Big Money Stakes: DNA, 25th June 2007

The success of mega IPOs should not blind us to some vital concerns

The spectacular success of the DLF and ICICI Bank IPOs is significant for more than one reason. The companies represent two booming sectors, which quite coincidentally share a symbiotic relationship, with the banking sector providing the finance for the real estate sector, while the real estate sector has been swelling the loan book of banks and hence their profit lines.
But why is there such a rush for oversubscription of these IPOs? There are essentially three categories of investors here: domestic investors, corporates and foreign investors. IPOs have a psychological influence on investors as they normally set a floor price for a share, below which it is not expected to go in the medium to long run. Therefore, companies price their IPOs at a premium to the past prevailing prices which is then accepted as a base rate under normal market conditions.
Individuals and mutual funds are the domestic investors, who are lured with a rising Sensex and assume that there will be no looking back now. This sentiment by itself keeps the market in the upward direction. The capital market today provides the best after-tax returns to investors — high nominal returns and low tax rates.
The corporate interest in the IPOs cannot be just for investment purposes as the yield per se is low. Theirs is a strategic investment in terms of getting hold of the company at a later date. It has been mentioned that some of the corporates have invested in the ICICI Bank IPO, which is interesting because it indicates that when regulation permits, they would be interested in having a say in the financial sector too. Such investments in companies may also be viewed as the starting point of M&A (merger and acquisition) activity at a later date.
The third interest is from foreign investors who still feel that the price-earnings (P-E) multiples of 15-20 in India can be improved. Typically we would have expected these funds to slow down in India given that interest rates in the West are improving, as are the markets. The fact that they are investing in India means that they believe that the India growth story is there to last and therefore their investments would continue to give good returns.
However, it must be remembered that this is the story in other Asian markets too where portfolio investors are rushing in, such as Indonesia, Russia, Malaysia and Latin American countries. Given the increase in the overall size of such portfolio investment it is but natural that India will receive progressively larger allocations.
The success of these IPOs raises three broader issues. First, where is this money coming from? Second, is all this money accounted for, especially as such IPOs fuel a secondary market multiple? Lastly, how long can this optimism last?
The high growth witnessed in the last three years could be the reason for the channeling of these funds into the IPOs, which count as savings officially, unlike funds in the secondary market. The savings rate in India has now gone past the 30 per cent mark, which means that it is on the upward trajectory.
Nine per cent growth and a 30 per cent savings rate is the ideal platform for the capital market where IPO money is used for capital investment either in fresh land, buildings and machinery, or loans if raised by financial companies. There is, however, no evidence of any substitution taking place in the household portfolio of savings and investments.
The second question raises an apprehension about how much of such money is black money. It has been observed in India that stock market booms, along with the real estate sector, invariably churn out a lot of black money which may be difficult to track.
As for the last question, investor interest in IPOs today is primarily because of the gains to be made in the secondary segment. The stock market does not mimic economic performance and the fall of the NDA government in 2004 was a classic example where the market fell even though the economy performed well. Also, at the present high levels being witnessed, the maintenance of such volumes will be a challenge as large quantities of money has to continuously flow in to ensure that the bullish trends continue.
Stock market returns closely resemble a Ponzi scheme where good money has to keep coming in to ensure that the apple cart is not upset. And therein lies the rub.