The banks that take the call on pricing must have more skin in the game. One way to ensure this could be to have a rating of banks based on how often they got the pricing right and how often they over-stated this.
The IPO market has always been an enigma. The past year was a boom time, with several companies, especially start-ups, riding the wave with their IPOs. The premium charged was quite phenomenal in most cases as the market had the appetite for the same. As the market has subsequently moved southwards, their performance has been mixed, with roughly half the set quoting lower than the issue price. Some of the big IPOs have also turned out to be very disappointing.
The regulator, Sebi, is concerned, since many investors have lost money. Normally, this should not be a consideration, given that everything is okay in the market provided adherence to all rules. There can be no complaints here. However, the problem is with the pricing of IPOs. Sebi has always talked of the misselling of products, and the same applies here. Only, here the mis-selling is not from the agents but through the pricing.
Ever since free pricing of shares (since the past three decades), there is no formula involved, and it is the investment banks handling the issue that arrive at the price band. The band is misleading as it would be in a range of Rs 10-20. That does not help when the basic price is over-stated. Sebi is right in asking for transparency, though the layman will never know what this means given that the red herring report runs into hundreds of pages.
The numbers that a potential investor looks at is the profit made by the company. Intuitively, when a company is making losses for, say, three years in a row, the valuation should be low. For traditional companies, this makes sense. However, the market logic changes when it comes to start-ups where the valuation is based on future prospects, which cannot be linked with the past, which is always under a shadow. This is what we end up reading in all the business columns where the experts talk of the future potential of these companies due to a very strong business model. Often, when there has been an investment by a PE investor or a fund house, their valuation becomes the anchor for valuation for IPO. Therefore, transparency may not help, as there is a logical basis for such valuation.
There is a rather large canvas of opinion-makers with expertise in corporate valuation, who provide a rosy picture of the issue. Even if there is dissent on valuation, rarely does the other view talk of something which is even 25% lower than what is quoted. While there can be some red flags raised on the future growth stories of these start-ups, it is never a case of saying that the price is wrong. This, along with the frenetic advertising that goes into the IPO, creates the buzz that is required for success.
A way out is to ask for a detailed evaluation of the IPO. This can foment some debate, but it will be more in the vein of different forecasts made on any economic variable. Besides, most of the assumptions made would sound logical, and the investor will not be able to read anything adverse.
Another option is to have a regular list of all the IPOs on Sebi’s site where the investment bank’s name is also stated, so that investors can do some analysis regarding which ones have a tendency to over-state the price. This will be a check on the bank that assigns this value because if they tend to be wrong more often than not, their credibility will be affected. There will, of course, be justification for the price movements as the overall market comes into the picture. But, a thumb rule can be that if the price at the time of listing is lower than the issue price, then there is a problem in valuation. Ideally, there should not be a crash within a week or 10 days after the listing takes place. Arguably, subsequent price movements can be due to several factors and, hence, cannot be feasible yardsticks.
In fact, going ahead, all investment banks/lead managers involved in the valuation process of IPOs should ideally be graded or rated purely on performance by an independent credit rating agency. This will evaluate how the entity has tended to perform in terms of pricing IPOs. This is quite different from IPO grading, which was once made mandatory and then abandoned, where the evaluation was more on how strong the promoter was, and it was explicitly stated that there was no call taken on the price. The rating would not be of the IPO but of the entities which fix the price. The judgment can be extended to cover not just the listing price but also how the stock has performed against benchmarks over a period of, say, 6-12 months.
There is a need for some checks on over-valuation of IPOs where there is no existing price benchmark. The test is more of the banker that fixes this price, and credibility is of supreme importance. Such valuation should be free of the promoters’ influence and based on objective criteria. Potential investors would be better off taking a decision once they see this rating of the banker, which in turn would be a bit more circumspect once this process is in place. In short, they should have skin in the game.
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