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					What Ails India's Initial Public Offering Market?: India Knowledge@Wharton (http://www.ikw.in/)

What Ails India's Initial Public Offering Market?
Published: February 21, 2008 in India Knowledge@Wharton

                                                            Is greed killing the initial public offering (IPO) market in
                                                            India? In recent weeks, several large equity offerings,
                                                            including those from reputable business houses, have
                                                            struggled to hit their targets. India's stock markets have been
                                                            volatile, reacting to fears of a widening global credit crunch
                                                            and fears of a U.S. recession. Wharton professors and
                                                            investment experts interviewed by India
                                                            Knowledge@Wharton say that while markets correct
                                                            themselves every now and then, their imperfections also
                                                            show up at such times.
                                                            In January, the Indian primary equity market was chalking
                                                            up new records. Now, suddenly, there are hardly any takers
                                                            for new corporate paper.
                                               The first casualty of the Indian IPO bubble was, ironically
enough, a hospital. On February 7, Wockhardt Hospital pulled out its Rs. 676 crore ($178 million) IPO.
It had exhibited all the signs of a patient on his last legs. The price band of the book-built issue was
lowered from Rs. 280-310 ($7-$8) to Rs. 225-260 ($6-$7). The last date for subscription was extended.
But qualified institutional buyers, including foreign investors, mutual funds and hedge funds, applied for
only 0.06% of their quota in the Wockhardt issue. The non-institutional portion (mainly for high
net-worth individuals or HNIs) was subscribed 0.0048 times. Even the retail part saw demand for barely
more than half the pie. It was an unmitigated disaster and the first time in recent memory that an IPO
from a respected business house has flopped in India.
Close on its heels, real estate company Emaar MGF, a joint venture between the Dubai-based Emaar
group and MGF Development of New Delhi, also had to withdraw its IPO in the face of low demand.
The Rs. 6,500 crore ($1.7 billion) issue started with a price band of Rs. 610-690 ($16-$18). It was
brought down to Rs. 530-630 ($14-$16.50) in two tranches. The last date of subscription was extended
by three days, but to no avail.
"We are clearly a victim of the (secondary) market," says Emaar MGF managing director Shravan
Gupta. Along with other markets around the globe, the Indian stock markets, too, have had a torrid run
the past few weeks. The Bombay Stock Exchange Sensitive Index -- Sensex -- touched 21,207 on
January 10, an all-time high. Barely a month later, on February 10, it fell to 16,608, a five-month low.
Wockhardt and Emaar MGF were bad enough for investor sentiment; more issues are being withdrawn
or postponed. But the massively-hyped Reliance Power IPO was the most high profile casualty. This was
an issue from the Ambani stable; word on the street is that the Ambanis have always made money for
their investors. At Rs. 11,500 crore ($3.025 billion), it was India's largest-ever IPO.
The Reliance Power IPO was subscribed one minute after it opened. It was eventually oversubscribed 73
times and raised $190 billion. Some $100 billion of this came from foreign funds. This constitutes
one-and-a-half times the total foreign institutional investor (FII) money coming into the country since
1992. "When Reliance Power lists early February, it will be among the 10 top listed companies in India,"
Anil Ambani, the younger son of Reliance founder the late Dhirubhai Ambani, told a press conference

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What Ails India's Initial Public Offering Market?: India Knowledge@Wharton (http://www.ikw.in/)

Anil Ambani, the younger son of Reliance founder the late Dhirubhai Ambani, told a press conference
shortly after the IPO closed. "If we assume it lists at the issue price of Rs. 450 ($12), the market
capitalization for the group will be around $100 billion."
It was not to be. Reliance Power ended its first day on the markets at Rs. 372 ($9.80). Millions lost
money. The Sensex dropped 863 points in sympathy. The myth of Ambani invincibility was shaken. The Financial T
Financial Times of London wrote: "It's only when the tide goes out... that you discover who has been
swimming naked. Few are caught in quite such an alarming state of undress as Reliance Power."
Clearly, it didn't help the Reliance Power IPO that the Sensex lost more than a fifth of its market
capitalization between January and February. Wharton management professor Saikat Chaudhuri sees
nothing wholly unexpected in these developments. "The market periodically has to adjust," he says. "If
there is a bull run, the market usually pulls back to an extent, especially now because there is so much
uncertainty surrounding the credit crunch."
The Hole in the Credit Barrel
Chaudhuri points to the continuing flow of "bad news on the credit crunch, particularly from banks," and
says that several private equity deals are also stuck. He doesn't see any respite until some clarity emerges
on the actual size of the credit crisis. "Until this is resolved -- say [for example] people know that the top
10 banks will take a $50 billion hit -- the market will continue to be jittery," he says. "Short-term
investors are very nervous. They are not sure if the problems associated with the credit crunch have been
adequately addressed and if the market has all the information it needs."
Fears about a possible U.S. recession are also stoking the uncertainty in the Indian markets, says
Chaudhuri. "If the U.S. is headed for a recession, then of course a lot of growing firms in India,
particularly those in the IT sector, are going to take a bit of a hit because they are still very heavily
dependent on the U.S. market."
Franklin Allen, a finance professor at Wharton, says primary markets will continue to be "tricky" until
the markets settle down. "When you have so much volatility [in the secondary market] -- it's up 2% one
day and coming down 2% the next day -- it is very difficult to do these primary market operations; that is
the underlying problem," he says. "This happens also in developed markets when there is volatility."
"Now, if I were an investor, I don't think something like Reliance Power should have taken a hit," says
Chaudhuri, pointing out that India is power-deficient and its infrastructure sector is "growing very well.
In the worst case, if India's growth needs were to come down a notch, its power needs will still have to be
While the fall in the Sensex and the air of pessimism hurt the Reliance Power listing, many people point
to high valuations as a reason for the IPO market going bust. "The bull frenzy led to unsustainable
valuations," says Prithvi Haldea, chairman and managing director of Prime Database, which tracks IPOs.
"Retail investors feel they have been cheated," says Kirit Somaiya, president of the Investors' Grievance
Forum (IGF).
"It's just a question of timing," says Chaudhuri. "It is fine to be greedy, but you have to do that when the
market is rising. I am not making a value judgment, but everybody is always trying to extract the most
that they can at any point in time. That's their natural quest." He says it may have been a good idea for
some promoters to postpone their IPOs until things got clearer on the credit contraction front.
Sudip Gupta, professor of finance at the Hyderabad-based Indian School of Business (ISB), says, "What
is interesting and important is what to expect now when things look relatively bad worldwide. The
informational cascade effect comes in here." He explains that the first few investors in an IPO bring in
bad news, forcing a price cut, scaring away potential investors, and "thus generating an informational
Gupta says that if the IPO's price cut is "too much," investors may start to wonder "why the firm is so
desperate for cash." In other words, he says price cuts don't necessarily work. Gupta of Emaar MGF says
the company will come back to the market in three to six months, when he hopes it will be less volatile.

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What Ails India's Initial Public Offering Market?: India Knowledge@Wharton (http://www.ikw.in/)

Reliance Power's Make-Good Gesture
In a post-listing development, Reliance Power has announced that it will issue bonus shares to its
investors; however, the promoter group will not be entitled to these shares. Reliance Power has since
risen to more than Rs. 400 ($10.50). But analysts read into the bonus proposal a tacit admission that the
pricing was indeed too "aggressive" in the first place.
"The pricing of an IPO is dependent on three factors -- the state of the capital markets, sector
fundamentals and company performance," says S. Ramesh, chief operating officer at Kotak, one of the
leading investment bankers in India. "One needs the tailwinds of all these three to achieve good IPO
response and post-listing performance." He says what is important is a stable market; if you are on a
rollercoaster ride, all bets are off.
Most merchant bankers agree. And there is no disputing the fact that, if the market hadn't tanked, all
these issues would have done very well on listing. The reason why so many were disappointed in the
performance of Reliance Power was its showing in the gray market in several cities of the western state
of Gujarat. This unofficial and illegal market trades in shares even before the IPO and allotment. (The
final settlement is when the scrip lists.)
Reliance Power changed hands at Rs. 900 in January. When the market fell in February, it came down to
Rs. 600 ($24). Even at this reduced rate, it commanded a premium of Rs. 150 ($4) over the issue price of
Rs. 450 ($12). When it listed at less than Rs. 400 ($10.50), these investors -- mainly high-net-worth
individuals -- ran up huge losses.
Many investors had borrowed at high interest rates to buy Reliance Power shares. A
back-of-the-envelope calculation shows that the share would have to list at Rs. 600 ($24) for them to
break even. What happened was a disaster for these speculators. Many are refusing to pay up. And there
is turmoil in the illegal betting shops in cities like Rajkot and Baroda.
Irrational Exuberance, Indian Flavor
Promoters are a shade more candid. "It takes two hands to clap," says Ravi Ramu, chief financial officer
of Puravankara Projects, a real estate developer in Bangalore. "If you ask about the greed of merchant
bankers and promoters, you should also talk about the irrational exuberance of investors. Do they rush to
invest in an issue simply because it rained harder that day? In the euphoria, they forget to look at the
Ramu and Puravankara must have a feeling of déjà vu. When Puravankara floated its IPO last August,
the ripples of the U.S. subprime crisis were hitting Indian shores. Puravankara had to reduce the price
band by 20% from Rs. 500-525 to Rs. 400-450 and extend the issue by three days. It finally did garner
adequate subscription. But on the day it listed, it closed at Rs. 362.80 against the issue price of Rs. 400
Puravankara is not a typical case. Most IPOs have been listing way above the issue price. Power Grid
closed its first day at Rs. 100.70 (against an issue price of Rs. 52). Other such runaway examples include
Mundra Port Rs. 440 (Rs. 961.70 issue price) and Power Finance Rs. 85 (Rs. 112.60 issue price).
"When things sell, everything sells," says Vivek Suchanti, managing director of Concept Public
Relations. Concept provides public relations services for IPOs, which basically means hard selling the
issue to the media.
"Bankers and promoters sell anything at any price on the story going ahead," he continues. "Investors
look at gray market prices and buy. This is also true of the 'sophisticated' investors such as FIIs and
hedge funds." Says Somaiya of IGF: "Emaar MGF, Wockhardt Hospitals and Reliance Power were
absurdly overpriced. Euphoria was created which was not supported by fundamentals."
Some numbers do suggest aggressive pricing. Based on the issue price, Emaar MGF would have a P/E
(price/earning) ratio of 165 at the lower end of the price band against 73 for DLF and 49 for Unitech, the
established leaders in the real estate sector. At the Wockhardt Hospitals P/E of close to 200, it was
looking at a valuation around Rs. 2,700 crore ($710 million), when its older and larger listed peer Apollo

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What Ails India's Initial Public Offering Market?: India Knowledge@Wharton (http://www.ikw.in/)

Hospitals commands just Rs. 2,500 crore ($658 million).
Reliance Power, of course, doesn't have a P/E; it has no earnings. As its prospectus explained: "We
currently have no power plants in operation or other revenue-generating operations, and we have no
significant operating history from which you can evaluate our business and future prospects and
viability... Commercial operations at our first power plant -- Rosa Phase I -- are not scheduled to
commence before December 2009..."
For many it is not overpricing that is the norm but underpricing. Gupta of ISB says that this is not just an
Indian phenomenon. "One of the stylized facts about IPOs that are universally verified is initial
underpricing," he says. "What we have observed in the Indian IPO market so far is not very different."
Gupta explains the reasons for the underpricing. "An IPO is different from a secondary offer as investors
know little about the fundamental prospects of the project," he says. "Since investors cannot distinguish
bad quality projects from good quality projects, the good quality project has to be sold at a discount
(underpricing) so that investors are attracted to invest in the IPO." Gupta says the issuing firm also may
not know the actual prospects of the project, and improves its understanding from institutional investors
as the IPO gets listed.
Gupta says IPOs in emerging economies could be under priced by as much as 100%; this means the price
doubles on the first day. "Even in the U.S., generally known to have a transparent financial market, in
1999-2000 (the Internet boom), the first-day under-pricing was 65% on an average," he says
Adds Ramesh of Kotak: "IPOs are typically priced by leaving a discount to the realizable price at listing.
It is always a good idea to leave a discount to motivate investors to subscribe."
Regulatory Urge
Market watchers recommend other measures to regulate the behavior of investors, merchant bankers and
promoters. SEBI has been looking at putting a price band on the movement of the share on listing day.
But nobody is quite sure how that will help, except to stop huge volatility. All it may succeed in doing is
moving the volatility from day one to week one, say some investment experts.
"I don't think the regulator should set the price of issues," says Allen, who has other, longer-term
suggestions. "Make the markets efficient. As long as there are enough knowledgeable investors,
promoters who try to overprice won't succeed."
Another suggestion is to make the bankers more accountable. If the bankers are made to function as
underwriters, too (which means that they will have to pay out the money for the unsubscribed portion of
an issue), they are likely to be more circumspect about pricing. But this means that they will always opt
for caution and the promoters will never get the best deal.
There are other suggestions floating around, which many consider unworkable. The State Bank of India
(SBI) has suggested to Parliament that the agencies that currently rate IPOs should be allowed to give an
independent view of the pricing. But market participants don't think anyone will give pricing a second
look in a bull market, when they aren't likely even to read the IPO ratings. In a bear market, they are not
going to be investing in IPOs, anyway.
Gupta of ISB says the critical phase is now. "Although there may have been signs of investor greed in
the IPO process last year, investor fear may do more damage than investor greed."
According to Haldea of Prime, public issues may reach Rs. 75,000 crore ($19.7 billion) in 2008, a new
record. This includes Rs. 60,000 crore ($15.8 billion) of IPOs and Rs. 15,000 crore ($3.9 billion) in
follow-on offers. The study was done before the market went into a decline. But with a recovery in sight,
the figure is unlikely to change very much. Unless, of course, the bears win back the advantage.
Fear rules today, but it's not clear for how long. "Everyone suffers from a memory loss," says Ramu of
Puravankara. "All the investors -- and new ones -- will be back." Suchanti of Concept is a little more
pessimistic. "I am going on a holiday," he says.

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