DECELERATING THE SPEEDING “IPO GRAVY TRAIN” IN ITS TRACKS

In the last 18 months, an IPO fever has been raging fast and furious in the GCC; especially in Saudi Arabia, Kuwait and the UAE – the three most affluent Arab stock markets in terms of capitalization.  Of course, this flu / fever is not unique to this region and does happen from time to time in all emerging and developed markets.  The differences in the Western world are perhaps a little more subtle and seemingly professional. We saw it in full flow when the Google IPO unfolded in the U.S. In the  case of the GCC IPOs. These influenza strains are no different from the global syndrome that one witnesses in all bull(ish) markets. But in their manifestations, there are certain unique regional characteristics,  that would make for an interesting Harvard case study or PhD thesis - in particular the comparisons and contrasts thereof. The GCC IPO rage has become much more endemic and larger than life because of poor transparency, relatively low trading volumes in the stock markets and, as a result, accentuated price movements. The activities of a few street-smart / clever operators get visited upon the price paid by a silent majority.

In a similar vein, compliance with best practices in IPO management by some have been plagued by certain sharp market practices in the pre and post-IPO phases; involving inadequate levels of disclosure, front-running and vitiated allotment norms.  Conflicts of interest are galore and the surveillance of the IPO processes by the powers that be, have been tardy, if not non-existent. Of course, such scrutiny and oversight are easier said than done. While these regulations are almost holy grail or a fetish in the developed markets, the IPO road map  and acts of commission and omission are somewhat relaxed here; accompanied by an almost benign and condoning approach -  as starkly different as chalk and cheese.

Typically, in most IPOs, the retail investors expect the offering to be priced as to leave a little bit on the table i.e. profit margin or valuation differentials to be exploited  by them; as soon as the stocks are listed. This slack is therefore picked up profitably in the immediate  secondary market trading and in the aftermath of listing. Even prior to that, the shares / allotment letters tend to trade a bit in the grey market.  The investor thus has a reasonable opportunity to encash his gains quickly and feels good when the stock moves up nicely.  Such “valuation free-bees” or rebates are inherently built-in to the price, by the advisors and the IPO managers; in many cases. The company issuing the shares is also comforted that this real or perceived discount may help drive the sentiment higher and lead to oversubscriptions. On the other hand, speculators and investors recognize the potential and ‘lead the charge and join the gold rush’, with a clear game plan for the movement the stock is listed. They can then make a killing and the IPOs prove to be low-hanging fruits.

Furthermore, in the GCC, the ingrained experience is that all applicants in an IPO may only get a meagre allotment. IPOs are therefore deliberately oversubscribed many multiples over. The disappointed investors are thus spurred to go to the secondary market to buy the scrip.  Successful shareholders can then sell for the gains and realize their pound of flesh!  In reality, they are only part of the party. A number of traders / brokers in the market join the fray and tend to move the stock up and give it an adrenaline shot - day in and day out. If they become deeply committed participants, then the whole place is charged with a rare buzz and momentum. One can almost compare this to a Greek amphi-theatre or indeed the space-shuttle countdown at NASA, when the spaceship moves up in a vertical trajectory. All the heat and energy that goes into propelling it,  in an upwardly mobile thrust, can be found here. 

All these may sound highly enchanting, but heavens forbid, if one or two of these IPOs were to come a cropper. Then suddenly fear and paranoia take precedence over greed. The whole game plan and the financial models will be altered adversely. Then a lot of people will lick their wounds and sit uneasily over unrealised losses, with burnt fingers!  The charade degenerates into a mock-battlefield, where only the vanquished are littered all over the place and the victors are laughing all the way to the bank!

Hopefully, the foregoing does sound a little bit macabre, as it is intended to! Only those that have gone through bear markets and have been hit most unexpectedly, such as on Black Monday in NYSE (many years back) or the meltdown that followed each of the recessions in the last Century will understand the gravity in the situation. Indeed, if one were to go back to the grand / sad old days of the Great Depression of the 1920s, the lessons over the periods are loud and clear!

The other adrenaline shot now paced through the IPO processes is the phenomenon multiple leveraging. Many banks were almost touting this around in the street through their incentivized agents, and regarding leverage almost as a risk-free debt fiesta. By charging a front-end fee and earning a good spread (profit) over their cost of funds, some banks had a bonanza / bonfire over the IPOs.  If they were also the Receiving Bankers, then the money did not escape their system and became mere  book entries; without the funds leaving the bank. Perceptibly, the risks were all well and neatly contained. Even where they were not receiving bankers, the banks were prepared to venture out with gusto.   On every IPO, almost 80% of the monies stemmed from leverage. Even the balance 20% of the so-called real / investor monies were predicated on the supposedly proven theory of low allotment. Thus leverage became a deliberate doubling, trebling, quadrupling and multiplication of the bets. If the investor perceived for a moment, that he was only going to get a miniscule allotment, then he convinced himself that he has precious little to lose in such bets; except for locking up his cash, pending allotment. Similar to  FX, interest rate  and other derivatives, this lending binge may well qualify as a good parallel piece of hybrid financial engineering. 

It is interesting that some banks often used to lend upto nine times for IPOs / in the primary market; by misinterpreting (conveniently?) the rule by the UAE Central Bank (UAECB) that allows for no more than 10% to 50% bank lending against stocks or equities.  It is prudent and proactive on the part of the UAECB to reiterate, recently, the contents of the rule book. This is a good and salutary move that will help puncture any bubbles that may develop in the financial system.  Creative interpretations are not warranted in such sensitive matters that have profound and widespread impact on orderly development of capital markets.

Marxist / Leftists in yesteryears, used to call stock markets as nothing more than gambling dens or casinos. They were, in fact, referring to the Western stock exchanges /  secondary markets. The IPOs and the primary markets for equities in recent times, are now giving a run for the money and comes closest to representing the same emotive and highly charged atmosphere. People scramble, pull out all stops and may even become a little violent (as was witnessed in Saudi Arabia during the Ettihad Etisalat IPO) and one can well question whether all these are akin to the last gasps, before the gravy trains come to a screeching halt.  Of course, some may call them ‘free lunches’ or myths that disprove the truism -  i.e. that there is no such thing as a ‘free lunch’.

Understandably, the avenues for commercial banks to make high profit margins in their various businesses are becoming fewer and fewer.  Unfortunately, for them, all promising gravy trains often reach dead ends or proceed erratically in multi-directions with great speed and without let or hindrance; especially if there are no speed-breakers / bumps, along the way.

Ultimately, it is for the regulators and policy planners in the various countries to take a wise and prudent view and frame macro-economic policies and regulations. The financial institutions themselves and their Chief Risk Officers (CROs) ought to revisit these issues. It is interesting how, when some doors are shut, others open.  Opportunities for financial institutions will always be there but they need not clutch at every and any last straw as it / they present themselves.

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