the last year’s market meltdown. Future Capital listed in 2007 at a price to book value (P/BV) of 35. The company had priced the stock so aggressively that it is down 69%. Today it is trading at a P/BV of 2.5x. Being a new player, this is steep when compared to bigger players like Motilal Oswal (2.98x) and M&M Financial (1.72x). Precisely for this reason Future Capital’s daily compounded return is –33 % as compared to M&M’s 7%.

There are some who were battered by the economic circumstances. Like in case of Jet Airways, which was the only listed airliner. With Rs 400 crore profit in its first year of listing, the stock was reasonably priced at 26 times its trailing year earnings. But within two years of its IPO, its finances were shattered due to a price war and record high crude oil prices. It is struggling.

There were some IPOs where investors made money too, like the public sector companies, which usually don’t price aggressively. Public sector units such as Power Finance Corp (13.2x) and Rural Electrification (15x) were reasonably priced. Undergarments maker Page Industries (27x), and Tulip Telecom (13.9x) were attractively priced and have returned at least 38 %daily annualised returns. Besides pricing, their business model was very unique.

Like Page Industries is the sole manufacturer and marketer for the innerwear brand ‘Jockey’ for the last ten years. Thus it not only plays the role of a contract manufacturer but also actively creates brand awareness for the foreign brand. They raised funds for expanding their business and not setting up a business from scratch, so their gestation time to generate returns was very low.

While it is may not be appropriate to paint all the IPOs with the same brush, investors should be cautious that the majority are over-priced and may choose the ones that are priced at a discount to their listed peers, or wait for the market to arrive at a price, possibly lower than the IPO one.

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