We’ve previously discussed what to look for when considering an investment in an IPO. Please read here.
In this blog, our mission is to shed light on the often-overlooked aspects of IPOs, particularly their darker sides, which tend to elude mainstream media and public analyses.
At Globe, our goal is to provide you with the most user-friendly experience and help you make informed decisions in the equity markets.
The Economics of IPOs
Why do companies choose to go public through an Initial Public Offering (IPO)? There are several compelling reasons behind this decision:
Access to External Funds: One of the primary motivations for pursuing an IPO is the need for external capital. This allows companies to reduce their reliance on debt financing, which, in turn, helps alleviate the burden of debt and lowers interest costs.
Fuelling Expansion: Companies often embark on ambitious expansion plans that require substantial financial resources. An IPO can provide the necessary capital injection to fund these growth initiatives.
Optimal Timing: Promoters of companies may opt to dilute their stake in the company when they anticipate favourable market conditions. During bullish periods, they are more likely to secure higher prices for their shares, making an IPO an attractive financing avenue.
Unveiling the Hidden Motives of Promoters
Let’s delve into the concealed motivations of company promoters. Essentially, at the heart of a business owner’s intentions, when a company chooses to go public by offering its shares, lies the objective of securing the highest possible price. A higher price translates to greater returns for the company’s promoters who have plans to divest their shares.
The pivotal question is when promoters can command the highest prices for their shares. This often occurs during bull markets when investors are willing to pay a premium for stock ownership. Consequently, most IPOs are strategically timed to coincide with bull markets when stock prices are at their zenith.
In adverse market conditions or during bear markets, it’s common to witness a dry IPO market. This occurs because in bear markets, stock prices tend to be depressed, and companies often perceive their shares to be more valuable than the market is willing to acknowledge.
There are many examples when IPO was withdrawn due to poor market conditions. Some examples are: –
E-commerce player Snapdeal has shelved its plan for IPO through which it was planning to issue fresh equity shares worth Rs 1,250 crore amid weak market conditions, the company has said. Source – Times of India
Joyalukkas IPO deferred due to poor market conditions, ‘several small factors’; says MD. Source – Moneycontrol
Fabindia scraps $482 million IPO amid uncertain market conditions. Source – Economic Times
As an investor, this presents a unique challenge. Buying IPO stocks during bull markets means acquiring them at elevated prices when the overall market is potentially overvalued. While there is indeed a probability of achieving healthy returns in such scenarios, it often hinges on a significant element of luck.
Warren Buffet in Berkshire’s 2004 meeting said –
An IPO is like a negotiated transaction – the seller chooses when to come public – and it’s unlikely to be a time that’s favourable to you. So, by scanning 100 IPOs, you’re way less likely to find anything interesting than scanning an average group of 100 stocks.
Thus, it is safe to conclude that IPOs, often pitched as excellent investments by brokers in their IPO notes, frequently don’t live up to these rosy portrayals. In reality, IPOs tend to be offered during booming market periods when investors end up paying a premium for a stake in a business. Evidence has shown that only a handful of IPOs have rewarded investors handsomely out of the many that have entered the market.
In general, long-term returns in both the IPO market and the secondary market reveal that investors often achieve better results in the latter than the former. IPOs can indeed be one of the riskier routes to potential long-term financial loss.
One piece of advice always holds true: conduct thorough research on companies that go public. In the case of a hot IPO, it may initially provide listing gains, but as markets shift towards a bear phase, prices tend to drop. This presents an excellent opportunity to consider your chosen IPO for investment.