The Hindu Business Line : Public offers and sustaining the rally

FOUR of the last five book-built offers, that have since listed, are now trading at a discount to their offer prices. There are indications that a few banks may postpone their public offer plans. Some, such as ICICI, are reported to be considering attractive pricing to entice investors. This is a telling indicator that the market for public offers may be cooling off. But we can scarcely afford this, especially in the midst of a revival in industrial growth. As projects are funded with a heavy equity component, a weak IPO market can stymie industrial growth.

IPO trends: Trends over the past decade indicate how listing losses or gains tend to have a domino effect. Listing losses generally mean fewer companies access the capital market for funds.

A paper in the RBI's recently published Occasional Papers suggests that if the number of such companiesdeclines, in subsequent months even fewer companies will tap the market. Eventually, only a bull-run in stock prices can break this vicious cycle.

This is also an indicator of how fund-raising has become a victim of prevailing trends in the secondary market and gives one an idea of the possible state of the markets in developed countries. Investors are, however, dependent on IPOs in more ways than one.

IPOs have the potential to deepen the market, diversify investors' portfolios, reduce volatility in stock prices, bring back domestic investors' money into the market and attract FII funds. Given the need for capital by large and small firms, IPOs also promote economic activity.

In short, the conventional wisdom that more IPOs lead to more supply and, consequently, lower stock prices, may not be strictly applicable. More IPOs may be part of a virtuous cycle that promotes wealth generation. It could scarcely be allowed to remain dominated by volatile short-term stock price trends. There is a lot that domestic companies, investors and the stock exchanges can do to correct the anomaly.

Unrealistic fear: Domestic companies need to be convinced that good offers will always have takers. For instance, the offers of i-Flex and Bharti Tele in the cold days of 2002 were over-subscribed 2.5 times. This was despite the feeling then that the valuations were stiff.

In other words, pricing too will not have to be unduly conservative to attract investors. In addition, valuations prevailing in the secondary market are still significantly attractive. Public offers made now may not lead to an increase in cost of equity.

Research indicates that public offers are generally under-priced. Such under-pricing adds value to an investor's portfolio. Even offers made in 2005, in a high stock price valuation environment, have produced decent returns. Twenty-two of the 35 book-built offers made till now in 2005 are in positive territory.

About half the total offers have delivered returns of more than 20 per cent. IPOs thus do matter. And investors cannot afford to ignore them even if the secondary stock market is in a slump.

Role of exchanges: It is intriguing that exchanges such as the NYSE, the Nasdaq, the London Stock Exchange and the Singapore Stock Exchange encourage domestic companies to list abroad. In contrast, domestic exchanges do not launch any high-profile campaign or marketing effort to attract many of the several large companies yet to be listed.

Exchanges need to ensure that more than a handful of large companies list every year. Yet in 2005, only couple of large firms — Jet Airways and IDFC — got themselves listed. A number of large unlisted firms are in the public sector. Exchanges have to put pressure on the Government to get many such firms listed.

Also, several small and medium companies need capital. Again, there is no concerted attempt to bring them to the capital market. The IndoNext initiative (S-group stocks) by BSE was promising and it seemed that it would bring fresh money into small companies. The S-group stocks, however, have since been embroiled in the penny stocks controversy. Trading volumes have crumbled and threaten the sustainability of the initiative.

It is true that Indian exchanges host the most number of listed companies after exchanges in the US. Still, more needs to be done. If exchanges need capital infusion for such initiatives, they themselves should get listed. Either way, they need to go out and bring investors and companies together. Their role is not restricted to ensuring the orderly functioning of the secondary market.

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