CRITICAL ANALYSIS OF IPO’s FAILURE

Under the Guidance of Prof. Swati Basu Ghose

Every year No. of Investors looses their money in share market and much of the reason for lost is their investment in IPO .

Our main objective of Empirical Study is to find the reason why IPOs fails and for that finding we have studied various different aspects associated with IPOs .

An Initial Public Offering (IPO) is the first sale of a corporation's common shares to public investors. The main purpose of an IPO is to raise capital for the corporation .

EXECUTIVE SUMMARY

• Various process of pricing IPO .• Grading system of IPO under our study. • Details study of various 22 different companies whose IPO came in market in year 2009 .• Rural India .

We had made conclusion on base of all surveys, study, details and research we had done during our Empirical

Study

FIRMS ARE GOING PUBLIC

The main purpose of an IPO is to raise capital for the corporation.

Other than raising capital, the reasons for IPOs which we found were:

1. Liquidation of the shares of the company so that the founders and the rest of the existing shareholders will be able to "cash out“.

2. Increased Capital. Raised capital can be used as working capital, acquisitions, research and development, marketing, and expanding plant and equipment.

3. Expansion of the company into new territories not only by means of more funding, but also by regulatory or marketing reasons . Being public is associated with credibility and accountability.

4. Expansion of the company either by acquisition or merger.

5. Leveraging future sales or business to create extra value for the company.

BOOK BUILDING PROCESS“a process undertaken by which a demand for the securities proposed to be issued by a body corporate is elicited and built up and the price for such securities is assessed for the determination of the quantum of such securities to be issued by means of a notice, circular, advertisement, document or information memoranda or offer document.”

However, book building is a transparent and flexible price discovery method of initial public offerings (IPOs)

The traditional fixed price method of tapping individual investors suffered from two defects:

(a)Delays in the IPO process (b)Under-pricing of issue.

Steps involved in Book Building Process

Book Building VS Fixed Price Option in the IPOs

In fixed price process in IPOs, prices of IPO is fixed before and allotments of shares to all investors are made on proportionate basis. Institutional investors normally are not interested .

In Book Building the price is determined on the basis of demand received or at price above or equal to the floor price. Book Building process book is built by Book Runner Lead Manager (BRLM) to know the everyday demand

Limitations of Book Building Mechanism

1. The issuer company should be fundamentally strong and well known to the investors .

2. The book-building system works very efficiently only in matured market conditions .

3. The investors are aware of the various parameters affecting the market price of the securities.

4. There is a possibility of price rigging on listing as promoters may try to bail out syndicate members.

Green Shoe Option

- It is experienced that IPO through Book Building method in India turns out to be overpriced or underpriced after their listing of them - It can prevent the IPO from huge price fluctuations and save investors from potential loss. Such mechanism is known as Green Shoe Option

ICICI Bank has, used Green Shoe Option in first time

RURAL INDIA The villager, born humbly and bred hard, Content his wealth, and poverty his guard, In action simply just, in conscience clear, By guilt untainted, undisturbed by fear, His means but scanty, and his wants but few, Labour his business, and his pleasure too, Enjoys more comforts in a single hour Than ages give the wretch condemned to power.- Charles Churchill 

WOMEN OF RURAL INDIA - Women the word sounds so powerful.- Today women are equally competent behind the veils and outside world. - They are more confident and one can find them in every possible sphere of human‘s life. - Thanks to the efforts of government, NGOs, social welfare organizations and many such institutions, there has been a drastic improvement.

Empowering Rural India Governments have been emphasizing economic development by ensuring growth rates of seven-eight per cent annually

No. Of notable steps are taken by the Government of India for Empowering Rural India

Why Rural India do not invest in IPO. CONCLUSION

•Not a risk taker

•Conservative

•Lack of Access to Proper Information

•Alternative Investment Option

•No Technology

•Lack of Financial Organization. No Financial Inclusion

•No Encouragement to Banking Services

•Lack of knowledge about Financial Market.

•No Consistent income.

Questionnaire

Question 1 :

Have you included IPOs in yours or your clients portfolio?

Yes - 45 %No - 55 %

Sample Size : 60

Question 2 :

What was the size of Investment in IPO ?

As investors were not cooperative in telling their investment size which resulted in minimum response to this particular Question. Investors did not disclose their amount of investment to us.

Our sole aim was to find out confidence level of investors in IPO.

Question 3 :

Does 2009 IPOs gave returns according to your expectations ?

Yes - 65 %No - 35 %

Question 4 :

If not invested in IPO. What was the reason ?

- Various reasons were given and most of them conclude on one thing that Investor don‘t have trust on IPO .- Other reason told by them was of account decoration done by IPO issuing company which results in over pricing of IPO . - Few of investor raised question on genuineness of IPO Grading system and shown their disbelief in grading system of IPO.

Question 5 :

Generally what are your clients response towards investment in IPO ?

Investor responded strongly on this question. Responses were in favour as clients wants to buy IPO at lower price and want to yield profit long run .

Question 6 :

What risks you associate with IPOs?

Aggressive pricing – 25%IPO grading system – 10%Accounting Practise – 40 %Other – 25%

Suggestions Classes of IPO’s

During our empirical study we found need of classifying IPO into category that will help investors and other readers to know more

about IPO and about their nature. There are four classes of IPO's: 1. Story Teller – These Companies make lot of Hype about them. They may be well known and growing, unknown but with a great story of potential growth . They open with price above IPO list price.

2. Breath Takers – Financial model of these organisation is Ok, they're profitable. Risk is higher and returns don’t compensate the risk.

3. Dogs - Their financial model doesn't work, they don't know why they need the money or they are just trying to give your money to their original investors . Stock manipulation are high in these companies

4. Gladiators - Old companies with proven financial models that for some well defined business reason need the public capital markets. These can provide reasonable long term holds, and often do a slow rise.

Factors to watch before investing in IPOs

We want empirical study to be helpful for Investors and Corporate. Therefore we have developed few Factors which are to be watched before investing in IPOs which will develop trust of Investors in IPO and will result in

Success of IPO .

Primary, we suggest reading the offer document carefully. Their email IDs are given in the abridged prospectus. If they

do not provide, send a complaint to Sebi.

Is this an IPO or an FPO? Is this a fixed-price or a book-building issue? Is this a “good” promoter?

If there is any foreign collaboration of repute, it helps. What is the promoters‘ background and experience? Experience in the same business/industry

Is the promoter a liability or an asset? If you find too many defaults/litigations of a material nature or even one of a very serious nature, a the issue. – Criminal proceedings against the promoters.

What is the status of the issuing company? What to look for in the Balance Sheet?

Fixed assets, Investments, Loan Advances. How has been the performance of the company?

How are the cash flows?

What is the promoter’s attitude towards shareholder rewards, in case of listed group companies? Dividend policy, Bonus issues, Rights issues, De-listing of group companies,

How has been the performance of the group companies? Number of years in the business, Size of the companies, Growth rates, Market shares and

growth.

How significant are the related party transactions? • Is it a family business? • Do group companies constitute the main clientele? • Is most raw materials sourced from group companies? • Extent of related party financial transactions? • Is there any conflict of interest among group companies? • Are there companies in the group doing the same business

What are the products/ services of the company? What about technology? What is the size of the issue? A large issue ensures better allotment as also better liquidity

What is the promoter’s holding after the issue? A small post-issue stake does not inspire much confidence

Is the company/ group company already listed abroad?

Is the price justified?

What has been the capital build up? • Previous public issues/rights issues/overseas issues/preferential issues. • To whom, when, at what price? • Is there any venture capital/private equity fund investment in the company? • Who invested, when, at what price, for what stake? • How does the offer price compare with price of allotments made to them? • Are these now funds exiting fully or partially in this offer? • Partial exit or no exit is more confidence building; VCs are expecting a higher secondary market exit price.

What are the objects of the issue? • Finance a new project (new/diversification)? • Undertake expansion Augment working capital? • Repay debt? (to promoters?) Do acquisitions? Fund subsidiaries? Open branches?

What are the components of the project cost?

What has been the utilisation of existing capacity?

How is the company financing the objects of the issue? Are there any further capital raising plans?

What are the key risk factors?

Are any major government approvals pending? Where is the company listing? Are there any significant trademark/ brand/ copyright issues? What is the record of investor complaints in listed entities?

CONCLUSION Reasons why IPO FAILS

Aggressive Pricing OF IPO The companies that debuted with high valuations compared to their listed peers failed miserably. The company specific reasons, the common factor among them was their high price to earnings (P/E) multiple that they were asking.

Reliance Power. Reliance Power raised Rs 11,700 crore from the market at More Pictures five digit

earnings multiple and no revenue from operations . It is yet to generate any revenues from electricity.

JET AIRWAYS .With Rs 400 crore profit in its first year of listing, the stock was reasonably priced at 26 times its trailing year earnings . But within two years of its IPO, its finances were shattered due to a price war and record high crude oil prices. It is still struggling.

While it is may not be appropriate to paint all the IPOs with the same brush, we suggest that investors should be cautious that the majority are over-priced and may choose the ones that are priced at a discount to their listed peers

ISSUES ON EVALUATING THE ACCOUNTING CHARACTERISTICS OF IPO FIRMS

The companies that debuted with high valuations compared to their listed peers failed miserably

Two major issues arise from our empirical study for treatment of IPO firms‘ accounting numbers.

First, the prior IPO literature shows that the accounting properties of IPO firms are different from other firms and that these properties are likely to be endogenous to the decision to raise outside capital. On the other hand, life cycle–related operating characteristics can also affect the accounting properties of IPO firms. Prior studies investigate this hypothesis and suggest that the accounting properties of IPO firms are not the result of manipulation, but rather are endogenous to a firm‘s decision to seek outside capital and reflect a firm‘s growth characteristics surrounding the IPO date.

Taken as a whole, we suggests that simple accounting variables, such as raw sales, SG&A expenses, or R&D expenses, may not capture the more complex and interesting accounting properties of IPO firms.

IPO grading system fails to produce desired results

Grading of initial public offers has failed to make a major impact either on the investment rationale of retail investors. In fact, study reveals higher the grade of an IPO, the poorer has been its performance in the market.

Companies such as Reliance Power, Edelweiss Capital and Gammon Infrastructure, which were rated four out of five have posted losses in the range of 46 to 56 per cent.

The Securities and Exchange Board of India had made it mandatory for all IPOs to be graded by rating agencies from April 2007 onwards.

Grading do not evaluate it as an investment proposition. Pricing of the issue is an important part, which is not covered by rating agencies while grading

an IPO

Analysis of the performance of IPOs that hit the market in 2006, 2007 and 2008 shows that the pricing of IPOs was more

reasonable in 2006 than in the later two years.

Psychological Factors Lower level of Profitability

Firms are going public now that are riskier than they used to be in the past. Investor look at the profitability of IPO and find himself standing no where near profit in near future.

Low Offering Price Risk Studies find that if a firm goes public with a low offering price, that's an indication of a higher failure risk firm, and if a firm is more mature when it goes public that's an indication of a lower failure risk firm because they have the history behind them and knowledge of operations.

Lack of Trust in Capital Market

Common person lacks trust in capital market because of everyday news about fraud and scam on Dalal Street. Lack of trust of Investor in any new company will obviously be lower than listed companies

Wait for Cooling down – Following old myths During year 2009 its been noticed that many IPO failed in beginning but later gained the trust of market. This simply shows that investors don‘t invest big on IPO at initial stage of opening but later after looking at performance of IPO, they invest into IPO.

THANK YOU

Presented By

Dhirendra Kr. Singh – 8113

Nitin Goswami – 8125

Piyush Kr. Tulsian – 8130

Vipin Singh - 8160