Trends and returns of initial public offerings in India With special reference to the period 2006-08.
Singh, Satyendra K. ; Govil, Mani
[ILLUSTRATION OMITTED]
Introduction
The existence of the phenomenon of "underpricing" is a
well-established phenomenon for the common stock initial public
offerings (IPOs). Research concerning the primary capital market has
unequivocally concluded initial public offerings are offered at a
discount. It has been found that an average firm goes public with an
offer price that is lower than the price that prevails in the immediate
aftermarket. As a result, IPOs register significant excess returns on
the first day of trading. The underpricing is thus corrected by the
market on the listing day.
During the fiscal year 2000-01, the book-building route was made
compulsory for companies, which do not have the track record of
profitability and networth as specified in entry norms prescribed by
SEBI. The book-building route has also been made compulsory for IPOs
with issue size more than five times the pre-issue networth and for
public issues by listed companies worth more than five times the
pre-issue net worth. In these cases also, 60 percent of the 'offer
should be allotted to Qualified Institutional Buyers(QIBs). While book
building has become increasingly popular especially for large issues,
smaller issues by relatively small firms continue to be offered on fixed
price basis. Though other issuers can use fixed price offers also, most
have been using book-building route ever since. The reason being that
there are no restrictions on minimum asset size and profits incase it
opts for the latter provided it is able to place at least 50 percent of
the stocks offered to QIBs.
The existence of the phenomenon of "underpricing" is a
well-established fact for the common stock initial public offerings
(IPOs). Research concerning the primary capital market unequivocally
concludes that the initial public offerings are offered at a discount.
It has been found that an average firm goes public with an offer price
that is lower than the price that prevails in the immediate aftermarket.
As a result, IPOs register significant excess returns on the first day
of trading. Underpricing is a phenomenon that is largely restricted to
the opening transaction. And hence, the underpricing is almost entirely
"corrected" by the market at the opening transaction.
This study aims to study the initial and long run returns of common
stock initial public offerings made during the years 2006 and 2007 and
understand the level of underpricing. It aims to understand the
relationship between the performance of the index and the average
returns of the IPOs of some important sectors. This paper is organized
as follows: Section 2 gives the overview of trends and performance of
IPO during 2006 and 2007; Section 3 reviews the empirical literature on
the performance of IPOs in the short and long run; Section 4 describes
the data sources and methodology of study; Section 5 presents the
results and analysis and section 6 concludes the findings of the study.
Trend in the IPO Market
The number of issues during 2003 to 2007 grew at a good pace which
peaked in 2007 due to high market sentiments, good economic growth,
exceptional high FII activity, market friendly regulations etc. The
period of study (years 2006 and 2007) was an important one since Indian
companies raised Rs. 33,258 crores through 78 Initial public offerings
in 2006. This was due to the fact that the Indian economy exhibited
acceleration in growth, led by manufacturing and services sector
activities, in this period, facilitated by financial market conditions,
which remained orderly. Real gross domestic product growth accelerated
from 9.0 per cent during 2005-06 to 9.4 per cent during 2006-07.
The year 2006, owing to the strong investment climate in the
economy, was an exceptional year for the Indian IPOs, India being the
eighth largest, the first being the United States, followed by Japan and
China. The energy companies raised more than 59 percent share of funds
raised. Real Estate and Energy sector dominated the surge in IPOs in
1997, too. This was due to the high growth in the corporate sector, a
near double-digit economic growth, phenomenal growth in the sensex
spurred by the heightened foreign institutional investors (FII) activity
etc. Localization and qualified institutional placements also picked up.
During 2006-07, cross-border activity and role of foreign capital grew
and FIIs contributed three-fourth of new capital flowing into the
market. The benchmark index, sensex gained over 44 percent between
January'07 and December '07. The year 2007 will be remembered
as one of the best years for stock investing as the domestic market more
than doubled in value. The market capitalization during the year,
increased by 110 percent. The period under study saw seven top
infrastructure companies, such as Larsen and Toubro, Patel Engineering,
Punj Lloyd, Nagarjuna Construction, IVRCL and Hindustan Construction
growing by over 50 percent. This sector attracted total investment of
over 2 crore between April 2005 and March 2007 including two mega hydro
power, road and metro projects.
Real estate companies were the foremost sector in mopping up huge
amounts from the primary market through IPOs during 2007. Quoting the
figures given by Assocham, property developers mobilized as much as 42.7
percent of the total funds through IPOs. Table 1 lists the amount
mobilized during the last few years by initial public offerings.
Out of total Rs 34,119 crore raised in the primary market from
January 1, 2007 till mid December, Rs. 14,591 crore was raised by realty
firms. DLF mob ilized Rs. 9,1 87 crore, Housing development and
Infrastructure Ltd Rs 1,707 crore and Purvankara Projects Rs 858.7
crore. Real estate companies namely IVR Prime Urban Developers (Rs 778
crore), Omaxe (Rs 650 crore), Brigade Enterprises (Rs 671 crore) and
Akruti Nirman (Rs 361 crore) raised money through public issues. Power
and telecom companies raised Rs. 4,519.18 crore and Rs 2,964.06 crore
respectively. Even though interest rates were high to curb inflation and
the RBI and the govt., curbed the real estate sector to access funds,
they proved to be most aggressive in raising funds (refer to table II).
The factors contributing to the growth was due to strong underlying
demand, easy availability of home loans, easy repayment facilities,
aggressive marketing, entry of new players and upsurge in retail and
multiplexes.
Due to the US recession, prevailing slow-down and volatility in the
Indian markets, IPOs are giving way to private equity route. The Indian
realty sector which was earlier on a boom, witnessed a deluge of funds
from investors and builders, despite the private equity deals picking
up. Another trend was entity level partnerships in realty sector, such
as that of Morgan Stanley acquiring a stake in Mantri developers.
Overseas builders too perceive a huge opportunity in this market. The
other sectors too faced slowdown due industrial slowdown, drying up of
foreign funds and high oil prices, 2008 onwards. Due to supply
constraints and sluggish increase in output, major infrastructure
industries- crude petroleum, petroleum refining products, coal,
electricity and finished carbon steel suffered major drop in growth.
By the third week of January 2008, the sensex was down by 10
percent. Banks were badly affected due to the US sub-prime losses and
real estate and oil sector were also major casualties. Only 3 IPOs were
issued in the first quarter of 2009. FIIs are waiting for a more stable
environment to start investing again, a scenario which is expected to
take a couple of more quarters.
Quoting a report by SMC Capitals in March 2009, out of 278 IPOs
during 2005-2008, only 13 percent are in the green. This was when the
sensex gained 51 percent during this period. The IPOs of 2006 traded at
a loss of 19 percent whereas the IPOs of 2007 at a loss of 44percent.
Only the infrastructure IPOs of 2006 were trading at a gain of almost
35percent. Table III gives the average returns for the last four years.
Literature Review
On studying the initial returns of IPOs, it was observed that
underpricing has been the norm rather than the exception to compensate
uninformed investors. Benveniste and Wilhelm 1990, Spatt and Srivastava
(1991) and Benveniste and Busaba (1997), have proved by using
theoretical models that book building as compared to fixed price option
has shown lower underpricing. Benviniste and Spindt(1989) study showed
that underpricing is a natural cost of compensating investors for giving
truthful disclosure of private information. The early empirical studies
on IPO markets in India focussed mainly on initial returns. A study by
Krishnamurti and Kumar (1994) from 1992-93 for 98 IPOs revealed an
average initial returns of 35.3 percent, Shah(1995) mean initial returns
of 105.6 percent for the period Jan 1991-April 1995 on a data set of
2056 IPOs. The significant level of underpricing could be to compensate
retail investors for their ignorance as reported by some studies done
during the mid 1990s. The study conducted by Pandey and Arun Kumar
(2001) found mean initial market adjusted returns of 69.8 percent on
equally weighted basis. Though, most of the analysis was pertaining to
initial returns rather than longrun returns, Shah (1995) reported that
IPOs reported high average long run returns. This could be possibly due
to the optimistic market sentiment and liberalization in the Indian
economy post 1992.
Subsequently the long run returns started reducing and a large
number of issuers are reported to vanish after mobilizing capital. A
worldwide survey of literature on the phenomenon of underpricing of IPOs
exhibit three fundamental characteristics: (a) the initial price
reaction phenomenon or in other words 'underpricing': the
immediate after market price, on average is significantly higher than
price at which the initial offer was made; (b) the Hot Issue Phenomenon:
there are distinct cycles outlined, both in the number of issues that
come to the market and the level of initial price reactions; (c) the
long-run "Underperformance" phenomenon: initial offers are
said to perform dismally in the long-run compared to the industry
counterparts for the same period.
The data on IPOs for the years 2006 and 2007 was obtained from the
official website of National Stock exchange, www.nseindia.com. A total
of 168 public issues were issued in the calendar years 2006 and 2007,
through the National Stock Exchange, out of which, 73 were issued in the
calendar year 2006 and 95 in 2007. Out of the total, 34 IPOs could not
be studied due to late listing, follow on shares, or non-availability of
the continuous time-series of their prices on NSE. Thus a total of 134
IPOs were analysed for initial returns. The IPOs included in the sample
had to be common stock only, be the company's first public issue,
listed on NSE and those whose share price time series were available for
500 trading days since listing date.
Of the 134 IPOs, as many as 34 were from the infrastructure
industry comprising of power, telecom, mining, cement, highways etc. and
14 were from the realty sector. The rest being from entertainment (12),
Information technology (10), banking (10), pharmaceuticals (9) and
textiles (8) industry. Thus out of 119 total IPOs in the period during
study, a sample of 48 IPOs (34 from infrastructure and 14 from realty)
were studied in detail regarding their initial and long run returns and
compared with their respective indices namely CNX Infrastructure index
and CNX realty index. The infrastructure sector picked-up, benefiting
from strong growth in cement, basic metal and alloy industries.
The 25-stock CNX Infrastructure Index represents about 78.77
percent of the market capitalization and 77.07 percent of aggregate
turnover of the companies forming part of the Infrastructure Sector
Universe. Infrastructure Index constituents represent about 21.43
percent of the total market capitalization as on March 31, 2009. CNX
Infrastructure Index includes companies belonging to Telecom, Power,
Port, Air, Roads, Railways, shipping and other Utility Services
providers.
The initial returns on the total sample of 134 IPO's were
studied by finding their percentage return based on the first day of
listing as given by-
(P-O)/O*100
Where, P= Closing price on the day of listing
O = Offer price
Long Run Returns
The long run performance of only 48 IPOs, 34 from the
infrastructure and 14 from the realty sector IPOs were considered. These
being the sectors, which mobilized the maximum funds during 2006 and
2007, exhibiting the robust growth of the economy. For analysing long
run performance of the IPOs in the sample, the average daily returns for
upto 500 trading days after listing were considered. This was done by
computing the average daily return of 500 days after the day of listing.
Longrun performance was computed by: ([P.sub.t-] [P.sub.t-1])/
[P.sub.t-1] where Pt = Closing price of the stock on day
As 34 of the 134 IPOs in the sample are from infrastructure sector,
the returns are compared with CNX Infrastructure index and the
relationship between the two is judged by the Student t test for finding
significance of difference of mean. For the realty sector (14 IPOs), CNX
realty sector was used.
The standard deviation, which measures the risk of the asset, is
also computed for realty and infrastructure IPOs under study.
The correlation of infrastructure companies and CNX Infrastructure
index and correlation of realty companies and CNX Realty index was
computed.
The sensitivity of the IPOs with the market movements, indicated by
the beta value is also calculated to study the systematic risk of the
IPOs under study. Beta for the security X is calculated by following
formula: [beta] = cov([R.sub.x], [R.sub.w])/Var ([R.sub.w])
where return on IPOs which is dependent variable (Rx) and return on
market index is the independent variable (Rm). Since the CNX
infrastructure index and CNX realty index were formulated in February
2006 and December 2006 respectively, the average daily returns of the
indices, the t-test for difference of mean daily returns, the
correlation between the IPOs and the index and the beta value has been
calculated from the average daily returns from February 2006 and
December 2006 for the infrastructure and realty IPOs respectively. The
study faced some limitations constraining the inference on long run
performance. The market returns need to be adjusted with an index, which
is representative of small capitalization stocks. The results otherwise,
could be easily affected due to the presence of well known "size
affect" in the capital markets. A further study could be made by
considering the issue-size weighted initial returns and average
cumulative adjusted returns for long run performance.
Findings and Analysis
Initial Returns
In line with the evidence on initial returns from IPOs worldwide,
IPOs included in the sample also provided positive and significant
initial returns on an average. The average initial returns were positive
and significant. It was 28.34 percent on an average for the years 2006
and 2007, based on the opening offer price and the closing price of
listing day. This was 24.95 percent for the year 2006 and 30.63 percent
for the year 2007. The median returns on these IPOs were 15.67 percent,
even though the variance of the initial returns was at 52.25 percent.
Out of the total sample of 134 which were studied for initial returns,
45 IPOs were underpriced whereas 89 were overpriced (refer table IV).
The equity markets were very volatile during the second-half of August
2007 and second-half of December, in tandem with trends in international
equity markets.
The 34 IPOs of infrastructure industry gave average initial daily
returns of 37.32 percent ranging from -30 percent to 235 percent. The
median returns of this sample were 27.34 percent. The issue size of this
sector ranged from approximately 24 crore to 5261 crore, the average
issue size being 502 crore.
The 14 IPOs of realty sector gave initial average daily returns of
20.95 percent ranging from -24 percent to 75 percent. The median returns
were 14.62 percent. The issue size of realty sector was much higher,
ranging from 51 crore to 9187 crore, the average issue size being 1073
crore. While the standard deviation of the realty sector was 30.86
percent, it was as high as 55.2 percent for the infrastructure IPOs.
The cross-sectional differences in initial returns arises due to
various factors like quality of underwriters, institutional and venture
capital stake in the firms, proportion of the issuing firm's
capital being offered in the IPO, financial competence, reputation, size
of the issue, age of the issuer etc.
Long-run Performance of the IPOs
Return on IPOs decline with the passage of time (long-run). Daily
return for the 500 days period also shows a decrease with the passage of
time. Whereas the average daily return for the 500 days after listing is
-.11 percent for the realty sector, it is -.03 percent for the
infrastructure sector. The positive returns of both have been wiped out
by the third day.
Whereas the infrastructure initial public offerings have negligibly
underperformed the index, the realty offerings have shown almost similar
performance as the CNX realty index. The standard deviation for the
realty sector IPOs was 1.56 percent whereas for the infrastructure
companies, it was .90 percent, which is insignificant. These sectors
have thus not shown much volatility and risk during the years under
study. Infact, infrastructure sector during 200607 showed highest growth
since 1999.
While 19 of these 33 infrastructure IPOs ended 500 days with
positive average daily returns, remaining 14 had negative average daily
returns. For realty IPOs, only 4 showed positive average daily returns
for 500 days, and the rest 10 negative returns. There was insignificant
correlation between infrastructure companies and index at .12. (The CNX
infrastructure index has been taken from 17th Feb '06 post its
formation upto 500 days).
Between realty companies and its index, there was no correlation.
(The CNX realty index average returns have been taken from 2nd Jan
'07 post its formation upto 500 days).
Graph 1 traces the changes in average daily returns of realty and
infrastructure IPOs from month 1 to month 17 starting from January 2006.
[GRAPHIC OMITTED]
The correlation between infrastructure IPOs is 0.76 and for the
realty IPOs 0.99, which is very strong.
The beta value for the realty IPOs is computed to be 0.92 whereas
it is 0.46 for infrastructure IPOs. Since, these are less than 1; it
indicates that the IPOs under study are less volatile than the market.
([beta]<1) indicates that the security has less systematic risk or is
less volatile than market.
Overall the results are consistent with evidence of relatively poor
long run performance of IPOs reported across countries. The findings do
not agree with the analysis of Shah (1995) which shows excess returns on
IPOs even after listing. According to this study, most of the excess
initial returns on an average are wiped out in the first year after
listing. The study however has informational constraints. The excluded
IPOs from the sample were the ones for which time series data was not
available.
The gains made by the IPO investors soon turned to losses due to
underpricing and spillover effects of the US sub-prime mortgage crisis
seen in India too by the mid of 2009 but the adverse impact could be
felt much earlier. The banking and the realty sector were most
prominently adversely affected since the RBI raised CRR, SLR and the
interest rates to reign in inflation. The housing sector, heavily
dependent on loans are facing a demand slowdown and falling prices which
is expected to continue for the next two years. Developers who are
specialized in building homes and offices are planning to expand their
scope of work by building warehouses due to the high growth in Indian
retail sectors and slowdown in realty sector.
The bullish trend in the capital market was seen in the IPO volume
of 2007, as a record volume of USD 8.18 billion was raised. This was due
to the accelerated growth in the Indian economy led by manufacturing and
services sector activities. However, the value of the amounts raised has
heavily eroded by Oct 2008 across all industry segments.
[GRAPHIC OMITTED]
* This study investigates the initial and long run (up to 500 days)
returns of common stock initial public offerings in the years 2006 and
2007. The average initial returns made on the first day of listing on
the offer price are quite high at 28.34 percent. Only 44 out of the 134
IPOs that were made after 1 January 2006 till 31 December 2007 were
listed at a discount, the rest at a premium.
* The long run performance of 48 IPOs under study belonging to the
infrastructure and realty sector, the hot sectors under the period of
study, showed insignificantly negative, long run average daily returns
(up to 500 days). The SandP CNX Nifty index gave a positive but average
daily return of .17 percent.
* The long run average returns of the realty and infrastructure
IPOs were found to be consistent with that of their respective indices.
* The standard deviation of both the sectors, realty and
infrastructure, is negligible, As such, investing in these sectors in
2006 and 2007 were not risky for the investors. Infact, the IPOs of
infrastructure sector which came in the market in 2006 were still
trading at a profit in March 2009. The growth of core infrastructure
industries at 8.6 per cent during 2006-07 has been the highest since
1999-2000 (9.1 per cent).
* There was insignificant difference of means of average returns of
IPOs and the respective index, as verified by t-test.
* There was high correlation and thus high degree of relationship
between realty and infrastructure IPOs and their respective indices.
* The IPOs of realty and infrastructure IPOs have shown less
systematic risk than their respective indices. Thus their returns were
less volatile than the returns on their respective indices. The reason
could be attributed to the favourable economic scenario in these years.
* The infrastructure and realty sectors were good sectors to have
invested in the period 2006 and 2007.
* Acceleration in the growth rate during 2006-07 was attributable
to buoyancy in the industrial and services sectors, which exhibited
double-digit growth (11.0 percent). This favourably affected the
performance of IPOs. (see chart 2)
Going forward, pricing of the forthcoming issues in the bear market
will be a major challenge for the issuers as the fundamentals and
technicals of the issue prices are not being considered by the market.
The forthcoming IPOs may witness an underpricing in their share values
in order to get their issues subscribed. Another interesting area of
further research would be the impact of share allocations, which is
decided by a variety of means, on the IPO's performance on the
first day.
References
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Characteristics of Issuers: Differences in Indian IPOs following Fixed
Price and Book Building Processes",
www.iimahd.ernet.in/publications/data/2005-01-07ajay.pdf
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Practices and Contemporary Thoughts.
Satyendra K. Singh
Lecturer
International Institute for Special
Education, Lucknow.
Mani Govil
Senior Lecturer
IISE'S Business School, Lucknow.
Table--I
Resources Mobilsed from the Primary Market
Rs. No. of
(Crore) IPOs
2000-01 2,722 114
2001-02 1,202 7
2002-03 1,039 6
2003-04 3,434 21
2004-05 13,749 23
200506 10,936 79
2006-07 28,504 77
2007-08 42,595 85
2008-09 (as on 31/01/09) 2,010 20
Source: handbook of statistics on the Indian
securities market 2006, www.sebi.gov.in
Table--II
Distribution of IPOs during Jan'06-Dec'07
IPO amt (Rs %
crore) share
Construction & real estate 18641.7 21.17
Construction (excluding DLF) 9454.2 10.74
Banking & Finance 16261.6 18.47
Oil & Gas 14243.1 16.17
Manufacturing 21854.45 24.82
IT, telecom and other services 7604.6 8.64
Total 88059.65 100
Source: ETintelligence.com
Table--III
Trends of returns
No. of IPOs Returns as on March 17,2009
2005 -25.19%
2006 -19.03%
2007 -44.39%
2008 -56.27%
Table--IV
Initial returns of IPOs under study
Returns greater No. of issues
than
99% 9
75% 17
60% 27
50% 34
40% 47
30% 54
Table--V
Findings
Infrastructure
Average daily returns-. -.03
Standard deviation. 90
Average daily .15
returns of SNP infra
index
t-test for difference insignificant
of means between
average returns of
index and IPOs
Correlation between .76
IPOs and index.
Beta(index and IPOs) .46
Realty
Average daily returns-. 11
Standard deviation 1.56
Average daily -.20
returns of SNP
realty index
t-test for difference insignificant
of means between
average returns of
index and IPOs
Correlation between .99
IPOs and index
Beta (index and IPOs) .92
