The lure of public offers is hard to fight. It’s even harder, in most cases, to find a rational reason to subscribe.

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A gush of liquidity in fiscal 2020-21 helped Indian corporates raise Rs 188,900 crore via equity issuances, the most in any fiscal. Of this, over Rs 74,000 crore was via public offers (IPOs, FPOs and OFSs), according to Prime Database. That’s good news for the fundraising corporates, and those already invested in them. Not so much for issue subscribers. Why so?

Well, this stems from the primary objective behind a company issuing equity: raise long-term capital at the lowest possible cost. And cost for the company reduces if the premium on its shares goes up.

Looking at it another way, the primary task of any investment manager is to help the issuing company ensure full subscription of its offer at the highest valuation prudent. While the approach to valuing equity varies across company managements, for most it is about getting maximum value. A few managements might leave something on the table for subscribers, but consider yourself lucky if you get new equity cheap.

As legendary Warren Buffet has articulated it so well: “An IPO situation more closely approximates a negotiated deal. I mean, the seller decides when to come to market in most cases, and they don't pick a time necessarily that's good for you.”

Bull runs and IPO booms

It is difficult to think of a boom in the primary market for equity without the backdrop of a bull run. Most years of large equity fundraising have coincided with elevated index levels and high price to earnings (PE) multiples—the fund-raise to Sensex correlation is a high 0.76 for the FY1999 to FY2021 period, while it is 0.67 for fund-raise to Sensex PE.

Interestingly, though, the number of offers hitting the market has a very low correlation with Sensex levels, though the fundraising is lower.

Source: Prime Database, BSE

What this implies is, that share offerings flood the market when the sentiment is positive and potential investors are willing to pay top dollar. Also, in a bull market where investors are hunting for new ideas, public offers (especially IPOs) present an opportunity to participate in a positive or new business story.

Here it is important to note that few managements would go to market saying the future is bleak, and so the commentary will always be positive and numbers will be presented to support this case. That, of course, doesn’t mean everything will pan out as planned.

To sum up, given the backdrop of high valuations, new equity, mostly, doesn’t come cheap.

New doesn’t mean good

Just because a company is coming to the market for the first time, via an IPO, doesn’t mean it will do better than its listed peers. Smart investment bankers know how to pitch an offer. They can pick out a number or set of metrics to justify at par or even premium valuations to listed peers. Often enough, it isn’t very difficult to see through this ploy.

When investing in equity, what you need to be clear about is the business you are investing in—listed for ages, getting listed or unlisted doesn’t matter. Does the business have a competitive advantage? Does it have a leadership position, or can it get there? Does it manage its capital efficiently and deliver a healthy return on the capital invested? These are the key questions you should concern yourself with.

Let’s take the case of Indigo Paints that listed recently. The company commands a 2 percent share of the paints market, well behind listed peers like Asian Paints at over 40 percent and others like Berger Paints (12 percent), Kansai Nerolac (7 percent) and Akzo Nobel (5 percent). Now, while an increase to even 3 percent from 2 percent would spell a hefty 50 percent topline growth, as a long-term investor, what you should be asking yourself is: can Indigo Paints get to 7-12 percent in 10 years? The answer to that question should guide your investment decision.

For now, the Indigo Paints stock has delivered excellent returns if you bought it at the offer price. But if you chased it on listing day, you would have burnt a hole in your pocket. Important to note here is that some new offers may deliver a listing day surprise gain, but that’s the wrong reason for an investor to play for. If you are a gambler, playing the odds, that’s another thing altogether.

IPO does not spell gains

There is nothing in the rule book that says a new offer has to list at a premium, or that it will continue to trade above the offer price. Check out the offer prices and listed prices of IPO issuances over time; the results will be far from inspiring. Below is the list of recent issuances in 2021, and even in those—though not far from the listing date—the results are less than flattering.

Of the 16 IPOs that came to market in 2021, so far, 7 are today quoting below their offer prices and 10 are below their listing day close prices. Truth be told, I’m not surprised to see some like Anthony Waste Handling perform the way they have. It was tough to see an investment case.

Not rushing into subscribe to IPOs is prudent unless you are confident about the business and comfortable with the valuations. If you are not (on valuations), be patient, often life offers the patient an opportunity to buy in cheaper.

I have my eye on a few businesses too, but not at these valuations. I’ll wait.

Also Read: IPOs in April: Lodha Developers, Sona Comstar, Seven Islands Shipping to hit D-Street

First Published:Apr 3, 2021 1:52 PM IST