IPOs: Free pricing has become a free-for-all

Time was when blue-chip companies had to grovel before the Controller of Capital Issues (CCI) for a premium on issuing their shares, which would be granted grudgingly – say, a share of Rs10 at a premium of Rs15. That was till we junked the CCI regime in 1991, flush with the excitement of liberalization and globalization. The Securities and Exchange Board of India (SEBI), which replaced the CCI befitting the mood of the economy, enabled free pricing which, predictably, has degenerated into free-for-all IPO pricing.

Nowadays, any company can demand, and get, a 21,400% premium and more on its IPO without batting an eyelid. Paytm, which last year issued Rs10 shares on IPO at Rs2,250 a share, got such a fabulous valuation at the hands of book builders in cahoots with its merchant banker, only to drop to less than half within months on the bourses. It is not Paytm alone. The Indian IPO saga is replete with instances of listing losses for small investors when they were looking for listing gains and an exit.

That an IPO offers itself as the easiest get-rich-quick scheme in town is due to the Pied Piper role played by book builders in the 100% book-building regime put in place by SEBI. If they discover that a Rs10 scrip is worth Rs2,250 despite the staggering accumulated losses, no one can demur. The norm otherwise is a three-year track record of profits and dividend, which SEBI is willing to cast aside if the book builders say so. It is now common knowledge that if you can get hold of a SEBI-accredited merchant banker and pay the requisite fees, you can get away with an unconscionable premium. One behaves more responsibly when he gets a taste of his own medicine – in this instance avaricious and aggressive pricing. It must be made mandatory for merchant bankers to take up a significant equity stake so that they are sober in valuing unlisted scrips. Skin in the game is what is required.

Aggressive pricing of IPOs is not premised on mobilizing funds for the company alone. It has a more sinister design. The offer-for-sale (OFS) regime that rides piggyback on IPOs in India plays an insidious role. Promoters offload a bulk of their holdings by way of OFS which takes place simultaneously, seamlessly, almost surreptitiously with the IPO. Thus, promoters get to sell their shares subscribed at par at the mindboggling IPO price. This is a classic case of conflict of interest.

In other words, aggressive pricing benefits more the promoters than the company. In this game of self-aggrandizement, venture capitalists and angel investors too are often partners-in-crime, so to speak. OFS has been the villain of the peace. It is time promoters and venture capitalists were told to unload their shares on the bourses after the IPO. The bourses are the best place for price discovery. Retail investors would do well to bide their time and watch how a scrip performs at the bourses before buying, instead of trying to become venture capitalists, at least until SEBI brings a modicum of discipline in the primary market.

SEBI has certainly been alive to the dangers of free pricing, but its remedies have been inefficacious. First it rolled out a regime to rate IPOs and preened that this was an avant-garde, unparalleled move, forgetting that rating an IPO without rating its pricing offers cold comfort for the small investor. Predictably it dropped the regime in May 2018 along with another farcical regime – safety net. Under the optional safety net mechanism in force till then, a promoter could stick his neck out and offer to buy out small investors, not more than 1,000 shares from each, if the market price fell below the IPO price any time in the first six months after listing. There were, predictably, no takers. The farce was ended by throwing the baby out with the bathwater instead of making the safety net regime mandatory so that merchant bankers and promoters have skin in the game.

New-age companies wear their losses on their sleeves with the claim that such losses are harbingers of cornucopian profits in the future. SEBI recently tried to make them more accountable by mandating greater disclosure on how they got venture capitalists interested, what the number of eyeballs caught are, etc, but what would ultimately work is reading them the riot act. New-age or old, no company should be allowed to go public unless it has come of age and started commercial operations profitably.

The public should not be cast to the wolves. It is disingenuous to say that equity is the riskiest form of investment and so investors should stew in their own juice. The truth is equity is not monolithic. It is one thing to invest in the equity of companies that have come of age and quite another to invest in equities of companies that are still in the incubation stage. The latter are meant for venture capitalists with a voracious risk appetite.

Nor should the powers-that-be be lulled into complacency by the act of double-takes like offering bonus shares on the back of aggressively priced IPOs, as Nykaa did recently, taking a cue from what Reliance Power did back in 2008, as if to atone for its avarice. Issuing bonus shares out of the share premium mindlessly collected may be an act of contrition, but it is also rank misuse of the concept. Ditto for offers of buyback like Paytm is now making by way of penance.

The writer is a freelance columnist for various publications and writes on economics, business, legal, and taxation issues