IPOs: Need Vs Greed
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The benefi ts of a company going public are well known, and can be reaped amply by both companies and retail investors. However, when promoters overstep the company’s needs to use the proceeds from IPOs for purposes other than the stated ones, investors are the ones who end up paying heavily, Shashikant explains.
Greed, for lack of a better term, isgood. Greed is right”, said corporate raider Gordon Gekko, portrayed by Michael Douglas in the 1987 movie ‘Wall Street’. That role, mind you, earned Douglas an Oscar. But that of course, was reel life. In real life, greed isn’t glamorous, especially when one is dealing with public money.
Public money comes into play for companies in a big way when they come out with Initial Public Offers (IPOs). At the heart of an IPO lies the need to raise capital in one of the most economical ways to build and expand businesses. However, the lower cost of raising funds sometimes tempts promoters to raise money more than what they truly need for their projects. Therefore, the guiding principal of an IPO many a times becomes more of ‘greed’ rather than ‘need’. What also increases their appetite is the soaring equity market, which normally leads to companies biting more than what they can chew.
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What this essentially means is that once a company garners a good amount of money through an IPO, it may squander the proceeds and fail to use the funds optimally (as we will see further in this story). Some of the companies that came with the largest IPOs during the height of the bull run (between 2007 and the early part of 2008) point towards the same fact, which resulted in collossal losses for gullible retail investors.
To understand how greed has outweighed needs of a company while raising funds through an IPO, we studied data for three years starting from 2006 till 2008. The reason we took into account the past data is that normally an IPO comes up to raise money for projects that might take a few years to be completed. Further, the benefits of those projects take some time to seep into the company’s financials. For example, Reliance Power, which came up with its IPO at the start of 2008, was expected to complete work on all but a few of its power plants by FY12. Hence, it makes sense to look back and analyse the progress of projects and the utilisation of the IPO proceeds by companies.
We studied 185 companies, though a total of 236 companies came up with IPOs during the said duration. We have excluded companies like Pyramid Saimira Theatre, Evinix Accessories, etc. that have been suspended and are no longer being traded. Similarly, companies like Reliance Petroleum that have merged now have also been left out.
Out of these 185 companies, the shares of 130 companies are trading at less than their issue price after adjusting for corporate actions like splits or bonus declarations. This reflects the sorry state of the performance of IPOs, where seven out of 10 companies are trading lower than their issue price. The loss in rupee terms for those who had invested in these IPOs is a whopping Rs 2701 crore, which is almost four per cent of the total amount that had been raised through IPOs during this period.
Nevertheless, the actual loss is set off by the gains made by some of the companies that came up with IPOs during the same period. For example, Cairn India has added more than Rs 5000 crore to its market capitalisation (only of the shares issued) since its listing. If we exclude the gains of such companies and consider only those who have seen a loss in their market cap, the losses add up to an eye-popping Rs 28262 crore. This figure is bound to cross Rs 30000 crore if the losses incurred by investing in companies that are not traded any more (Pyramid Saimira Theatre, Evinix Accessories, etc.) are included.
What is even more disturbing is that the top two issuers by size also happen to be the two highest losers. Reliance Power and DLF, which raised Rs 10260 crore and Rs 9188 crore, have lost Rs 7026 crore and Rs 5390 crore respectively. Though the equity market has not been doing too well overall, one cannot blame only the volatile market conditions for such humongous losses.
One of the prime reasons for such losses is the greed of the promoters. According to market analyst Ambareesh Baliga, “Any promoter coming to the market would like to get as much as possible as he sees it as one of the opportunities to get a return of whatever he has done in the past and this is the time to get the valuation”. These promoters are fully complemented by investment bankers, whose fees are mostly related to the issue size. Larger the issue size, the higher their income. Therefore it is a win-win situation for both the promoter as well as the investment banker. But it is investors who are the ultimate losers.
The situation is no different in the international arena too, where recently we have witnessed the debacle of the Facebook IPO. Within 90 days of its listing, the company has lost more than USD 50 billion in market value. Most of the investors and pundits are pointing a finger at the Wall Street banks, particularly Morgan Stanley, which led the offering.
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Issues come out at such expensive valuations that they hardly leave anything on the table for investors. For example, Edelweiss, which came up with its IPO at the fag end of 2007, had priced its IPO steeply. Each of its shares with a face value of Rs 5 was priced at a PE of 36x and a price to book value of nearly 4x, which is comparable to a premium institution like HDFC Bank and way above its larger peers like Indiabulls Financial Services that was trading at a PE of 32x. Today, the share price of Edelweiss is quoting 63 per cent lower than its issue price after adjusting for bonuses and splits, and investors have already lost Rs 432 crore having invested at Rs 825 per share.
In addition to companies in the financial sector, another sector that has really made investors poor is real estate. Out of the 16 issues that hit the market from this sector, 14 are trading in the red (including construction companies) and investors have lost around Rs 10000 crore by investing in the IPOs. It is worth noting that almost half of these losses were accounted for by DLF alone.
Although the worsening macro-economic conditions remain one of the prime culprits of such performance, one cannot rule out the greed of the promoters who often come out with expensively priced issues trying to take advantage of the irrational exuberance of the markets when the going is good. For example, DLF, which came up with its IPO during June 2007, was asking for a PE multiple of 49 at its upper price band and a whopping market cap to sales (FY07) multiple of 35. Another significant value destroyer from the real estate stable is Housing Development and Infrastructure (HDIL), which raised Rs 1485 crore without a green shoe option and Rs 1698.6 crore with a green shoe option. The value of these investments today stands at just one-fifth or 20 per cent. In other words, investor losses stand at Rs 1338 crore. What is even more surprising is that despite the net asset value (NAV) per share of the company standing at just Rs 391 (according to various research reports) at the time of issue, the shares were issued at Rs 500 per share – a premium of more than 25 per cent to the NAV!
It is not the pricing alone that has caused such a huge value destruction for investors. The subsequent decisions taken by company managements with regard to the utilisation of these funds are equally responsible for the losses incurred. In the case of DLF, according to the prospectus, Rs 3500 crore was to be used only for the acquisition of land and development rights and the rest was to be ploughed into the construction of ongoing projects in FY08 and FY09. However, Rs 5669 crore was used for the acquisition of land in the first year itself. Similarly, in case of HDIL, the prospectus stated that over eighty per cent of the proceeds (Rs 1501 crore) were to be used for construction of ongoing projects in three years and the remaining for land acquisitions. In reality though, they reversed the use, and most of the funds (Rs 1188.1 crore) went into land acquisition and that too within one year against three years as mentioned in the RHP. All this signifies the sub-optimal use of the funds raised through the IPO route, which led to poor financial performance of these companies subsequently.
We believe that many factors that impact the operations of a company are not under the control of the management. However, the pricing of the IPO and (mis)utilisation of issue proceeds remains primarily under the preview of the management and they should exercise utter caution while deciding on these matters. Another befitting example of the misuse of IPO proceeds is the case of India’s second largest IPO, Reliance Power. We find that not only have the funds have not been utilised according to what was stated in the prospectus, but the clause regarding the utilisation of IPO proceeds has itself been revised to include projects that were not mentioned in the RHP. Now, this very project at Andhra Pradesh may cost the company dearly as it has been delayed and the company is at a risk of losing its Rs 300 crore bank guarantee.
The list of such breach of trust by companies is long enough to be covered over a few pages. One thing is clear though, that the practice of changing the objects of the issue after the IPO is quite widespread. This is not limited to a few large issues, but the smaller issuers are equally responsible for value destruction. An analysis of the loss by issue size suggests that IPOs where the issue size has been between Rs 25-100 crore have been the worst performers, with almost eight out of 10 such companies trading below the issue price. In absolute terms, 64 out of 82 companies are trading below their issue price. Even issues from government are not very attractively priced nowadays, and we believe that they are also following the footsteps of their private sector counterparts.
Of course, we cannot generalise this and paint all IPOs with the same brush. There are various examples that show that promoters who have come out with IPOs with the right intentions and valuations have made investors rich. A case in point is Page Industries, which came out with its IPO in the year 2006 at a PE multiple of 22.5 when its competitor Maxwell Industries (with a brand like VIP) was trading at a PE multiple of 26. Currently, the share price of Page Industries is more than 7.5x of its issue price and the IPO investors have already minted around Rs 800 crore since its issue.
One of the reasons why the promoters of companies escape with no serious penalties despite being greedy and squandering public money is the large regulatory gaps and loopholes that exist in the system. For example, companies are not mandated to share information with the SEBI regarding how the IPO proceeds are used. The Registrar of Companies is the right authority to do so, but there too, only a yearly filing is done and it might be too late to suggest any wrongdoing and perpetrate corrective action. Auditors also prepare reports in outdated formats prescribed by the SEBI, which serves the token purpose of merely recording changes in the IPO object clause and nothing beyond that.
We feel that IPOs remain one of the best ways for retail investors to channelise their savings into investments. But the greed of some of the promoters is threatening to kill this goose that lays golden eggs, at least until the loopholes are plugged and the reporting is made more stringent. Now, even Michael Douglas has changed sides in his latest new role of an FBI informant in a new public service ad campaign, and agrees that “Greed is actually bad”.