Heavy Premiums Despite Losses Could Disenchant Small Investors

Arthur Hailey, in his novel Wheels, makes the ultimate oxymoronic statement---ugly is beautiful---while driving home the point that when the accent is on functionality and utility of a car, beauty takes the backseat.

In the capital market too, this message finds resonance---you pile up losses and it will pass off as a harbinger of long-term profitability. Amazon, for example, piled up losses masochistically and commanded huge valuation in the capital market. Indeed the sublime, if eerie, and supremely incomprehensible message is that accumulated losses portend a lateral strength invisible in the immediate run. It is perhaps this wooly notion and self-fulfilling prophecy that drives the IPO market in India.

There was a time when even an extremely profitable company with impressive net worth and future earning potential would be before the Controller of Capital Issues (CCI), virtually on its limbs, pleading for premium on public issue. But the stentorian and conservative CCI would condescend to grudgingly grant a small premium with reference to the face value of a share. But with the abolition of CCI on the advent of liberalisation in 1991, all such cautions have been thrown to the winds. The market regulator Sebi, to be sure, says that premiums will be granted only to companies with a track record of profitability but in the same breath, condescends to permit free pricing mechanism if the IPO is via the 100 per cent book building route.

The book building route is of, by, and for the Qualified Institutional Investors who bid aggressively, leaving the retail investors with no choice but to fall in line like the masses following the pied piper. In the book building model followed by the Sebi, with Dutch auction as its subset and cornerstone, the price discovered is the lowest of the bid price at which the public issue gets subscribed. This price is applicable to all the participants in book building as well as to the retail applicants.

Incidentally, the French auction model discourages aggressive bidding by making the bidders pay up what they have quoted, resulting in multiple issue prices insofar as participants in book building are concerned. But be that as it may.

In 2018, Sebi abolished two pro retail investor measures:

--One was, the mandatory rating of public issues under the dawning realisation that rating sans rating of issue price was meaningless; and

--The limited voluntary safety net mechanism under which the promoters were enjoined to buy the shares, upto a maximum of 1,000 shares per retail investor, at the issue price, should the market price fall below the issue price during the period of twelve months following listing.

These two avowedly pro-retail investor measures were thrown out like baby with the bathwater. There was no reason why they couldn’t be made meaningful and deterrent. Rating of issue price should have been mandated just as the voluntary nature of the safety net should have been converted into mandatory roping in of the merchant bankers as well, lest they play ball with the promoters in aggressive pricing. Market fundamentalists bristle at such suggestions, saying equity inherently is about risk-taking and those who have no stomach for risks better stay away.

The bottom line here is that primary market has now got a whole new meaning and implication. It was perceived to be the safest entry point into the equity cult with the potential of listing gains being the gravitas. With mind boggling IPO price, listing losses often stare in the faces of retail investors. Small wonder the bandwagon effect is pronounced in an IPO season---no one likes to pass up the opportunity to pile up capital bulk of it by way of premium, accumulated losses or not, so long as the merchant bankers can convince the participants in the book building exercise that the company has a bright future.

Unlike debts, equity is not required to be serviced compulsorily. A Rs 10 share issued at a premium of Rs 490 begets the issuing company Rs 500 and if it declares even a 100 per cent dividend, the ROI is just 2 per cent, less than savings bank interest! Market fundamentalists once again have a ready answer---don’t seek your rewards from companies but from the market by booking capital gains.

Finance gurus have always recommended the mutual fund route for secondary market investments by small investors. They can very well recommend the same course for primary market investments as well. That would of course be a sad denouement---complete hijack of the capital market by institutional investors.