BETTING ON RED-HOT IPOs

The last few weeks have seen three outstandingly successful, albeit not entirely unqualified, Initial Public Offerings (IPOs); originating and taking place, as it were, in India, in the U.S. and last week, in the U.A.E. The Tata Consultancy Services (TCS), now the largest IT / software company in India, adopted the innovative book-building approach and was a well managed offering at that. In the case of Google, the promoters of the company chose to adopt an unusual Dutch-auction method to raise public subscriptions.  The Arabtec IPO was, out of necessity, a non-book building but traditional capital market transaction.

Shares in TCS jumped some 16% in its market debut / upon listing. The company had raised US$ 1.2 billion in one of India’s largest capital market transactions. TCS relies on the growth of outsourcing and software consuming successful Indian IT companies. Indeed, General Electric (GE) of the U.S. accounts for some one fifth of TCS’s annual turnover of US$ 1.3 billion and GE reportedly cashed its holdings in the company. Most analysts expect TCS to record a high earnings per share (EPS - always an important indicator of the performance of the company and reward potential for shareholders). At IRS 42/- EPS, TCS will record a 25% jump over previous years. Having started off as an advisor to TISCO (Tata Iron & Steel Company), TCS now has over 30,000 employees who have been given stock options.

The TCS IPO attracted applications from 1.25 million retail investors. The offer was for only 13.3% stake in the company and was oversubscribed some 7.7 times.  It was first listed on the Bombay Stock Exchange (BSE) and opened at IRS 1050/- against the original issue price of IRS 850/-; thus valuing the company at over US$ 12.5 billion.  

Google Inc. on the other hand, has been an Internet icon and the worldwide web’s now most popular search-engine. Google raised US$ 1.67 billion in its Dutch-auction, much higher than TCS was able to achieve in India through its book-building approach. Google’s entrepreneurs decided to bypass the normal IPO process and therefore a departure from Wall Street practices. The stock has now made it to the S&P 500 index.

But the Company did run into a quite a few issues with the Securities and Exchange Commission (SEC), who are believed to be investigating interviews given by the promoters (Mr. Larry Page and Mr. Mr. Sergey Brin)  to the Playboy magazine; as they  may well have violated the mandatory “quiet period” before any securities offering in the U.S.

As far as the Google’s IPO process is concerned, ‘the jury is still out as yet’. The Professor at the Wharton Management School (Mr. Raffi Amit) believes that the company managed to float an offering, when ten deals were cancelled in the week before that and despite it being a soft-tech market.  Others feel that Google overshot in its initial estimated price of US$ 135/- and was only able to achieve US$ 85/- i.e. a drop from US$ 3.6 billion to US$ 1.67 billion in subscriptions. This is because it may have thumbed its nose at the Wall Street’s merchant banking community. The Dutch-auction, effectively, enabled retail investors to bid and cut out the commissions paid to investment bankers.  Raffi Amit believes that the Dutch-auction helped establish a fair market price. 

What caught everybody’s eye was Google’s unusual Dutch-auction style. Bids had to be made directly to Google; bypassing the normal book-building or order approach. This meant that the Wall Street investment and brokerage firms were clearly annoyed. The stock was priced at US$ 85/- in the Dutch-auction, but started to trade at a premium upon listing. The stock closed last week at US$ 108.31, thus valuing the company at about US$ 30 billion! 

If one took TCS’s jump on the National Stock Exchange of almost 41% and Google’s 30% uptick, then this would illustrate the phenomenon that red-hot IPO fever is not unique to the UAE.  When Arabtec went to the market some two weeks back, several were wondering whether August is the best month to launch an IPO, what it being the peak holiday / summer month. In the event, the IPO was subscribed 65 times; disproving the quiet period myth.  

‘Leveraging’ done in the Arabtec IPO could be mind-boggling to the conservative dyed in the wool bankers.  Leveraged lubrication is akin to adrenaline / performance-boosting drugs.  In India, leveraging is limited to what the regulators allow as lending against equity. In the UAE and elsewhere, IPOs appear to be an exception to the 50% equity lending norms, as prescribed by the regulators. The factor that encourages leveraging is that there is an implicit lien and non-cash in-house movement i.e. that as receiving bankers, you hold the cash that does not go out of the system and is only a book entry.  

Ultimately, oversubscriptions are predicated on one simple premise; that upon listing, IPOs will double in appreciation and within a short period of time. Indeed, the cost of such leveraging, including the fees that banks charge, would push up the breakeven level to about 140% of the issue price. Investors’ bets will begin to make money only if the share starts to trade at a substantial premium immediately. The only problem will be that if there are more leveraged speculators than genuine investors in the market, then  all of them may rush to sell it quickly. If there are not many buyers in the secondary market to take up whatever is being sold, then the price will struggle. Clearly their sustenance of such bets will depend on who is there to support  such share prices from falling. Otherwise, the stock market could resemble a casino.  The TCS and Google IPOs did not have much leveraging support.  Having said that,  both the U.S. and the Indian stock markets have greater breadth and depth in terms of liquidity and “market-making”. Bulls in the stock market expect ‘rocket’ like (not Apollo 13) behaviour but bears hammer down scud and stock missiles and if misfired, can cause considerable collateral damage. If a red-hot IPO fails to perform as expected, it can set back market confidence for a few years. This is where the authorities need to reflect, review and carefully monitor the mechanisms to ensure that no unethical practices are followed. Nor should there be an attempt to distort the market or twist it in any one direction tendentiously. Of course, one could argue that if you take the risk, you reap the rewards or face retribution and suffer losses. We should not curtail choice but curb irrational exuberance in the market place, if it does not wash itself out. When retail investors’ interests are manipulated in any manner or best practices are not followed, the authorities do need to step in. Their surveillance of IPO excesses need to be rigorous.

Ultimately, market volatility and risk-taking are functions of sentiment and anticipation and that is what a secondary market is all about.  Of course many informed investors review the financial details and the Prospectus presented to them and proceed carefully. Even they get carried away by the runaway responses to IPOs and do not want to be the odd ones missing out the bonanza!  So, there is sometimes a “wilful suspension of disbelief”! Healthy scepticism, natural reticence and conservatism are thrown overboard in the gold rush! IPOs tend to mimic a Kenyan safari, where herds of sheep, elephants, cattle and zebras are all charging in one direction. If more established businesses companies come to the ‘market’ as IPOs  and there are greater opportunities available, some of this scarcity premium will get arbitraged away. The excessive enthusiasm will taper off and will be replaced by careful financial analyses and assessment of the reward potential of every investment offering.  A vibrant and responsible marketplace will emerge when the arbitrary entry barriers are removed and the resident investors are able to access a wide range of domestic and regional opportunities.

[The author is General Manager of Emirates Bank.  However, the views expressed in this article are not necessarily shared by the Bank].

Back

Top