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Aarati Krishnan

UNTIL recently, most Initial Public Offerings (IPOs) were good investments because they were an attractive entry point to a listed or yet-to-be-listed company's shares.

Companies that debuted on the bourses did not price their initial offers stiff. This left some money on the table for investors who entered the stock through the IPO route. Listed companies also offered new shares at a substantial discount to the prevailing market price. Investors were thus reasonably sure of a good after-market if they managed to secure allotment. This made the entire process of locking significant funds into new offers and even borrowing to fund these applications worthwhile. But it is time to rethink this strategy.

Ambitiously priced

To start with, the asking price for participating in IPOs is becoming stiffer. The majority of public offers made since the end of 2004 have done so at expensive valuation levels. Every public offer, starting from that of Deccan Chronicle Holdings in November 2004 to the recent 3I Infotech, has been priced at 15-20 times the company's latest earnings.

This is despite the fact that the offers spanned a wide range of sectors and industry segments, with varying growth prospects. A few, such as Bharati Shipyard and IVRCL, are in cyclical businesses, while others, such as Deccan Chronicle are in relatively mature ones.

What is more, the valuation for the offer is pegged to a fairly high earnings base, which may or may not be sustainable over different phases of the business cycle.

With the economy buoyant, several companies have reported a surge in their earnings for the financial year preceding the offer. Therefore, the price for the current crop of offers is pegged to a high absolute level of earnings.

Complex or new businesses

Retail investors may also find it quite difficult to form a reasonable assessment of the recent IPOs because of the lack of comparable benchmarks.

Several recent IPOs have featured companies that want to foray into relatively new or complex businesses about which investors may not have any concrete information.

Gateway Distriparks, which made its IPO in March, for instance, provides containerised cargo services to exporters and importers. UTV Software, an integrated entertainment company, is raising funds to ramp up its presence in the programming space.

Companies in established businesses are not too easy to evaluate, either. Though the airline business in India is decades old, Jet Airways was the first airline company with a sizeable scale of operations to make a debut on the Indian equity market.

Bharati Shipyard is the only listed company with a presence in the ship-building business.

Adlabs Films is the only listed stock that can be compared to Shringar Cinema, which is in the film distribution and exhibition business.

As there are no listed companies in the airline or ship-building businesses, information on the profit margins or likely financial contours of the companies in these areas is hard to come by. This can make it tricky for an investor to decide, for instance, whether he should pay, say, 20 times earnings for an airline stock, or 15 times for an integrated entertainment company.

In this respect, the book-building process, through which the majority of companies now raise funds, has also proved to be a less-than-perfect mechanism for deciding on the fair price a retail investor should pay for a company's shares.

With institutional investors and affluent individuals developing an insatiable appetite for Indian equities, every IPO in recent times has attracted subscription levels that are several times the offer size.

With aggressive bidding, the final price for the offer is invariably set at the higher end of the price band. All but two of the 17 public offers over the past year have set their final offer price at the upper end of the price band (exceptions were TCS and Deccan Chronicle Holdings).

Listing gains may not hold

These factors have contributed to patchy post-listing performance of a few of the recent IPOs. Stocks such as Deccan Chronicle Holdings, UTV Software and Emami are now hovering at levels barely above the final allotment price.

This suggests that retail investors should probably become much more selective in their approach to investing in IPOs. For a start, investors may need to seek out informed inputs and put in much more homework before they decide to invest in an IPO. Second, taking a more balanced view of all IPOs would help.

The decision to invest in one is no longer a no-brainer, as the prospect of a handsome return on listing is no longer a certainty.

If you are not sure that the pricing of the IPO offers a particularly attractive entry point to the stock, why not wait until it lists? Then, you may have greater flexibility when you take exposures and can also benefit from a more measured view on the prospects.

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