The Hindu Business Line : Take a cue from the big guys

There are a slew of IPOs vying for your attention, many of them from "sunrise" sectors such as real-estate, financial services and media. Spoilt with choice, you are unsure which ones should lay claim to the funds in your bank account. Can you pick up cues about the attractive IPOs from the big guys who invest in these offers? We are referring, not to the bids put in by institutional investors during the offer, but to the equity stakes taken by institutions in companies by way of pre-IPO placements.

Consider this. When Advanta India, with a global presence in hybrid seeds, floated an IPO earlier this year, it did not attract much retail investor interest, possibly because of the difficulty of analysing the prospects of a company with few peers in the Indian market. The retail portion of the IPO was subscribed only 0.17 times. On the other hand, the QIB (Qualified Institutional Buyers) portion was subscribed over five times. The offer listed at a premium of more than 30 per cent in a difficult market and has gained another 16 per cent since.

However, the quality of pre-IPO placements the company made could well have offered a clue to investors that they need to consider the offer more seriously. Big names such as Morgan Stanley Investments, Citigroup Global Markets and Deutsche Securities had backed the offer at a pre-offer price of Rs 625, which was within the issue's price band.

How far should investors rely on pre-IPO placements? Apart from looking at whether a company has attracted pre-IPO investors, they should also look at the pricing of such placements, the stakes acquired and the pedigree of the investors.

Business Line reviewed some of the prominent offers with pre-IPO placements that hit the market since 2005. The findings reveal that such placements can provide pointers to the merits of an offer. Pre-IPO placements are not, however, a guarantee of listing gains.

Why pre-IPO placements

Pre-IPO placements generally refer to allotment of equity stakes in the months before the public offer to institutional investors at a pre-determined price. Companies going public bring in blue-chip institutional investors right at the pre-IPO stage as a means of inspiring investor confidence about the company's credentials and, to a certain extent, of the pricing of its offer.

Markets tend to view investments by institutional investors with a reputable track record positively; such investors are generally seen as capable of making a more judicious assessment of a company's prospects and the valuation it can command. Promoters are, therefore, willing to dilute some of their stake ahead of an issue, as making a pre-IPO placement often ensures greater success for the public offer.

For serious institutional investors convinced of a company's long-term growth prospects, participating in a pre-IPO placement offers them a chance to secure a significant stake in a company than what they would typically get through the book-building route.

With the QIB portion of the issue often heavily oversubscribed during the book-building process, such investors are not always guaranteed allotment of a sizeable chunk of shares.

In the offers of Action Construction Equipment, Reliance Petroleum and Fortis Healthcare, for instance, the QIB portion was oversubscribed more than 60 times. But pre-IPO investors got, on an average, 4-5 per cent stake of the post-offer equity base.

However, as a trade-off, these investors would have had to lock in their investments for a year.

Some of the recent big pre-IPO placements include those by Reliance Petroleum and Cairn Energy. The latter raised about $800 million through the pre-IPO route. The placements also helped reduce the size of the offer ultimately made to the public.

Pedigree of players

Placements are made to a range of investors, from FIIs to private equity investors to high net-worth individuals. In some of the recent offers, such as by ICRA and Idea Cellular, allotments were made to promoters, directors and high net-worth individuals at the issue price.

Promoters choose to subscribe to shares at the offer price to retain their stake in the company. The practice also usually sends a positive signal to the market as it conveys the promoter's conviction of the company's prospects.

In recent offers, FIIs and established private equity players, such as Morgan Stanley, Merrill Lynch, Citicorp and Chrys Capital, participated in pre-IPO placements. When a blue-chip institutional investor backs an offer, it typically lends credibility to the management that is taking the company public.

Pre-offer vs issue price

However, of key interest to those evaluating an IPO is the price at which the pre-IPO placements are made. Most placements in recent times have been made at a price within the price-band determined for the issue. From the company or merchant banker's perspective, pre-IPO subscription to shares at a similar price range serves to reinforce valuations. This might explain the success of some expensively priced offers.

Institutional investors tend to seek some kind of a discount to the final issue price as a way of compensating them for the one-year lock-in period. The discount in most recent offers has, however, rarely been more than 15 per cent, although in Celebrity Fashions and ABG Shipyard, the pre-offer price was about 40 per cent lower than the final issue price.

In rare cases, such as GMR Infrastructure and Fortis Healthcare, the pre-offer price has been at a premium to the final issue price. Vasco Inc, an investment arm of leading consultant McKinsey, took a small stake in Fortis at Rs 159 per share, a huge premium to the final issue price of Rs 108. This premium may have indicated its positive view of the company's long-term prospects. However, retail investors who took the allotment price at face value may have been disappointed by its poor performance post listing.

Investors would also do well to read the fine-print. In some cases, shares are allotted to pre-IPO investors at a particular price, but the agreement may contain a clause whereby the difference between the pre-offer price and the issue price is refunded to pre-IPO investors.

For instance, while the pre-IPO placement of Cairn Energy was made at Rs 176.5, the final issue price was fixed at Rs 160. This entitled pre-IPO investors such as Merill Lynch to have shares allotted at Rs 160, instead of the pre-offer price.

More than the offer price, what investors could watch out for is the stake that the pre-IPO investor has on a post-offer equity base. A willingness to take a sizeable stake, say, about five per cent, would suggest a stronger conviction in the idea over the long term.

Post-listing

Should you set great store by pre-IPO placements? Most offers that attracted pre-IPO investors have done well post-listing. This may not be saying much, considering it has largely been an excellent market for IPOs over the last two years. However, of the scores of offers that hit the market since 2005, only a tiny proportion attracted pre-IPO investors of the blue-chip kind. This suggests that those offers that make the cut deserve more consideration.

Second, while pre-IPO placements may not always justify the valuation of an offer, they are a good indicator of the likely institutional interest the stock will attract in the near- term.

Third, the backing from blue-chip investors does, in most cases, validate the long-term prospects of a business. In offers such as of Advanta India or Time Technoplast, which are relatively more difficult to assess, it might make sense to take stock of the quality of institutional investors backing the offer.

However, while most offers backed by pre-IPO placements have sustained strong gains since their listing, it is important to note that even institutional investors, flush with funds but with few investment opportunities, have not been right every time. Pre-IPO investors have lost out in the cases of Cairn Energy, Fortis Healthcare and Celebrity Fashions.

Pre-IPO placements, therefore, remain more of a strong comfort factor in the risky business of investing in IPOs.

More Stories on : IPOs | Insight | Private Placement

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Take a cue from the big guys