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Indian stock market had witnessed introduction of some important institutional mechanisms in the early part of this millennium in the realms of primary market and secondary market as well. These initiatives were aimed at bringing in the best practices and making the Indian stock market comparable to the global markets. An important reform in the primary market sphere is the introduction of Book building process of issuing shares. Book building involves soliciting from the professional investors how many shares they are willing to buy and at what price. On the basis of the resulting demand curve, the firm and its investment bankers determine the IPO offer price.
IPO’s in India An Initial public offering (IPO) is the sale of a company’s stock to the public for the first time. The primary motive for an IPO is generally either to raise capital or to offer an exit strategy to some of the firms existing owners, but a number of other motivations and considerations also influence a firm’s decision to go public. This decision process illuminates a firm’s goals in issuing an IPO, which are important to evaluate the potential reasons for the under pricing we observe. Start-up companies rarely have the resources, history, or credibility to conduct an IPO. In fact, firms in the most incipient stage of development generally rely entirely on personal loans, savings, family, and friends for their initial financing. Even as a company begins to develop and show some signs of promise, it will rarely attempt a public offering; instead, it will look to angel investors or venture capital. Angel investors are wealthy individuals, often prior entrepreneurs, who will provide financing in exchange for equity in the company. Venture capital comes from firms rather than individuals, but the principle is the same: investors offer financing in
return for a stake in the company. Both angel investors and venture capital firms frequently take an active role in the company, advising management on the most of issues it faces. The initial investors are naturally hesitant to provide all the funding upfront, and different private equity investors target companies at different stages of growth. Thus, successful companies will typically undergo multiple rounds of financing and will develop a base of investors that intend to eventually liquidate their stakes. When an “IPO-ready” company requires additional financing, it has multiple options: pursue further equity financing from the private market, issue debt, or conduct an IPO. So what prompts investors and the company to go with the IPO option? In addition to provide an immediate capital influx and mechanism through which existing owners can cash in on their investment, there are other advantages of going public. Since the expectation is that a liquid aftermarket will develop following the offering, firms conducting an IPO can expect to be in a position to raise additional capital relatively easily and on favorable terms following the initial offering. The increased liquidity also makes it possible for public companies to offer stock-based incentives and compensation, which can help them attract and retain top employees and improve employee productivity. 1.1 IPO Process The firm has to select an underwriter for selling its securities in primary market. The company usually consults with an investment banker to determine how best to structure the offering and how it should be distributed. Since most of the new issues are too large for one underwriter to effectively manage, the investment banker, also known as the underwriting manager, invites other investment bankers to participate in a joint distribution of the offering. The group of investment bankers is known as the syndicate. Members of the syndicate usually make a firm commitment to distribute a certain percentage of the entire offering and are held financially responsible for any unsold portions. The underwriter syndicate can choose either best effort method or
firm commitment method for selling of the securities. There exist two main mechanisms in India for the sale of public issues. 1. Fixed Price Method. 2. Book Building Method 1.2.1 Fixed Price Method In a fixed priced offer, an issuer company is allowed to freely price the issue. The basis of issue price is disclosed in the offer document where the issuer is closes in detail about the qualitative and quantitative factors justifying the issue price. The issuing firm (with the help of the underwriter) decides upon a selling price and offers a set number of shares at that price. The underwriter does not build a book of potential orders; instead, the price is based upon the underwriter’s judgment of the market conditions and the intrinsic value of the company. The Issuer company can mention a price band of 20% (cap in price band should not be more than 20% of the floor price) in the Draft offer documents filed with SEBI and actual price can be determined at a later date before filing of the final offer document with SEBI. In its offering materials, the issuer will give both a qualitative and quantitative justification for the chosen price. If the offering is oversubscribed, the shares are allocated on a pro rata basis. This type of offering is commonly used in Singapore, Finland, India and the U.K. 1.2.2. Book Building Method In the traditional IPO process, an investment bank is always hired to “underwrite” an IPO. The issuing firm will choose a “lead underwriter” (book runner) or “co managers” risk, the investment banks themselves almost always form a syndicate, and each member of which will sell part of the issue .Deals can be structured in a variety of ways. One major consideration is whether it is a "firm commitment" or “best efforts” agreement. In a firm commitment, the underwriter buys the entire offer and resells it to the public, thus guaranteeing the amount of money that will be raised; under a best efforts agreement the underwriter sells as much of the security to the public as it can sell at the offering price, but it does not 3
guarantee the quantity. Underwriting contracts will also specify he underwriter fee (typically 5%) and the “green shoe” option (allows the underwriter to increase the number of shares offered, typically by 15%).After the details of the deal have been worked out, the underwriter files a registration statement with the SEBI. This document provides details on the offering, as well as company information, such as financial statements, management backgrounds, legal proceedings, and insider holdings. Next, the underwriter puts together a “red herring” (a preliminary prospectus that obtains information on the company and offering), and goes on a “road show” in which they present to potential investors and gauge demand. Most of these potential investors are institutional investors, such as mutual funds, pension funds, and hedge funds, and they give the underwriter feedback as to how much stock they intend to buy and at what price. This is called the “book building process” since the underwriter builds a book of potential orders. After the SEBI approves the registration and the road show is complete, the underwriter and issuing firm decide on an offering price range, which will depend upon the success of the road show, the current market conditions, and the company’s goals. After the offering range is decided upon, the underwriter will accept bids from interested investors. If the orders exceed the value of the issuance, the IPO is “oversubscribed.” When this is the case, the offering will price at the high end of (or even a little above) the offering range, the underwriter will have partial discretion over how to allocate the limited shares among the bidding institutional investors, and the underwriter will exercise its green shoe option. When an offering is undersubscribed, it will price at the low end of the range; or, if the offering is extremely undersubscribed, the issuer may decide to postpone the deal. Since institutional investors are their best clients, investment banks heavily favor them over retail (individual) investors. Thus, there is a degree to which retail investors are “excluded” from IPO’s. This is compounded by the fact that in many IPO’s, only those individual investors who have a brokerage account with one of the underwriters are even eligible to participate in the offering. The defining features of the book 4
building mechanism are: a price that is elastic to demand but ultimately set by the underwriter, and a discretionary share allocation mechanism that has historically led to the exclusion of most retail investors. This method is used in almost all domestic IPO’s 1.3 Phenomenon of Underpricing. A sample of 1597 companies having made an Initial Public Offer (IPO’s) during 1989 to 1995 and listed at the Bombay Stock Exchange form the data set for the analysis. Out of the 1597 IPO’s offered and listed for the period 1989-1995 considered here, 72 issues were fairly priced (zero returns on listing); 157 were overpriced (negative returns on listing) and a total of 1368 were under priced (positive returns on listing). Considering the Net Return (Em), 1268 out of the total 1597 IPO’s registered positive return on the stock index whereas 259 IPO’s registered negative returns. Initial returns on IPO’s are found on an average to be quite high. Return on listing for the total sample (1597) is found to be 94%. Return on listing for the trimmed sample (2% of the highest and lowest observations) falls down to 81%. This is an attempt to limit the sensitivity of the extreme observations. 1.4 Concept of underpricing Generally, it has been found that investors, who purchase IPO’s on the offering day, experience high returns on the first trading day, indicating that these shares may have been priced at the time of their offering to the public at values much below their intrinsic value. The phenomenon is known as Underpricing. Underpricing of issue represents the first day returns generated by the firm, Calculated as: (Closing Price on listing day – Offer price) X 100 Offer price
An issue is under (over) priced if the price received by the issuer in the primary market is lower (higher) than the price of the same securities in the secondary market on the first day of trading. The existence of the phenomenon of “underpricing” is a well-established fact for the IPO’s issued all over the world. 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, IPO’s 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 under pricing is almost entirely “corrected” by the market at the opening transaction. A worldwide survey of literature on the phenomenon of Underpricing of IPO’s 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. 1.5 Extent of Underpricing: International Evidence The table below shows the number companies which underpriced their shares in different countries at the respective time duration and the sample size of the observation made. Table 1.5.1 showing the extent of underpricing in other countries Country Period 6 Sample Size Performance (%)
Australia Germany U.K U.S.A Malaysia Singapore
1966-78 1977-87 1980-88 1975-84 1978-83 1978-83
93 97 712 1526 21 39
29.2 21.5 14.3 14.7 166.7 39.4
Source: Handbook of Statistics on the Securities Market 2006, Table 12
Studies on the Indian capital market also confirm the phenomenon of underpricing of IPO’s. Most of the Studies on the Indian primary market concerning the phenomenon of ‘underpricing’ are found to be in the post-liberalization period i.e. after the abolition of the CCI. The initial excess return on IPO’s in the Indian primary capital market is very high as compared to the experience of the capital markets of countries abroad. 1.6 Company profile of Kotak Securities Limited Kotak Securities Limited is a subsidiary of Kotak Mahindra Bank, is the stock broking and distribution arm of the kotak Mahindra Group. The company was set up in 1994. Kotak Securities Limited is a corporate member of both the Bombay Stock Exchange and the National Stock Exchange of India Limited. Its operations include stock broking and distribution of various financial products – including private and secondary placement of debt and equity and mutual funds. Currently, Kotak Securities Limited is one of the largest broking houses in India with wide geographical reach. The company has four main areas of businesses: 1. Institutional Equities, 2. Portfolio Management, 3. Retail (equities and other financial products) and 4. Depository Services. Institutional Business 7
This division primarily covers secondary market broking. It caters the needs of foreign and Indian institutional investors in Indian equities (both local shares and GDR’s). The division also incorporates a comprehensive research cell with sectoral analysis which covers all the major areas of the Indian economy. Client Money Management This division provides professional portfolio management services to all high net-worth individuals and corporates. Its expertise in research and stock broking gives the company the right perspective form which to provide its clients with investment advisory services. Retail distribution of financial products Kotak Securities has a comprehensive retail distribution network, comprising approximately 7000 agents 73 branches and over 200 franchisees across India. This network is used for the distribution and placement of arrange of financial products that includes company fixed deposits, mutual funds, Initial Public Offerings, secondary debt and equity and small savings schemes. Depository Services Kotak Securities is a depository participant with the National Securities Depository Limited and Central Depository Services (India) limited for trading and settlement of dematerialized shares. Since it is also in the broking business, investors who use its depository services get dual benefit. They are able to use its brokerage services to execute transactions and its depository services to settle these. Kotak Securities with volume, width and quality of offerings regularly earned many accolades from industry monitors. In recent times, these have included:
i. The “Best Brokerage Firm in India” by Asia money for four consecutive years 2006, 2007, 2008 and 2009.
ii. Best Performing Equity Broker in India - CNBC Financial advisor Awards 2008 iii. Euro money Award (2006 & 2007) – Best provider of Portfolio Management iv. Finance Asia award (2004 & 2005) – Best Equities House in India v. Asia money Award (2005) – Best Equity House in India Vi. Prime Ranking Award (2003-04) – Largest Distributor of IPO’s Kotak Institutional Equities Kodak Institutional Equities is among the top institutional brokers in India. It mainly covers secondary market broking and the marketing of equity offerings, including IPO’s to domestic and Foreign Institutional Investors (FII’s). Its fullpledged research division comprises many analysts engaged in micro-economic studies, industry and company specific equity research. It has full financial service capability, which includes derivatives, facilitating market access through affiliates and the distinctive offering of corporate access to investors. The division serves over 250 clients including FII’s, pension and mutual funds. The division has sales desks in Mumbai London and New York, with the India desk also serving clients in Hong Kong, Singapore, Japan and Australia. The group has a net worth of over RS 5824 cores, employees around 20,000 people in its various businesses and has a distribution network of branches, franchisees, representative offices across 370 cities in India and offices in Network, London, San Francisco, Dubai, Mauritius and Singapore. The group services around 5 million customer accounts.
Value statement of the company: whether you are a customer with small or large investment you can expect us to bring value to you in every form. Quality research, Quick trade execution, Low brokerages, Accounts that suit your investment profile and Risk profile Service: The Company believes in high standards of service and that’s precisely what they offer. It’s an honor to be awarded the most customer responsive company award in the financial institution sector by AVAYA global connect award both in 2006 and 2007. Robust Technology: The company have developed their own proprietary trading plat form which is robust and among the best in the industry. It has more than 150 technology professionals constantly working on upgrading and speeding up all their systems. Centralized Risk Management System: Unlike many other players Kotak Securities have centralized risk management systems which allow them to offer the same levels of service to customers across all locations. Exceptional Research: Unlike most other competitors Kotak Securities have their own in-house research team. The in-house research team is among the best in the industry and they have many years of experience in the financial markets. They scan through the group of stocks and find the scripts that have a high potential of providing
a good returns to the investors. The investors get research results of technical and fundamental analysis, derivatives analysis, macro economic and mutual fund research. Large presence: Kotak Securities is present in 321 cities with 877 offices allover the country. Their employee strength extends beyond 5100. Background of the study This study is carried out in order to know the effect of Underpricing on the price performance of IPO’s in the short and long run period. Short run period ranges from listing day to first six months. The long run period means more than one year and above after the IPO’s listing in the stock market. this study was conducted during Jan2007 to Mar-2010. The main aim of this study was to identify the factors which influence the investor’s decision of investing in IPO’s, and to know how they affect the price performance of the IPO’s. 1.7 Significance of the study Making a firm public is significant turning point in the life of a firm with serious wealth implications for the existing shareholders. The success of the public listing depends, among other factors, on the ability to determine an offer price. This is a difficult process. Thus, if the firm’s shares are overvalued, their sale to the public will fail; if it succeeds, it will entail a transfer of wealth from the new shareholders to the old ones. In case the new shares are undervalued the old shares will relinquish a claim on the firm’s cash flows at a price below its fair value. To avoid certain uncertainties involved in the public sale of their securities, firms retain underwriters who undertake the risk of pricing and selling the new securities. The conditions under which new securities are offered to the public and the role of underwriter are both affected by the regulatory and institutional environment of local IPO market.
Indian securities market had witnessed introduction of some important institutional mechanisms in the early part of this millennium in the realms of primary market, secondary market as well. These initiatives were aimed at bringing in the best practices and making the Indian capital market comparable to the global markets. An important reform in the primary market sphere is the introduction of Book Building process of issuing shares. Book Building involves soliciting from the professional Investors how many shares they are willing to buy and at what price. On the basis of the resulting demand curve, the firm and its investment bankers determine the IPO offer price. Book building is an established process of public issue of securities in many markets Argentina, Brazil, China, Finland, France, Germany, New Zealand, Japan, and the U.S. Book building process helps the issuer not only to determine the demand but also aids the process of 'price discovery' i.e., the price at which shares shall be issued will be determined by the demand and supply forces of the market. In this paper we attempt to see short and long run price performance of the book-built IPO’s. 1.8 Purpose of the Study The study intends to examine the performance of the Indian IPO’s listed on NSE, using a sample of IPO’s that tapped the NSE market during 2007-2010 by taking in consideration of their prices. The short run as well as long run analysis of their price performance has to be done by taking the gap of time intervals of one weak, one month, three month, six month and one year, two years, respectively. In addition to that an analysis to be conducted to know the influence of the factors such as Issue size, Lead time, Age, Subscription level and Market timing on the price performance of the IPO’s. these factors are explained below.7
Issue size Total amount of money the company wants to rise through issuing IPO’s. This is equal to the product of total no of shares and the price per share. Lead time 12
Lead time is the time gap between the date of allotment of shares of IPO’s and the listing of the shares the first day in the stock market. Age of the company Age of the company is the time from when the company is in the business, what is the reputation of the company in the market. How the company was performed in the past years. Subscription level The percentage level of the shares the investors are willing to buy. It is a measure of demand for the shares in the market. Usually measured in terms of how many times the shares are subscribed before the allotment day.
Market timing Market timing is the time when the company issued the IPO’s, and gives information about what was the market condition at that time. It is mainly related to the ‘Opportunity Window’, that is the choices available for the investors. The primary objective of the study is to determine how the market timing at the time of issue of IPO’s going to affect on the price performance of IPO’s in short and long run. It may affect on the systematic over-optimism of the market investors and managers at the time of IPO events. The performance measures being used are postissue long-run holding period stock returns, Along with return obtained for potential earnings growth.
1.9 Objectives of the study More specifically, the study has been designed to achieve the following objectives: 1. To measure the initial under-pricing of IPO’s in India issued between Jan-2007 to Mar-2010. 2. To study the underpricing on the short run performance of IPO’s in India up to six months. 3. To study the underpricing for the long run for more than one year till Mar-2010. 4. To study the factors influencing Investors decision of investing in IPO’s.
1.10 Limitations of the study:
The important limitation of the study is that due to non availability of ‘one size
fits all’ model for studying IPO under-pricing phenomenon. 2. The time horizon taken is considered short for the analysis of long run
The literature review examines recent and important research studies, company data, or industry reports that act as a basis for the proposed study. It is a critical summary and an assessment of the current state of knowledge or current state of the art in a particular field. The literature review provides evidence that a certain amount of relevant literature in the topic has been read and understood prior to the start of the proposed study. Literatures on sales management are vast. However, a few literatures have been highlighted here for the project.
2.1 Literatures on IPO’s in International perspective A survey of literature on the phenomenon of Underpricing of IPO’s 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. Source: "The After Market Performance of Initial Public Offerings in Latin America" Financial Management (Aggarwal R, Leal R, & Leonardo H, 1993) By examining the issues of relative performance of the over-the-counter market with the initial common stock offerings, underpricing, and the risk involved thereof. The total period had been covered by the study w.e.f Jan 19, 1965 to June 30, 1970 with a random sample of 400 initial common stock offerings. The market returns and risks associated with these 400 issues have been calculated for 16 time periods, ranging from one week to one year after the offering date. The study conducted so far suggests that the investment bankers have either underpriced or pushed in the aftermarket those IPO’s in which they held greatest financial interest (Blum, 1993). By analyzing the ‘hot issue’ market of 1980 with 1028 issues during 1977-82 periods in the U.S., The study calculated the initial percentage returns that were not adjusted for market movements. For each month in the period January 1977 to December 1982, an equally weighted average initial return was calculated by taking 16
the simple arithmetic average of the initial returns of all unseasoned new issues having offering dates in that calendar month. For the 1960-76 periods, a monthly time series of the number of issues and average initial returns has been collected, allowing an analysis of the time series behavior of initial public offerings for the 23 years period i.e. for the 1960-82. The results of the study depict that there has been 3 or 4 periods during 1960-82 in which monthly average initial returns on unseasoned new issues has been extremely high for prolonged periods. During the hot issue market of 1980, for 15-month period the initial return is 48.4%, as compared to with the average initial return in the period 16.3% of 1977-82 periods, the cold issue market. The study also presents a theoretical framework which explains the phenomenon of underpricing i.e. ‘Rock’s theory of underpricing of Initial Public Offerings’ (Ritter, 1984) Almost a third of the new issuers returned to the market with a seasoned offering. Other explanations include ‘Tinic’ in 1989 who suggested that underpricing discourages investors to file lawsuits against the issuer and ‘Benveniste and Spindt’ propose that investors with more information ill be enticed to reveal more information by underpricing the IPO’s( Welch,1989). The study on the role of secondary market in pricing and underpricing of IPO’s considered 1002 IPO’s during the period 1977- 1984. IPO’s are above $ 1.5 million, underwritten and subsequently traded on NASDAQ, AMEX or NYSE. The analysis is done with the use of Pearson correlation coefficients calculated between initial returns, Offering size, age and time of offering. They had argued that incomplete spanning of the primary issues in the secondary market and limited investors access play an important role in the pricing of IPO’s. The results derives price differential between primary and secondary market which are consistent with IPO underpricing. The study reveals that the IPO initial returns are negatively related to offering size and company age, and are not related to systematic or beta risk. (Mauer and Senbet, 1992) An information-theoretic model of IPO pricing in which insiders sell stock, in both the IPO and the secondary market, have costly private information about 17
performance of the firm. High value firms, which know that they are going to pool with the low-value firms, induced outsiders to engage in information production by underpricing which compensates outsiders for the cost of producing information. So underpricing results from insiders inducing information production in order to have a more precise valuation of their firm in secondary market. (Chemmanur, 1993) The signaling model of underpricing was studied by taking the samples from 1980 to1986 period. The study has included all IPO’s of the given sample period but it has considered only ‘firm commitment’ IPO’s and has excluded the best effort offerings. The results of the study show that there is a positive relation between IPO underpricing and the probability and size of subsequent seasoned offering. But contrary to the basic implication of the signaling hypothesis, the evidence shows that issuers do not have to rely on the costly underpricing mechanism to signal to the market information relevant for future equity issues. Therefore the support for the signaling hypothesis as a major determinant of IPO underpricing is weak (Jegadeesh, 1990). The aggregate IPO market activity was examined by the initial returns at the firm level. The research also studies strong cycles in the number of IPO’s by calculating the average initial returns realized by investors from 1960 to 1997.The statistical measures being used in the study are mean, median, standard deviation and auto-correlations. The results show that IPO’s cycles occurs and has subsequent effect on returns and underperformance. The study also shows that clustering of IPO’s happens in the market and is also associated with predictably different initial returns. And also the information about the value of an IPO which is being available during registration period has an effect on the prices and offering decisions of other firms (‘Lowry and Schwert, 1999) 2.1 Literatures on IPO’s in Indian perspective Studies on the Indian capital market also confirm the phenomenon of underpricing of IPO’s. Most of the Studies on the Indian primary market concerning 18
the phenomenon of ‘underpricing’ are found to be in the post-liberalization period i.e. after the abolition of the CCI. The initial excess return on IPO’s in the Indian primary capital market is very high as compared to the experience of the capital markets of countries abroad.
In the study on IPO’s from the period Jan 1960 to Dec 2002 observed 16 IPO waves and used regression analysis for analyzing IPO performance. The researchers have used Market Returns, Market Volatility, and Aggregate M/B ratio and time series analysis. The study presents a theoretical framework on different aspects such as IPO waves, Optimal IPO timing, and IPO valuations. Empirical evidence shows that the results are inconsistent with the long run underperformance of IPO’s (Pastor and Veronesi, 2003). In the Indian context ‘Shah’ documents a phenomenal 105.6% excess return over the offer price in a study of 2056 new listings over the period January1991 to May 1995. However, this study provides evidence on the short run performance only while ‘Madhusoodanan and Thiripalraju’ analyze the Indian IPO market for the short term as well as long term underpricing. They also examine the impact of the issue size on the extent of underpricing in these offerings and the performance of the merchant bankers in pricing these issues. The study indicates that, in general, the underpricing in the Indian IPO’s in the short run is higher than the experiences of other countries. In the long-run too, Indian offerings have given high returns compared to negative returns reported from other countries. The study also reveals that none of the merchant bankers showed any better pricing capabilities from a study on IPO’s offered on BSE during the period 1992 to 1995shows that underpricing was higher than the international experiences in the short run and in the long run too they yield higher returns compared to the negative returns recorded from the international markets. ‘Krishnamurti and Kumar’ (2002) working on a sample of IPO’s that hit the market between 1992 and1994 demonstrate that the underpricing is to the extent of 72.34% (market adjusted returns).’Kakati’ (1999) analyzed the performance of a sample of 500 IPO’s that came to the market during January 1993 to March 1996and
documents that the short run underpricing is to the tune of 36.6% and in the long-run the overpricing is40.8%. Madhusoodanan and Thiripalraju in 1997 analyzed the Indian IPO market for the short term as well as long term underpricing. They also examine the impact of the issue size on the extent of underpricing in these offerings and the performance of the merchant bankers in pricing these issues. The study indicates that, in general, the underpricing in the Indian IPO’s in the short run is higher than the experiences of other countries. In the long-run too, Indian offerings have given high returns compared to negative returns reported from other countries. The study also reveals that none of the merchant bankers showed any better pricing capabilities.
The evidence of the long run underperformance in the Indian market was examined using the data set of firms over the period of 2000-02. The researcher has taken a sample of 116 companies from various industries. The sample of the study consists of 116 IPO’s issued by companies in the Indian market during the period from 2000 to 2001. The aftermarket performance is taken for five years. (Janakiramanan, 2007) An evidence for the wide spread underpricing of Indian IPO’s is provided by analysing386 IPO’s in post liberalizing era, from the period July 1992 to Dec 1994.The empirical evidence confirms the underpricing phenomenon in Indian Market by using Raw returns, Market Adjusted Returns. It also analyzed the factors responsible for pervasive and persistent occurrence of underpricing in the IPO market (Krishnamurti, 1999). A study is done on the price performance of IPO’s in the NSE. The study suggests that the demand generated for an issue during book building and the listing delay positively impact the first day under pricing whereas the effect of money spent on the marketing of the IPO is insignificant. The study considers the data from March 2004 to Oct 2006 and takes into account 55 companies for analysis. The researcher has verified that the demand generated for an issue during book building and the 20
listing delay positively impact the first day underpricing. Whereas the effect of money spent on the marketing of the IPO is insignificant. The researcher has found that the degree of underpricing in the sample is varying from- 33.04% to 82.5% with a mean value of 22.62%. There are only 27.27% which got listed at a discount to their offer price (i.e. overpricing of issues), whereas 72.73% firms showed underpricing phenomenon (Vaidayanathan, 2008). The researcher has also thrown light on the fact that the average underpricing has gone down up to 22.62% during the period in context, as compared to 105.6% (reported by Shah, 1995) during the period 1991 to 1995. This is due to change in regulation whereby the allocations to informed investors are allowed, which makes the market more efficient. An important finding of the study is that there are a large number of firms (54.5%) in the sample which give a negative return, unadjusted for market returns just one month after their listing, when at the same time adjusted for market returns (more than 58% of the firms in the sample) give a negative return in a period of one month. In simple words, the researcher has tried to explain that if an investor would have invested in the IPO’s of all firms of our sample, got allocation in each one of these and waited for a month then he would have on an average earned return of 1.06%. But this is 1.13% below the market returns. Thus, an investor would be better off by investing in index based mutual funds during the period of the study rather than investing in IPO’s if only a short term horizon of one month is considered. One of the important and unique contributions of this study is that the after market in India regards the final offer price which has been set after book building as a credible signal for the firm’s underpricing. Another finding of the study is that the returns form IPO’s get diffused within one month of the listing of the firms and on an average the gains in one month after listing are lesser than those of the market. Kumar has analyzed the long run as well as short run price performance with respect to the book building process in India and has verified the presence of 21
underpricing phenomenon in Indian IPO’s up to the time span of twenty four months from the date of listing. The study examines 156 firms (which issued their IPO’s through book building route on the NSE) over the period of 1999 to May 2007. The researcher has used the analyzed the short run performance by applying the simple returns and market adjusted returns to capture the market movements during the period between the offer closures to listing. The long run performance analysis is done by studying the buy and hold adjusted returns (BHAR) and monthly market adjusted returns (MMAR) at regular monthly intervals from the second day of their listing. The index Nifty has been used for calculating the market adjustments. The results suggest that the larger the issue price, the lesser is the underpricing. If the general market conditions are optimistic, the issue attracts more investors thus leading to higher premium in returns. From the literature review the following inferences can be made: 1• Short-run underpricing of IPO’s is an international phenomenon and in the longrun the evidence is mixed. 2• Underpricing in the Indian market is quite high compared to the international experiences 3• So far all the studies done in India were based on data pertaining to the post CCI regime and prior to the introduction of book building process. 4• The IPO’s in that period are priced by the issuers and were offered to the investors on take it or leave it basis, in other words the issue prices were purely determined by the sellers (issuing companies) but not by both buyers and sellers dealing with each other at arms length. Therefore it is possible that the IPO market was characterized by adverse selection and moral hazard problems. 22
From 1999onwards most of the IPO’s were issued through the book building process, hence it will be of interest of the company to examine the price performance of book built IPO’s in the recent years. The company can utilize this information to help their investors to make proper decissions and also to increase there total trade volume in future.
CHAPTER 3 RESEARCH METHODOLOGY
Research is any organized inquiry carried out to provide information for solving problems. Business research is a systematic inquiry that provides information to guide decisions. Methodology may be a description of process, or may be expanded to include a philosophically coherent collection of theories, concepts or ideas as they relate to a particular discipline or field of inquiry. The research methodology comprises of collecting, organizing and evaluating data, making deductions and researching to conclusions. A strategic methodology was framed to provide a strong base to conduct the present study. This chapter focuses on various research techniques used during the study and also discusses the rationale behind the selection of those techniques.
3.1 Need for Research It was very much needed to conduct an observational study, especially when secondary data is collected and analyzed. The present research throws light on the decisions for investing in IPO’s. By analyzing the past performance of IPO’s in India the investors and the company will get some important facts. The observations and findings can be used by the investors to make right decisions, and by the company to motivate investors to invest more on IPO’s and increase the companies trading volume. 3.2 Research Design Research design is the detailed blueprint used to guide a research study toward its objectives. It expresses both the structure of the research problem- the frame work, organization, or configuration of the relationships among variables of a study and the plan of investigation used to obtain empirical evidence on those relationships. The process of designing a research study involves interrelated decisions. For the present study, first of all a research design was prepared to make possible smooth and timely accomplishment of the study. A well-planned strategic research design was thus prepared focusing on all aspects from laying down objectives to data analysis, methods to be adopted for collecting the relevant data, techniques to be used in analysis, time frame during which the study was required to be done, so that the research could be conducted within a particular time frame with enhanced efficiency. 3.3 Research Approach The study would adopt a holistic and integrated approach to the study. However the main approach would be to present unbiased views on all the issues taken into consideration for the present study.
A mixed approach is used for this study i.e. both exploratory approach and descriptive approach are used for this project. Since some of the variables were not known, the exploratory method was used to find out the variables. Once the variables were known the descriptive approach was followed. Exploratory research is a type of research conducted where the problem has not been clearly defined. Exploratory research helps determine the best research design, data collection method and selection of subjects. It often relies on secondary research such as reviewing available literature and data, or qualitative approaches such as informal discussions with consumers, employees, management or competitors, and more formal approaches through in-depth interviews, focus groups, projective methods, case studies or pilot studies. Descriptive research, also known as statistical research, describes data and characteristics about the population or phenomenon being studied. It answers the questions ‘who’, ‘what’, ‘where’, ‘when’ and ‘how’. Descriptive research deals with everything that can be counted and studied. The major objective of descriptive research is to describe market characteristics or functions. Mixed approach is adopted for the study to analyze the short & long run performances of IPO’s based on observation of the secondary data and reasoning. For short run analysis the price of the IPO’s collected at an interval of first one week, one month three month & six month. When the market returns are adjusted for that time period the Simple Moving Average is calculated for the purpose of analysis. Similarly For long run analysis the price of the IPO’s collected at an interval of first one year, when the market returns are adjusted for that time period the Simple Moving Average up to March 2010 is calculated for the purpose of analysis. Exploratory research approach for the factors affecting the performance of IPO’s by
1. Search of literature on the related topic. 2. Interviewing the senior investors and experts in the subject 3.4 Sampling Sampling is basically selecting some of the elements from a given population. The basic idea of sampling is that by selecting some of the elements in a population, we may draw conclusions about the entire population. A population is the total collection of elements about which we wish to make some inferences. The compelling reasons for sampling are lower cost, greater accuracy of results, and greater speed of data collection and availability of population elements The sample of the present study includes the prices of IPO’s at the end of particular days in Rupees. The issue size of the respective IPO’s. Allotment date and listing date of the respective IPO’s on either NSE or BSE for the first time. 3.4.1 Sampling Technique In the present study includes all the IPO’s which listed on either NSE or BSE OR both during Jan-2007 to Mar-2010. The study includes the prices of those Companies IPO’s which satisfy the following criteria: i. The IPO is listed on the NSE or BSE and has been traded for six months for short run Analysis, and more than one year for long run analysis. In other words, companies Pricing performance is available on the NSE or BSE for the time period considered. ii. Data regarding offer price, listing date, listing price and the prices subsequently required are available.
iii. Short-run analysis: All IPO’s, with equity share as an instrument, listed on NSE or BSE for the time period from Jan-2007 to Mar-2010 have been considered. The total no. of Companies is 188 for the short run analysis. iv. For Long-run analysis: All IPO’s, with equity share as an instrument, listed on NSE or BSE for the time period from year 2007 to 2008 have been considered. For the long run analysis the total no. of companies is 145. (102 in 2007 and 43 in 2008). v. For the factors affecting IPO’s price performance analysis: All IPO’s that’s data has Been available are considered for study and experts opinion is collected by interviews.
3.4.2 Sample Size The study is based on the secondary data. Secondary data has been collected from the National Stock Exchange of India (SEBI), Kotak Securities websites and other reliable sources. The total sample size consists 193 companies among which 21 companies data is either fully not available or the company is de-listed from the stock exchange by SEBI for some reasons. For short run analysis remaining172 companies are all considered and the required data is collected from the sources. For the long run analysis 136 companies are considered for one year. 119 companies for two years and 35 companies for three years time period are considered. 3.5 Data collection
Primary as well as secondary data were collected for the study employing various techniques. The secondary data were collected from the past records of Kotak Securities limited, other reliable sources like web sites of NSE and BSE etc. For the fourth objective to know the other factors affecting the price performance of IPO’s, and the factors which influence investor’s decisions are collected by the following methods 1. Search of literature on the related topic. 2. Interviewing the experts in the subject In view of the intricate data to be generated, both quantitative and qualitative approaches were employed for the collection of primary data. For collecting quantitative as well as qualitative data, elaborate interview schedules were designed to elicit information, pertaining to the objectives of the study from two different groups of respondents. First group includes senior investors who frequently investing in IPO’s from past five years or more. Second group, company executives suggested by the guides. 3.5.7 Interview process The interviews are conducted in the Kotak Securities office. The regularly visiting investors are requested by the company to have the interview at times suitable to the investors. One of the KOtak securities employ used to introduce the investors to me then request them to co-operate me in order to collect the required information. The interview is an unstructured one. That is no structured set of questions or questionnaire was not there. The interview process was briefly explained below.
i - First, 20 senior investors are selected and the list of IPO’s in which they were invested in the required duration is collected. ii - Based on their choice of the IPO’s and market timings questions are asked to know the investors opinion towards the IPO’s and the factors which influence their decisions. Points from the interview are noted down. iii - Repetition or the similarity of the opinions are underlined. Questions are asked in depth to know the influence of the mentioned factors, and the opinion is recorded for further analysis in the later stage. iv - The above points are compared with available information, and the findings were discussed with company executives check the validity of the points. v - Final conclusion in made based on the observation & opinions of experts.
CHAPTER-4 ANALYSIS AND RESULTS
Data analysis and Interpretations
The study has been aimed at appraising the price performance of the Indian IPO’s and to judge the extent of Underpricing. This chapter covers the objectives of the study, data and methodology covered in the study.
The section below Deals with results obtained from the study and the analysis. The Analysis has been done on the basis of information collected from deferent sources like kotak security record books and websites, NSE and BSE websites. The price of different company scripts are collected as specific intervals based on their listing date. The prices were then compared with the respective IPO’s offering price. To test whether a stock has been priced at its intrinsic worth or not and to determine the magnitude and degree of the deviations of market price of the stock from its offer price, returns have been computed. If the returns are positive, the indication is that of Underpricing while negative returns imply overpricing. It is not possible to compare these returns across the board, because the market was in different phases during the period. So, this return has been adjusted using the returns on the CNX S&P Nifty Index for the corresponding period. In order to analyze the short run Underpricing, one week, two week, one month, two month, three months and six months time intervals have been taken. In case the share prices are not available for a particular date, a seven days window has been considered and the price available on the nearest date has been selected. The initial return on IPO’s has been computed as the difference between the closing price on the first day of trading and the offer price, divided by the offer price. R_Ret. = (P1 – Po) * 100 --------------------- (i) Po Where R_Ret. = subscriber’s initial return (hereafter raw return) P1 = closing price on the first day of trading Po = Offer price The return measured by Equation (i) would be valid in a perfect market, where there is no time gap between the IPO’s allocation date and the first day of trading, no opportunity cost of money deposited with the application (or demand for shares does 30
not exceed the supply of shares and hence no rationing takes place), and no other costs associated with lodging an application. If the first condition is not fulfilled, returns should be adjusted for changes in market conditions during this period. In most cases the gap between the IPO’s allocation date and the first day of trading would be very small and is likely to have a negligible effect. But, in India this gap is quite long. During this period, a major change could occur in market conditions and the observed premium (discount) measured by equation (i) could be caused by a change in market conditions rather than initial Underpricing. Therefore, the raw return estimated by equation (1) has been adjusted for market return. MAR = (P1 – P0) _ (M1 -M0) * 100------------------(ii) P0 M0
Where MAR = Market adjusted return M1 = Closing value of Market Index on the first trading day Mo = Closing value of Market Index on the offer closing date. The return measured by Equation (i) would be valid in a perfect market, where there is no time gap between the IPO’s allocation date and the first day of trading, no opportunity cost of money deposited with the application (or demand for shares does not exceed the supply of shares and hence no rationing takes place), and no other costs associated with lodging an application. If the first condition is not fulfilled, returns should be adjusted for changes in market conditions during this period. In most cases the gap between the IPO’s allocation date and the first day of trading would be very small and is likely to have a negligible effect. But, in India this gap is quite long. During this period, a major change could occur in market conditions and the observed premium (discount) measured by equation (i) could be caused by a change in market conditions rather than initial Underpricing. Therefore, the raw return estimated by equation (1) has been adjusted for market return. 31
(P1 – P0) _ (M1 -M0) * 100------------------(ii) P0 M0
Where MAR = Market adjusted return M1 = Closing value of Market Index on the first trading day Mo = Closing value of Market Index on the offer closing date. The returns for the different time period gaps considered is calculated by taking closing prices of the given stock after the specified time gap (i.e. one week, 1 month etc.) from the listing day. The market adjusted returns are calculated for the given time periods, by using the following formula. The formula used in equation (ii) is adjusted as follows: MAR t = _ (Mt – Mo) * 100 --------------(iii) Pt Mo Where MAR t = Market adjusted return at the end of time period t Pt = closing price at time t Po = closing price on Listing day Mt = Closing value of the index at time period t Mo = Closing value of the index on Listing day The average of R_Rett values, for all securities gives the return on days‘t’ for the sample.
TABLE 4.1 No of IPO’s issued from Jan-2007 to Mar-2010(monthly)
(Pt – Po)
UNDER PRICED MONTH Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 4 7 4 3 2 3 9 9 3 7
FAIRLY PRICED 0 1 2 1 1 1 0 1 0 0
OVER PRICED 1 3 9 0 2 3 1 3 0 0
TOTAL 5 11 15 4 5 7 10 13 3 7
Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10
5 7 5 3 2 3 1 2 2 2 2 1 1 0 0 0 1 0 0 1 0 1 3 1 0 0 3 4 6
0 0 0 3 0 1 0 2 0 2 0 0 0 0 0 0 0 0 0 0 1 2 0 1 1 0 1 1 1
2 1 1 4 1 0 0 0 4 0 0 0 0 0 0 0 0 0 0 0 0 0 1 2 1 0 0 4 1
7 8 6 10 3 4 1 4 6 4 2 1 1 0 0 0 1 0 0 1 1 3 4 4 2 0 4 9 8
Source: survey data Fig 4.1 graph showing the percentage of companies which under/ overpriced their IPO’s during the study period (Jan-07 to Mar-10).
UNDER PRICED PRICED AT PAR OVER PRICED
A large number of IPO listed during 2007 & first half of 2008 (Total 120 up to Jul 2008) when the Indian stock market was in a boom. After July 2008 due to the economical slow-down a few companies listed during Aug-2008 to Jul-2009 (only 11 companies). Later when the stock-market activity is increasing now a day, Number of IPO’s released from Aug-2009 to Mar-2010 has seen a good improvement (total 34 companies). The extent of Underpricing is highly seen in India. From the above table about Two third (61.49%) of the companies underpriced their shares where as 13.22% of the companies issued their shares at-par & 25.29% of the companies overpriced their shares.
TABLE 4.1.2 Av. Underpricing based on listing day closing price EXTENT OF UNDER PRICING
Duration(3 months) JAN-MAR-07 APR-JUN-07 JUL-SEP-07 OCT-DEC-07 JAN-MAR-08 APR-JUN-08 JUL-SEP-08 OCT-DEC-08 JAN-MAR-09 APR-JUN-09 JUL-SEP-09 OCT-DEC-09 JAN-MAR-10 Total
No. of Companies 15 8 21 19 10 6 6 2 1 1 4 1 13 107
Av. Underpricing (%) 97.76% 71.80% 54.17% 53.52% 63.94% 47.38% 32.36% 40.49% 127.33% 23.60% 7.72% 35.68% 28.03%
Source: survey data Fig4.1.2 Graph shoving the Average Underpricing (%) of the IPO’s during the period
A v.Underpricing(% ) 140.00% 120.00% 100.00% 80.00% 60.00% 40.00% 20.00% 0.00%
20 07 -J AN 20 -T 07 O -A PR - MA R -T 20 O07 JU -J NE UL 20 -T 07 O-O SE CT P 20 -T 08 O-J AN DE 20 C -T 08 O-A MA PR R -T 20 O08 JU -J NE UL 20 -T 08 O-O SE CT P 20 -T 09 O-J DE AN 20 C -T 09 O -A PR - MA R -T 20 O09 JU -J NE UL 20 -T 09 O-O SE CT P 20 -T 10 O-J DE AN C -T OMA R
63.94% 54.17% 53.52% 47.38%
40.49% 32.36% 23.60%
It is observed that the extent of under pricing is gradually decreasing over the period. In 2009 very few companies listed their shares which results in the abnormal 35
fluctuation shown in the table & the graph. There is only one company during Mar-09 (Edserv Softsystems Limited) which underpriced its IPO heavily. On the listing day the IPO has seen an increase of 127.33 % over the offered price. Except that the graph shows a gradual decrease over the period. This clearly indicates the companies are less underpricing their IPO’s. The maximum return from the IPO’s that an investor can earn on the listing day is 881.89% (Global Broadcast News Limited) whereas the maximum loss is 34.98%.( Emmbi Polyarns Limited) These figures itself shows the scope or the wide range for the profit. The higher end for the profit is quite high as compared to losing end along with the overall return. The fact is that an investor can earn a huge amount from an underpriced IPO on the listing day. Whereas the maximum amount of loss he has to incur is not too much different form that of the market loss. In other words if any trader buys the IPO’s with an intention of profiting from liquidating the position on the listing day at closing levels he be able to earn economically significant returns. This is also true for any day trader aiming to profit from buying and selling the share on the listing day. This is because of the more volatility of the IPO’s on the listing day. The investors can strategically invest on all underpriced IPO’s, and sell them on the listing day to maximize his profit. There is a chance that he may gain very less in some of the IPO’s by selling them on the listing day, but in an average, he will be at higher profit if he invests equally on all the underpriced IPO’s and sells the share on the listing day irrespective of the percentage of return on his investments.
4.2 Price performance of Underpriced IPO’s: short run analysis
Short run analysis of price performance of the IPO’s is essential to study the extent of Underpricing. For this purpose, the buy and hold period of first trading day i.e. listing day, one week after listing day, two week after listing day, one month after listing day, two months after listing day, three months after listing day and six months after listing day have been considered.
TABLE4.2 Price performances of Underpriced IPO’s in short-run (particular day’s closing price) PERFORMANCE OF UNDERPRICED SHARES OFTER No. of Compa nies 1 week 2 week 1 month 2 month 3 month 15 8 21 19 10 6 6 2 1 1 4 1 13 119.74% 70.75% 47.58% 53.71% 49.87% 35.45% -12.56% -1.25% -0.64% -40.73% 13.36% 92.43% 30.38% 116.14% 72.67% 48.09% 54.58% 36.21% 53.80% -29.76% 16.37% -32.64% -47.77% 8.73% 98.78% 31.86% 102.85% 77.82% 52.36% 64.53% 24.06% 23.60% -35.99% -4.54% -74.43% -48.84% 4.59% 143.40% 38.35% 96.31% 82.23% 45.31% 62.93% 20.09% -7.12% -37.92% -2.02% -92.78% -59.77% 0.69% 143.94% 52.53% 113.53% 103.21% 34.01% 46.67% 4.69% -22.39% -26.01% 2.59% -111.81% -55.34% 0.61% 287.44% 30.91%
Duration(3 months) JAN-MAR-07 APR-JUN-07 JUL-SEP-07 OCT-DEC-07 JAN-MAR-08 APR-JUN-08 JUL-SEP-08 OCT-DEC-08 JAN-MAR-09 APR-JUN-09 JUL-SEP-09 OCT-DEC-09 JAN-MAR-10
6 month 121.80% 154.23% 48.87% 28.95% -8.19% -16.85% -25.86% 49.92% 20.87% -64.92% -12.95% 29.29%
Source: survey data The overall returns obtained from the IPO’s are shown in the table 2.1. The returns, thus calculated are the Adjusted Market Returns taken on the listing day, one week after listing day, two week after listing day, one month after listing day, two months after listing day, three months after listing day and six months after listing day so as to analyze the price performance of the IPO’s in the short run. These returns are in turn compared with that of the market returns, which are calculated by taking into consideration the S&P CNX Nifty Index (so as to represent the market behavior during the exactly same time span).
Fig 4.2.1 short run analysis of Underpriced IPO’s after one week, two week and one month (based on the closing price at that particular duration).
We can see in the graph 2.1 that the AMRt are quite high on the listing day, and have fallen considerably over the short run time period. These returns showed the extent of Underpricing of the IPO’s which generate returns to the investors on the first trading day of price discovery. The returns fell down dramatically after one week from the listing day and subsequently to compensate for the price appreciation and tend to normalize thereon in the long run 38
Again the exceptional case is in Oct-Dec-09 is because of there is only one company issued IPO’s (Thinksoft Global Services Ltd) which performed well after the listing day. On the listing day 36% up, where as in subsequent time the stock price increased by 143%, which is resulting for the abnormal fluctuation in the graph.
Fig 4.2.2 short run analysis of Underpriced IPO’s after two month, three month, six month
3 5 0 .0 0 %
3 0 0 .0 0 %
The overall returns obtained from the IPO’s are shown in the graph 4.3.2. The returns, thus, calculated are the adjusted market Returns taken two month after listing day, three months after listing day and six months after listing day so as to analyze the price performance of the IPO’s in the short run.
2 5 0 .0 0 %
We can clearly see the difference in the adjusted market returns of the IPO’s on the listing day and their decline thereof. In the short run the results highlight that there is an increase in the returns after the first month during 2007.that is the IPO’s issued during that time period were performed better after the first month, slowly moved up up-to 6 months. Where as the companies which issued their IPO’s in first half of 2008 were performed poorly, and resulted in negative returns means loss to the investors. The reason for the poor performance of IPO’s in this period is due to the economical crisis faced in Indian stock market due to which many company shares lost their price value. The companies listed during the last quarter of 2009 and in first quarter of 2010 performed better and gave positive returns. One more reason for the positive returns is again Think soft Global Services Ltd which shown a very good performance at this time. 4.3 Price performance of other company IPO’s: short run analysis Other companies also listed their IPO’s either at par or above par during the same period also observed for the purpose of comparison, and their performance was given in the table 4.
TABLE 4.3 Price performances of other shares in short-run based on particular day’s closing price PERFORMANCE OF OTHER SHARES OFETR No. of Compa nies 1 week 2 week 1 month 2 month 16 -23.31% -26.56% -26.78% -27.57% 8 -11.80% -12.73% -16.82% -13.79% 5 -20.58% -24.84% -29.05% -41.42% 3 -18.95% -18.19% -15.02% -31.09% 9 18.92% -17.90% -22.55% -21.43% 3 -31.22% -31.50% -28.96% -24.37% 4 -23.28% -24.06% -27.82% -25.61% 0 0.00% 0.00% 0.00% 0.00% 0 0.00% 0.00% 0.00% 0.00% 0 0.00% 0.00% 0.00% 0.00% 4 -6.94% -9.50% -14.25% -22.05% 5 -15.28% -14.64% -18.78% -22.86% 8 -11.60% -12.57% -10.84% -10.86% 65
Duration(3 months) JAN-MAR-07 APR-JUN-07 JUL-SEP-07 OCT-DEC-07 JAN-MAR-08 APR-JUN-08 JUL-SEP-08 OCT-DEC-08 JAN-MAR-09 APR-JUN-09 JUL-SEP-09 OCT-DEC-09 JAN-MAR-10
3 month -31.00% -13.35% -25.67% -37.96% -12.55% -22.06% -30.53% 0.00% 0.00% 0.00% -22.28% -27.35% 0.00%
6 month -35.69% -20.13% -4.29% -41.60% -12.81% -13.08% -28.91% 0.00% 0.00% 0.00% -0.92% -21.96%
Source: survey data
Fig 4.3.1 short run analysis of other IPO’s after one week, two week, one month
3 0 .0 0 %
These companies show a different pattern. The one week, two week and one month after the listing day trend is showing a continuously decreasing trend throughout. Except in Jan-Mar-2008 the one week price performance shows a positive return. The reason for this is ‘Reliance Power Limited’ (REPL) which issued its IPO
2 0 .0 0 %
in Feb-08, which is overpriced by 11.85% performed abnormally in first one week (48.6% increase in its price), because of its high reputation the IPO was oversubscribed and created an artificial demand in the first one week. There were no companies listed during Oct-08 to June-09. The same trend is observed among the companies which listed after Jul-09 till Mar-09. A steady decrease in the prices was observed from the listing day to one month. Fig 4.3.2 short run analysis of other IPO’s after two month, three month, six month
0.00% JANMAR-07 -5.00%
The above graph clearly shows how the other company IPO’s are performing in the duration of two month, three month and six month after the listing day. For the companies listed their IPO’s during 2007 the share prices are moved further low compared to one week, two week and one month after the listing day. Exception is those listed during Jul-Sep-07. Only which the prices were moved up. This is because of ‘Refex Refrigerants Limited’ whose price started increasing after second month and continued further. The companies listed during 2008 onwards showing a mixed pattern because of the instabilities in the stock market. 42
4.4 Long run analysis of IPO’s Generally, the investor envisages, what would be his return after one year, or two years, or three years or in subsequent years if he invested his money today in an investment avenue. Initial public offerings are an interesting investment opportunity which generally ensures positive return in the short run. But do they offer the same thing in the long run also? Do the IPO’s remain Underpriced in the long run or not? To answer these questions the long run price performance analysis has been done, which is presented below. The overall returns obtained from IPO’s are shown in the table 4.5.1. The returns, thus calculated are the Adjusted Market Returns taken on the listing day, one year after the listing day, two years after the listing day and three years after the listing day, to analyze the price performance of the IPO in the long run. These returns are calculated by taking into considerations the S&P CNX Nifty Index (so as to represent the market behavior during the exactly same time span).
TABLE 4.4.1 Price performances of price)
IPO’s in short and long-run (based on particular day’s closing
Price after Day1 Week1 Week2
UNDERPRICING IPO'S SIMPLE MOVING Wt. Av (%) Average 55.85% 51.54% 50.25% 31.21% 32.71% 35.74%
OTHER IPO'S SIMPLE MOVING Av (%) -11.42% -12.93% -19.53% Wt. Average -10.70% 5.07% -18.01%
Month1 Month2 Month3 Month6 Year1 Year2 year3
48.56% 45.08% 41.91% 46.09% 39.19% -9.71% -15.77%
38.64% 34.88% 36.98% 37.93% 20.21% 4.44% 0.06%
-21.42% -23.62% -23.38% -22.15% -33.63% -35.96% -75.38%
-21.47% -27.12% -27.93% -30.46% -33.40% -38.05% 28.71%
Source: survey data Fig 4.4.1a Price performances of Underpriced IPO’s in long-run compared with short run (weighted
Av. Is compared with simple moving Average)
SIMPLE MOVING Av(%) Wt.Av 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Day1 -10.00% -20.00% Week1 Week2 Month1 Month2 Month3 Month6 Year1
21 31. 85 55. % 5 51. 4% 50 .25 % 48 .74 % % .56 3 4% 8.6 45 .08 34 % .88 % % .09 1 % 46 9% % % .93 39.1 .98 37 36 21 20. % 4.4 4% 0.0 6%
Year2 71% -9.
year3 % . 77 -15
The above graph shows that the price of the Underpriced IPO’s steadily decreased up to one year after the listing day. Then onwards the price drastically decreased and reached negative. The above chart consists of two type of information. First is the Simple Moving Average and the other is the Weighted Moving Average? The issue size is taken as weight for calculating the weighted moving average. The simple moving average is steadily decreasing where as the weighted moving average is increased up to six month period. This shows that the price of the IPO’s of the companies with higher issue size increased in short run. And the price of
lower issue size company IPO’s decreased on average. This throws the light on the effect of issue size on the price performance of Underpriced IPO’s.
Fig 4.4.1b Price performances of other IPO’s in long-run compared with short run (weighted Av. Is
compared with simple moving Average)
The above graph shows that the price of the other IPO’s steadily decreased up to one year after the listing day both in short and long run. Except at the end of the three year ‘Cairn India Ltd’ showing a positive return (59.12%) compared to the offered price. The above chart consists of two type of information. First is the Simple Moving Average and the other is the Weighted moving Average? The issue size is 45
taken as weight for calculating the weighted moving average. Both The simple moving average and the weighted moving average are decreased continuously in both short and long run period. And the issue size of the company is not having much effect on the price performance of the IPO’s.
TABLE 4.4.2 Returns from the Underpriced IPO’s in long run
No. of companies giving positive returns No. of companies whose return is more than listing day return Total No. of companies
1 YEAR 2 YEAR 3 YEAR
36 20 5
21 11 4
88 77 18
Fig 4.4.2 Returns from the Underpriced IPO’s in long run
U N D E R P R IC E D IP O 'S
100 90 80 70 No. of companies 60 50 40 30 20 10 0 1 YEAR 2 YEAR 3 YEAR 36 21 20 11 5 4 18 88 77 N o . o f c o m p a n ie s g ivin g p o s s it ive re t u rn s N o . o f c o m p a n ie s w h o s e re tu rn is m o re th a n lis tin g d a y re t u rn To ta l N o . o f c o m p a n ie s
The above table shows the total number of companies which Underpriced their shares, number of companies giving positive returns and the number of companies
whose return is more than that of the listing day after the period of one year, two year and three years respectively. From the table it is evident that the no of companies performing better than the listing day has considerably reduced in all the time period of observation. From this it can be concluded that it is more profitable if the investors sells out his IPO’s can earn more than keeping it for a longer time.
TABLE 4.4.3 Returns from the other IPO’s in long run OTHER IPO'S
No. of companies giving positive returns No. of companies whose return is more than listing day return Total No. of companies
1 YEAR 2 YEAR 3 YEAR
6 6 3
9 6 3
48 42 17
Fig 4.4.3 Returns from the other IPO’s in long run
O T H E R IP O 'S
60 50 40 30 20 10 0 1 YEAR 2 YEAR 3 YEAR 6 9 6 6 3 3 17 48 42 N o .o f c o m p a n ie s g ivin g p os s it ive re tu rn s N o .o f c o m p an ie s w h o s e re tu rn is m o re t ha nlis t in g d a y re tu rn To t a l N o . o f c o m p a n ie s
No. of companies
The above table shows the total number of other companies issued IPO’s, number of companies giving positive returns and the number of companies whose
return is more than that of the listing day after the period of one year, two year after the period of one year, two year and three years respectively. From the table it is evident that the no of companies performing better than the listing day is more or same in all the time period of observation. From this it can be concluded that if the investors sells out his IPO’s after one year can earn more than keeping it for a longer time.
4.5 Interview results
An unstructured interview was conducted among the senior investors and the company executives to know the other factors affecting the price performance of IPO’s In short and long run. The results obtained are as follows. Other factors affecting the price performance of IPO’s Age and Performance of IPO’s Age of a company is the difference between the incorporation date of a company and its listing date irrespective of the company’s name change and sifting over from private to public limited. The age affects the Underpricing significantly, which is also the highest
returns are expected from the companies of age more than 20 years. According to the investors & experts view an increase in age results in the high returns. There are cases where a new company also performs well in the short run but for long run investors want to invest on the companies of age more than 10 years. Subscription level and Performance of IPO’s Subscription level of IPO’s depicts the total demand of the issue generated in market by investors’ viz. retail investors, NIIs and FIIs. Subscription level is being calculated by dividing total demand (of the issue) by total offer size. The benchmark
value of subscription level is 1. If the subscription level value is less than 1 then the issue is undersubscribed and if it is more than 1, it is over-subscribed. It is crystal clear that with an increase in subscription level there is a subsequent increase in listing day returns. This shows the clear correlation between the two, indicating that the issues which are more subscribed are bound to give significant positive initial returns indicating Underpricing Issue size and Performance of IPO’s It observed from the analysis and also from the experts opinion that the companies with higher issue size are performing better when compared to the companies with lower issue size. Simple moving average is declining in short run where as the weighted average is increasing in the short run, which proves the experts view. According Investors the IPO’s of the companies whose issue size is more than 200 crore perform better as compared to other companies whose issue size is less. Market timing and Performance of IPO’s Market timing is the time at which the companies issued their IPO’s in the market. To know what was the market condition at the time of the IPO’s issue. The investors are not sure about the how it will affect the performance of the IPO’s in long run, but in short run the market movements can effect strongly on the price performance of IPO’s. In the long run the opposite market movements will get offset and hence it will not affect the price performance of IPO’s. The expert’s opinions were also found consistent inline with the above statement.
CONCLUSION From the above analysis, it can be concluded that underpricing is present in Indian stock market. It can also be concluded that underpricing is more severe in the short run periods, i.e., from the listing day to the six months after the listing. However the long run IPO’s tends to move to their intrinsic value or true value wiping out much of the underpricing. The difference between the extents of underpricing in the two time intervals is very much. For long time interval is taken up to three years from the day of the listing of the company. It shows that if an investor buys and sells the share on the listing day he can earn more than holding it the considered time period. Where as the other IPO’s also shown the decreasing trend suggests that it is not worth holding the shares for a long run of more than two years. In India very few company IPO’s give good results in a long run. Therefore it is better to sell the IPO’s on the listing day or the investors can hold the share for a short period of one or two weeks. If the issue size of the IPO is more than 200 crore the investors can hold the shares up to six months. In addition to that an analysis of the influence of factors on IPO’s pricing performance has been done. The factors taken in to consideration are: Subscription level, Issue size, time and Age. The results show that these factors influence the initial returns, i.e., Raw Return on the listing day of the company.
The Market timing may have a influence on the price performance of IPO’s in the short run, but the effect will be offset in the long run.
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