Can IPOs make you rich?

Narendra Nathan, ET Bureau Jul 7, 2014

With the BSE Sensex settling above the 25,000 mark, company promoters and merchant
bankers are on an overdrive to 'revive' the primary markets. This explains why the number of
companies planning to hit the street with primary offers is increasing with every passing day.
Lavasa Corporation, promoted by Hindustan Construction Company and HCC Real Estate, is
the latest to file its draft red herring prospectus with the Securities and Exchange Board of
India (Sebi). It plans to raise Rs 750 crore through this initial public offering (IPO).

There may be a flood of IPOs if the stock market continues to remain firm for a few more
months. "There is no IPO frenzy as of now, but it will start in 6-12 months if the secondary
markets shows more strength," says Prithvi Haldea, chairman and managing director, Prime
Database.
In addition to buoyancy in the secondary market, other factors are also expected to contribute
to this IPO rush. Recently, Sebi extended the 25% mandatory public shareholding norms to
PSUs as well. It has given PSUs three years to comply with this new order. According to the
ETIG data, PSUs will have to issue shares worth Rs 62,000 crore to comply with the Sebi
mandate.
Recently, the market regulator also relaxed another rule that was seen as thwarting smaller
companies' primary market aspirations. It is no longer compulsory for companies with a post-
issue capital of less than Rs 4,000 crore to sell a minimum 25% stake at the time of listing.
Just like their Rs 4,000 crore-plus brethren, they are now allowed to come out with an initial
issue size of 10% and increase the minimum public shareholding to 25% within three years of
listing.
So, are you ready for the roller-coaster primary market days? We say roller-coaster because
IPOs can generate very high returns or very high losses. While some of the IPOs that hit the
street during the past one year generated more than 300% returns, there are others where
investors lost more than 50% (see table I PO Winners and Losers in 2013). The 10-year
analysis we did also threw up similar results. Therefore, investors have to learn the art of
distinguishing between potential winners and losers. They need to watch out for the danger
signs. Given below is a detailed guide to help ensure that you pick the winners.

Don't participate in just any issue that is announced. Promoters and merchant bankers may
flood the street with their offerings, but there is no compulsion that you participate in them.
"Investors have to pick and choose among IPOs," says Devang Mehta, senior vice-president
and head, equity advisory and sales (retail), Anand Rathi Financial Services. Though the
Controller of Capital Issues (CCI) was abolished way back in 1992, some investors continue
to live in the old days and act accordingly to their disappointment. Since the CCI used to
fix 'fair price' way below the market price all IPOs used to generate fabulous returns.
This is perhaps why investors who have not kept up with the times think that it is 'completely
safe' to invest in the primary market. It is high time they do a reality check.
Since there are no government agencies that fix the issue prices now, investors need to do
their own research. "All parameters that investors use to analyse stocks in the secondary
market should be applied to the primary market as well," says Sriram Iyer, CBO, Religare
Private Wealth. Let us go through the parameters one by one.
Promoters' promise
"The quality of the promoter is the biggest thing in IPOs," says Ajay Bagga, executive
chairman, OPC Asset Solutions. "See whether the promoter is honest and capable," says Iyer.
This can be done by tracking other companies managed by the promoter group. Investors
need to take a long-term view and analyse at least 5-7 years' data to determine the long-term
track record of the promoter.
"Read risk factors carefully as they contain all the details about the promoters including
income tax raids and cases against them. Avoid companies where the integrity of promoters
is doubtful," says Haldea. A careful research on the promoter will help you avoid investing
into companies that are floated by fly-by-night operators.

Business background
The performance of an IPO depends on the future performance of the company and,
therefore, you should only get into sound businesses. Compare the company's return ratios
and make sure that they command better margin than the industry average. You also need to
take a call on the business sector is it going to do well in the future or not? For example,
most IPO losers are from sectors that are under pressure now power, real estate and
infrastructure development.