IPOs (Initial Public Offers) have provided the zany element to an otherwise boring stock market this year. For investors, IPOs fell into one of two categories – they soared and delivered wholly unexpected bounty or bombed in equally spectacularly. Averaging the returns of the 2011 IPOs will not yield any meaningful results because the range of returns was so wide. While the best-performing IPO stock, Fineotex Chemicals, is up 350 per cent from its issue price in just four months, the worst performer, Acropetal Technologies, is down 81 per cent in the same period. Nor is it easy to explain why the market took such a fancy to the tiny chemicals and adhesives maker, while it beat up the conventional mid-sized IT company.

What fundamentals?

One thing seems clear, fundamentals had little to do with it. Take Fineotex Chemicals. It reported a healthy growth of over 20 per cent in both sales and profits for FY11. But with its small size (Rs 4.3 crore profit on sales of Rs 28 crore), it certainly doesn't deserve its price-earnings ratio of 84. Pidilite Industries, about 80 times this size, receives a PE of 31. Another top gainer, Birla Pacific Medspa, had a top line of Rs 1.6 crore and losses at twice that sum for the first nine months of FY11.

Mind you, the stock price returns can change in a blink. The stock of Birla Medspa has swung between a low of Rs.10.1 (issue price Rs 10) and a high of Rs.30.7 in the three weeks since its debut, before settling at the current Rs 17.

Irrational price action

So, what's with all this irrational price action in IPO stocks? Running down the list of companies that hit the IPO market this year shows the majority of them are of uninspiring quality. Fourteen of the 24 IPOs till date have been graded either 1 or 2 by rating agencies, indicating poor or ‘below average' fundamentals. Ironically, the ones with acceptable fundamentals either didn't go through (Galaxy Surfactants, Crisil Grade 4) or fared badly after listing. The tenuous link between the underlying business and the price action in IPO stocks can be partly explained by the subscription profile of the recent offers. While most IPOs had their retail and non-institutional investor (NII) portion over-subscribed, they struggled to fill the quota for qualified institutional bidders (QIBs). With the big guys out of the picture, speculators have had a field day.

Vanishing subscriptions

SEBI's recent investigation of Vaswani Industries (April 2011 IPO) provides a glimpse of what's been happening behind-the-scenes in recent IPOs. Shortly after the closing of the offer, the regulator received complaints from investors that the initial subscription numbers for this IPO had been grossly inflated. On investigation, SEBI found the following:

When the issue closed, the non-institutional portion of the offer was subscribed 11.29 times, the retail portion 6.8 times and the QIB part 0.16 times.

After the offer closed and before allotment was finalised, a good number of the NII and retail investors withdrew their bids. After this exodus, the NII subscription fell to 0.8 times while the retail portion was subscribed only 1.3 times. Second thoughts at the last minute?

High-net-worth investors put in applications worth Rs 44.6 crore on Day One at the upper end of the price band; these were all subsequently withdrawn.

Pending a further investigation, SEBI had passed an order in May asking both the exchanges to withhold listing of the stock. In July, it directed Vaswani Industries to give a withdrawal option to investors in the NII and retail categories. With the company appealing against the order, the matter is now with the Securities Appellate Tribunal, which has stayed SEBI's order until the next hearing. When and how investors in Vaswani Industries will be able to get their monies back is still uncertain. But this surely provides a great case study for what is afoot in obscure IPOs.

The message for retail investors is crystal clear. Don't be taken in by the live ‘subscription' numbers during the offer. Don't rush into offers which QIBs shun. And don't be lured by the big short-term gains on some of the recent listings. They may only be paper profits.

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