The events leading up to the SBI Cards and Payments offer show the hair-raising time that retail investors have when they decide to apply to IPOs (initial public offers).

Just weeks before the offer, SBI Cards was the toast of brokerages and online stock market forums, with analysts convinced that it was a not-to-be-missed ‘India consumption play’ that would have institutions queuing up to own it.

But once the IPO opened, the coronavirus scare took the wind out of the sails of the market and the mood swiftly changed. Wasn’t the credit card business, ahem, a little risky? Had SBI Cards perhaps priced its shares a little steeply at 45 times? Grey market premiums bandied about for listing shrank from 35-40 per cent to 25 per cent. Live subscription updates from the exchanges added to the confusion. Qualified institutional buyers (QIBs) and non-institutional investors (NIIs, or high net-worth investors) stayed on the sidelines for the first two days and rushed in at the nth hour.

The offer has finally closed with a bang, with the QIB, NII and shareholder portions over-subscribed 57, 45 and 25 times respectively; but, the retail portion was subscribed a muted 2.5 times.

The episode shows that, despite concerted efforts by SEBI to get retail investors to take informed decisions on IPOs based on their own due diligence, they often end up relying on unreliable indicators that lead them down the garden path. But investors cannot be entirely blamed for this.

Smart money?

In the developed markets, regulators ensure that issuers and investors in IPOs have a safety net by insisting on firm under-writing commitments from merchant bankers.

In India, however, the regulator takes a very different view and relies on institutional investors to quality-check IPOs on behalf of retail investors. It doesn’t mind offers failing if they don’t make the QIB cut.

SEBI’s ICDR (Issue of Capital and Disclosure Requirement) Regulations set strict financial eligibility criteria for companies tapping public markets — tangible assets of ₹3 crore, operating profits of ₹15 crore and net worth of ₹1 crore in three previous years.

Issuers who don’t meet these criteria are required to make their offers only through a book-building process, wherein 75 per cent of the shares are reserved for QIBs and 15 per cent for NIIs, with just 10 per cent allotted to retail investors. If the QIB quota isn’t filled, the offer must be withdrawn. Even issuers who do meet the profitability criteria and take the book-building route must make reservations of 50 per cent for QIBs, 15 per cent for NIIs and 35 per cent for retail investors.

SEBI’s complex quota system is intended to ensure that retail investors participating in IPOs get assured allotments while they take help from institutions in sifting quality offers from the lemons. In practise though, QIBs and NIIs have proved to be rather misleading guides of IPO quality, and don’t really help retail investors stay off risky bets.

Nearly 55 per cent of the IPOs made in India over the last 20 years trade below their offer price today, and this includes many with double-digit QIB subscriptions. Reliance Power, ARSS Infra, United Bank and Talwalkar’s Better Value are some of the 10-year-old IPOs that languish 90 per cent below their offer price. PNB Housing, Hudco, Inox Wind, S Chand are recent institution-fancied IPOs that trade at 50 per cent or less of their offer price. In PSU disinvestments, high QIB subscriptions are often indicators of friendly domestic institutions lending a helping hand. NII over-subscription numbers are even more unreliable, inflated as they are by bidders availing of short-term loans to multiply their applications and take a quick punt on listing gains.

Given this record, there’s a good case for SEBI to review its quota system in IPOs. It must also run an awareness campaign informing investors that over-subscription numbers and grey market premiums are very unreliable indicators of IPO quality.

Ineffective price bands

To ensure that issuers in cahoots with merchant bankers do not fix unrealistic asking prices, SEBI has made it mandatory for book-built offers to specify a price band for the shares, so that investors discover the offer price through competitive bidding. Institutions are required to bid first and retail investors can go with the cut-off price decided by their bids.

While this should ideally have led to the market discovering offer prices for IPOs that were close to fair value, it has not worked that way in practise. One in five IPOs in India in the last 20 years listed at a significant discount to the offer price, while one in eight delivered 50 per cent-plus listing gains.

One reason for these extreme outcomes is that, over the years, IPO price bands have narrowed to such an extent that there’s little actual room for competitive bidding. While SEBI rules allow a 20 per cent gap between the floor and ceiling price for book-built offers, most IPOs are now offered at wafer-thin price bands. The SBI Cards IPO wanted investors to bid within a price band of ₹750-755, Prince Pipes and Fittings at ₹177-178, Ujjivan Small Finance Bank at ₹36-37 and CSB Bank at ₹193-195.

For IPOs to offer scope for price discovery through auctions, SEBI must insist on a minimum spread of say 10 per cent, between the floor and ceiling price.

Information overload

To ensure that issuers make full disclosures to prospective investors, SEBI has steadily raised both the quality and volume of data that issuers must pack into their offer documents. IPO prospectuses now run into several hundred pages.

But whether retail investors are gaining from this is a moot point, because the very size of offer documents seems to make them loath to read them. Most individual investors end up applying to IPOs based on research notes or sound-bytes from market intermediaries. These are fraught with conflicts of interest, as intermediaries giving out these opinions may be related to the lead managers, funding the offer through their NBFC arms or earning commissions from the sale.

The abridged prospectus, a five-pager mandated by SEBI, is a good idea to ensure that retail investors have access to key information without having to wade through the entire prospectus. But the abridged prospectus is required to be provided only with IPO application forms, which most retail investors skip while placing online IPO bids. SEBI must insist on it being widely available on issuers’ and lead managers’ websites apart from online platforms, well ahead of the IPO.

Late price-setting

SEBI’s financial filters and disclosure norms have made sure that the quality of businesses tapping the Indian market has improved by leaps and bounds. But with IPOs still bunched up in bull markets, ambitious pricing trips up investors.

The pricing of an offer is a make-or-break input into the subscription decision. Yet, investors have a very limited window of time to assess valuations for IPOs, because SEBI rules allow price bands to be announced just two working days before the issue. Investors may be able to make better-informed decisions on IPOs, if they are given access to the price band a week ahead of the offer. Surely IPO pricing must not be so fickle as to be affected by weekly market swings.

But what if SEBI makes the above tweaks to the IPO process and still finds retail investors making IPO decisions based on informal sources? Well, it must then leave it to caveat emptor .

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