06 Sep 09 The Great Indian IPO Bazaar

IPOs in India invariably tend to attract huge media hype and analyst comment. No doubt this is a result of the substantial marketing spends legally carved out of IPO proceeds. Merchant bankers, PR and advertising agencies, and numerous others are rewarded well to promote IPOs. Analysts and journalists jump on the bandwagon, and with positive recommendations outweighing the negative, it is no surprise that most equity issues are highly over-subscribed.

It is also no surprise that a majority of IPOs do badly!

But what else do you expect? After all, the sellers (company management and merchant bankers) have the advantage of superior (asymmetric) knowledge – about the company, its prospects, industry dynamics, competition and everything else that could determine its future performance. Obviously, they look for the best price at which to dilute! If (according to them) the market pricing is below the intrinsic value of the stock, they would not sell. In contrast, when pricing is much higher than what they think its worth, they will be eager to sell. You only have to compare the flow and ebb of IPO volumes with Sensex values to realise this. Why do you think IPOs dry up when markets are down?

What is surprising, however, is that gullible investors like us get fooled, time and again. There is now considerable statistical and anecdotal evidence to suggest that most IPOs under-perform the indices and broad markets. I don’t know why this illogical investor behaviour recurs, but much could be ascribed to the “greater fool” theory. The pre-IPO hype leads us to believe that a quick, profitable exit is highly likely, so who cares about intrinsic value! In other words, even if we are not convinced about valuations, we have faith that a “greater fool” will buy in at a higher price.

We might blame the promoter or merchant banker or SEBI or the government, but the truth is that we investors have only ourselves to blame. By making decisions on perceived popularity rather than on fundamentals, we allow greed to take precedence over logic. If you know that valuations are stretched, but still invest your hard-earned money, you cannot blame those whose job it is to sell the issue. And if your defence is innocence or ignorance, then maybe you should not be investing directly!

There’s much more that I want to say about the Indian IPO markets, but will leave that for future blogs. For now, suffice to say that IPOs in general will not make you as much money as the secondary markets – the dice are too heavily loaded against the investor!