OVERSUBSCRIPTION OF IPOS : Rational Decision or Mass Ignorance?

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OVERSUBSCRIPTION OF IPOS : Rational Decision or Mass Ignorance?

IPOs being oversubscribed even during the current downturn in the economy isn’t surprising news.

--BY ANUGYA RIJAL

Initial Public Offering (IPO) has been a major source for raising capital for private companies for a long time. The transition from a private company to a public company enables the private investors to realise gains on their investments through share premiums while allowing the public investors to raise the capital for the company in exchange for part ownership. The benefits of issuing IPO are not limited to fundraising and share premiums. It helps in increasing the credibility of a company to its creditors as well as in reducing the cost of debt. Furthermore, using stock options as an incentive helps the company in sustaining the employees.

While the issuance of IPO can strengthen a company with a huge influx of new money, it has its downsides too. Issuing IPO means that the company has the public’s money now. A regulatory body, in this case SEBON, is involved whenever the public’s interest is concerned. The company is mandated to follow specific rules and regulations and publish their financial statements timely after they go public.

Applying for IPOs has become very easy in Nepal ever since the introduction of Mero Share software by CDS & Clearing Limited (CDSC). It allows the beneficiary to apply for IPOs, right shares and mutual funds from wherever they are, and effectively removes the hassle of having to wait in long lines to apply for IPOs as well as to get their money back. This is the primary reason why IPOs can be issued even during the lockdown.

A nation-wide lockdown was enforced by the government from March 24 to July 22 to control the spread of COVID-19 in the country. The IPO that was issued nearest to that period was of Nepal Re-Insurance Company (NRIC), issued on March 17. The IPO of NRIC was oversubscribed by 1.57 times within two days of issuance while the NEPSE’s index was down by 3.3674 percent at that point in time. Similarly, the IPO of NIC Laghubitta Bittiya Sanstha Limited (NICLBSL) got oversubscribed by 5.16 times and Sadhana Laghubitta Bittiya Sanstha Limited (SDLBSL) got oversubscribed by 16.44 times. The ratings for the IPOs of both companies was four, indicating a below average fundamentals.

Chairman of Association of Investment Professionals in Nepal (AIPN), Dr Manoj Shahi believes that one of the primary reasons for the oversubscription of IPOs is the lack of other investment products. “Retail investors are limited to the stock market, investment products provided by banks and insurance companies, and real estate. Real estate is difficult to get into and out of and locks investments for a much longer time, which magnifies the attraction of the stock market.” He further adds, “Also, the practice of mandatory issuance of shares at par value of 100 has essentially meant that investors were given access to equity shares that would, in most instances, go up in the secondary market. The only exception thus far seems to be hydro power shares.”
 
Dr Shahi further explains that the difference in performance of shares from different sectors is being taken into account by the investors, an example being the multi-fold oversubscription of Reliance insurance shares compared to the subscription of Liberty Energy Limited.

However, the over-subscription of Reliance Life Insurance shares cannot be considered irrational considering the lack of investment products and the almost guaranteed short term to the investors, who can get the IPO. This is not an act of irrational investing, but fundamental investment is also definitely not in play.  “Despite this, why anybody would invest in the equity of a hydropower company that isn’t operational yet with a declared IRR of 13.11 percent and has a whole variety of risks associated with it is beyond me. In addition, why invest at par value of 100 when you may be able to get similar hydro power shares at substantially less than par in the secondary market?” he questions.

IPOs being oversubscribed even during the current downturn in the economy isn’t surprising news. Historically, IPOs have always been oversubscribed even when NEPSE has been down or when the economy of Nepal was in a bad condition. NEPSE had dropped by 67.86 points and closed at 841.96 points on its first week of reopening after the earthquake of 2015. The primary market didn’t share a similar sense of pessimism as the IPO of Bhaktapur Finance got oversubscribed by over three times and the IPO of Mirmire Laghubutta Bittiya Sanstha Limited got oversubscribed by 220 times within two weeks of the earthquake.

Sahswot Pathak, stock analyst at iCapital Pvt Ltd expresses that IPOs have historically been a very lucrative investment as the investors get to apply at just Rs 100 per share. The amount usually jumps three to four fold when it gets listed in the secondary market. “Recently the IPO of NRIC was hyped with oversubscription. The people who invested on NRIC got handsome returns,” he explains. “But when we look at its prospectus, the shares do not look worth investing on despite its good ratings,” he adds.

“There is liquidity in the market and people are looking for avenues to invest in. Nepal doesn’t have other alternative investment asset classes readily available to the public, so they jump into the equity market,” Pathak continues. “There is a general tendency to disregard the prospectus. People do look at factors like book value, EPS, etc. before investing but it is mostly limited to trading in the secondary market. Fundamentals aren’t considered much when it comes to IPOs,” he says. He further adds that IPOs of many hydropower companies have been undersubscribed in the past. The reason for the shares of Liberty Energy Limited being oversubscribed may be the liquidity in the market. Even the fixed deposits do not provide much returns to an individual investor, which may be turning them towards the products in the capital market.

It should not escape our notice that while the IPOs of most of the sectors are being oversubscribed by a few times, IPOs of microfinance companies are clearly winning the race by being oversubscribed by as much as 126 times even during the lockdown. The price of shares of microfinance companies also usually get catapulted the highest when they get listed in the secondary market.

Santosh Mainali, executive chairman of Secured Securities notes that the price in our market is also supported by shortage in supply. “Total shares outstanding of microfinance companies combined together is less than that of two commercial banks. The major institutional investors in our market are banks and insurance companies, who are not restricted to investing in microfinance scrips. It sometimes creates good demand for these scrips,” he explains. “Also, our novice investors love right shares which were frequently issued by microfinance institutions. Due to these factors, scrips of microfinance are priced higher in the secondary market. When you can sell at a profit of more than 500 percent within a month, why to bother about the fundamentals?” he says. He acknowledges that even the smarter and the more knowledgeable investors think this way and hop towards the primary market. The technological advancements in the primary market has also made it easier for everyone to apply by a few clicks or taps.

He does not deny the prevalence of investor ignorance. Even with the availability of cheaper shares in the secondary market for hydropower companies, investors still beelined for the IPO of Liberty Energy Limited at par value.  “Most investors with savings and an access to IPO are unaware about such alternatives. Besides, it does take great courage to risk Rs 1000. People may choose to not bother to analyse all of this just to bet Rs 1000.” Investors that prefer not to analyse much before applying for IPOs may be guided by a feeling that if they apply and lose, they lose a maximum of 50 percent but not applying at all may cause a much higher opportunity loss.

Likewise, Girish Lakhey, Managing Director of Snowball Capital notes that the prevailing trend of issuing shares at par value (Rs 100) in the primary market makes it highly unlikely to go below the investment price in the secondary market. “For most companies, their fundamentals justify a price higher than Rs.100. IPOs have limited downside risk and huge upside potential. That is a major reason for IPOs oversubscription,” he says, “However, the same cannot be said for all of the IPOs so, a brief screening should be done by investors before applying.”

While the oversubscription of IPOs almost always results in handsome returns for the lucky investors that literally win the lottery, it also cannot be denied that it is also an indication of investors not necessarily being fully aware of the risks and returns associated with the investments they make.

Dr Shahi, chairman of AIPN views that many investors probably lack the tools/knowledge needed to make a comparison between existing shares and new IPOs. “There is a lot of information asymmetry in the market. This has a broader implication on the well-being of the domestic capital markets and highlights the need of having a professional investment advisory service sector that will help bridge the information and knowledge asymmetry in the markets,” says Dr Shahi. “It also highlights the need to have easy and timely access to operational and financial data on listed companies for analysis to make investment decisions which is sorely lacking,” he adds.

It can be inferred that investors in Nepal are making the best choices they can make with respect to past market behaviour, lack of investment alternatives and the limited information and analysis that they have access to. “Are they affected by sentiments and prejudices? Definitely. But the market determines the sentiments and prejudices. Can they be better investors? If the information and knowledge asymmetry in the market can be reduced,” concludes
Dr Shahi.

Rijal is a final year student at Kathmandu College of Management with finance and banking as her majors.

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