What to look for in IPOs, before investing

Valuations, promoter experience, placements, brokerage calls & analyst recos give a fair idea

MUMBAI: Since April 20, 2006, when the Sensex touched 12,000 for the first time, 155 companies have raised a total of Rs63,300 crore (including the yet-to-be-listed Reliance Power) through initial public offerings (IPOs).

In the last two days, two companies — Wockhardt Hospitals and Emaar-MGF — have withdrawn their IPOs, while a couple of banks have cancelled their follow-on public offers.

Understandably, when the stock market is doing well, investors subscribe to anything; few questions are asked. But, when it falls, the reaction is of the other extreme — investors just don’t invest. Still, nobody likes to do the “due-diligence”.

So, what should an investor look at while deciding to invest in an IPO?

“Read the red herring prospectus that the company files with the regulator,” a skeptic might say. However, that really isn’t an option.

Emaar-MGF’s prospectus ran into a total of 780 pages, Wockhardt Hospital’s 358 pages and Reliance Power’s 312 pages — no way an investor can read all of this.

However, an investor can definitely look at a few things, for making an informed decision:

1) Valuations: The first thing to look at is how aggressive the IPO is priced at with respect to listed companies in its segment. Take Wockhardt Hospitals — its price-to-earnings (PE) ratio could have varied between 169 and 195 depending on the price it was subscribed at. In comparison, a major existing player like Apollo Hospitals is currently quoting at a PE of 29.8. PE ratio can be calculated by dividing the price of the stock with its earnings per share.

This basic comparison clearly tells us that Wockhardt Hospitals was very aggressively priced. That is why investors, who have suddenly smartened up, decided not to invest.

R Balakrishnan, executive director, Centrum Broking Pvt Ltd said, “This is a market where people are scared and are holding back their investments. Hence, pricing issues like they were in the past year will not work. Valuations are the key.”

The more aggressively an IPO is placed, the lesser the chances of price appreciation.
V K Sharma, director and head - research at Anagram Securities said, “People need to look at an IPO from a longer-term perspective rather than from a listing gains view. They need to see whether, after the IPO, there is any space for price appreciation.”

Take the case of Emaar-MGF, whose PE varied from 165 to 197(based on annualised earning per share of Rs3.20). When compared to a listed entity like DLF, which currently quotes at a PE of 73.8, it seemed very aggressively priced. Indeed, Unitech, the oldest listed real estate stock, quotes a PE of 48.8.
Similarly, Reliance Power was issued at a PE of 5,625. In comparison, the PE of a much established NTPC currently stands at 21.8. When an investor has the opportunity to invest in a similar business in the secondary market, that is where he should be.

“Given a choice, I would rather go to the secondary market. There is enough information available on the listed companies. There is hardly any time between the Sebi approval and the launch of the IPO,” says Balakrishnan.

2) Promoters’ experience: In case of Emaar-MGF, as India Infoline Ltd had pointed out in a report, the Indian promoter, MGF, has a limited track record in real estate development. At the same time, DLF has been in the real estate business since 1946, and was responsible for building most of South Delhi and Gurgaon

3) Pre-IPO placements: A good metric is what price the company has made its pre-IPO placement to big investors. Emaar-MGF had made a placement with New York Life investments at a price of Rs248 per share in May 2007. The IPO, however, was priced in the Rs 530-630 range. So, what had changed so drastically in 8 months that demanded such aggressive pricing?

Balakrishnan of Centrum feels pre-IPO placements are used as a marketing tool by various companies during their IPOs. But it is debatable whether the sailing is easier for those with big names on their pre-IPO placement list.

4) Brokerage reports: Read the reports put out by various brokerages, but don’t take the recommendations too seriously. Brokerage reports on IPOs can provide the investor with all the information he needs on the company.

However, companies engaged in stock broking are also into investment banking, and investment bankers are hired by companies to manage the entire IPO. Hence, if a particular investment bank is handling an IPO, it is highly unlikely that its sister broking division will put out a negative report on the stock. So, the trick is to look at reports written by brokerages whose investment banking divisions are not handling the IPO. “Most brokerages do not like to put out “do not subscribe” recommendation on any IPO. But even a “neutral” recommendation should be read as avoid,” says a financial planner, not willing to be named.

5) Ratings: Lately, it has become compulsory for every company coming out with an IPO to get a rating on a scale of 1 to 5 from a rating agency. On whether one should use ratings provided by agencies as a parameter, Balakrishna says, “Ratings do not give you any guarantee of the IPO pricing.” In addition, there is an inherent conflict. The company being rated is also paying for it, so the question is “will the rating agency carry out the entire exercise objectively.”

k_vivek@dnaindia.net
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