Free the prices

The massive response to book-built issues should trigger a review of the way IPOs are sold

The debut of Avenue Supermarts should remain a milestone for the primary market. Not just because it received 100 times applications or opened 100% over the offer price. Like global financial markets are viewed from the pre and post-September 2008 perspective, issuers and investors should be able to look back and reminisce those heady days, not the least for the three-digit valuations of a grocer with limited presence in the western parts of India compared with the discounting of FMCG giants such as ITC, HUL and GCPL, whose products are neatly stacked in racks lining narrow aisles. There is a new-found respect for the local kirana store that began as a hole in the wall but has enlarged by leasing or buying the neighboring storefront and expanding the basket of goods on the shelves with own money. The bottom line is the entry barriers for the business are low. The model can be replicated, venture capitalist or private equity willing. The event should be seen as a trigger for the beginning of the end of the era of multiple times subscription and listing premium. The usual practice is for intermediaries to bombard the market regulator with pleas and recommendations to revive the new issue market during a dull period. There is absence of any calls for introspection even when mediocre paper is lapped at valuations near about or higher than larger peers. The huge demand is attributed to paucity of offerings. A languishing industry is rerated if an entrant’s track record shakes off long-held views on the sector. In the noise, the basic objective to open the company for scrutiny in lieu of public support is getting lost.

Promoters come to the market to collect funds for expansion and routine operations or to retire debt. The second purpose might be to provide exit route to the initial investors who have backed the idea. The conservative issuer divests a small part of his holding, while the ambitious expands the capital by adding new shares. Some opt for a combination of two, displaying prudence mixed with confidence. To encourage diversity in choice, the capital market watchdog permits as low as 10% outstanding capital. The decision was taken when the market was in a slump at the turn of the century due to the Asian Tigers’ currency woes. One of the few industries doing well was tech, riding on the Y2K scare. These players’ requirement of funds was tiny compared with those in the manufacturing sector. Besides, overseas customers were believed to be more comfortable with services providers having presence on stock exchanges and the attendant disclosures. The low float, however, makes a mockery of price discovery. What should be done? A book-built issue should ideally be subscribed not more than 2-3 times, signaling a fair valuation, and a modest 15-20% premium, indicating guarded optimism. A 5% discount is offered to retail investors in the belief they do not have the capacity to absorb shares at the consensus price. The price band’s cap is supposed to be the pain threshold to attract risk takers. In essence, the upper range is increasingly becoming the default offer price, particularly during a bull run.

Even giving the benefit of doubt to the book runners of the grocery retailer for misjudging the response, it is now clear that the method has outlived the purpose. Small- and mid-sized entrepreneurs, the driving force of the IPO market, are reluctant to dilute 25% of the equity, the minimum required to remain on the stock exchanges, in one go. Their worry centres on the capability to match expectation and loss of control. It is also likely that they might want to come out with an FPO at improved discounting after working up a solid track record. The problem is benchmarks are not available or peer presence is sparse in emerging sectors. The outlook can either be bubbly or lukewarm. The offer for sale mode should be made mandatory for up to 10% offloading by mid and small caps. Shares are offered at a price with the maximum bids, but those quoting higher prices get preference in allotment. Speculators seeking listing gains and multiple applications will eventually fade. Cash left after expenditure deployment can be used for buyback to support prices at a future date. The Avenue Supermarts issue should be a wake-up call to Sebi to draw up fresh regulations. There is a flip side to the entire episode. Investors’ solid backing to D-Mart spells optimism about Indians’ purchasing power. Thus, the retail story is a play on India’s domestic economy just as IT was a play on India’s services exports. Also, rich valuations seem to have become the new normal. Blame it on inflation that translates into higher revenues for the same volumes or the under-penetrated market that implies high growth rates. Rarely is an IPO that is priced less than peers or 30 times trailing earnings.

Mohan Sule