Sucheta Dalal :The Rules Of The Game Are Changing
Sucheta Dalal

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The Rules Of The Game Are Changing  

Sep 6, 2004


For too long, the Indian primary market has been held hostage to poor infrastructure and pressure from the investment banking community to ape international trends. Two recent initial public offerings (IPOs) have the potential to change the rules of the game, in a manner that will benefit issuers and investors and reduce the stranglehold of market intermediaries.


The first is the Google IPO, which broke several rules, kept out investment bankers, survived harsh criticism from powerful research analysts and problems created by the inexperience of their brash young promoters to pull off a successful issuance. Its successful listing is bound to rewrite IPO rules in the US and all countries that bow to the pressure of so-called international practices.


The Tata Consultancy Serv-ices (TCS) offering also has important lessons, not the least of which is the drastic need to improve primary market infrastructure and to cut down the offer-to-listing time. In fact, TCS has broken several primary market myths.


For starters, it is the first private sector IPO to raise over Rs 5,000 crore through a price discovery mechanism. TCS had offered a price band of Rs 775 to Rs 900 and finally allotted the shares at Rs 850 a share to leave room for post-listing price appreciation.


Consider this. The Securities Market Infrastructure Levera-ging Expert task force (SMILE) revealed that 97 per cent of retail investors tend to bid at the cut-off price — mostly, the top end of the price band. This happened in the TCS issue as well. Retail investors, including large bidders like Cyrus Poona-wala of the Serum Institute, showed more faith in the Tata bluechip and bid at Rs 900 or the cut-off price.


Conventional wisdom is that institutional investors or qualified institutional buyers (QIBs) are the best judges of valuation and lead the price discovery process. In this case, they seem to have got it all wrong. Almost all QIBs bid between Rs 800 to 850 for the TCS shares. But 60 per cent of the issue is reserved for QIBs, without any flexibility to the issuer to transfer the QIB portion to retail (who have a 25 per cent reservation) or high networth investors (who have a 15 per cent reservation and had a 19 times over-subscription).


Conventionally also, Indian firms are more worried about the retail segment being fully subscribed. Our retail investors have been hurt so often by artificially pumped up IPO prices, or the high dematerialisation expenses that they keep away from all but the very best issues.


SEBI rules hence provide that the under-subscribed retail portion can be allotted to QIBs; but it has never envisaged a situation where an issuer may want to cut institutional allocation and transfer their quota of shares to retail investors.


The TCS issue disproved conventional thinking on both counts. Since the issue opened at a premium to listing and had touched a high of Rs 1,198, it is clear that institutional inves-tors were completely wrong. In fact, their role in price discovery now seems highly over-rated. Yet, TCS was forced to issue the shares at Rs 850 in order to be able to allot shares to institutional investors.


Consider what could have happened if TCS had the option of pricing the issue at Rs 900 by raising the retail quota and pruning institutional allocation. QIB’s would have lost out. At the same time, no large institutional investor could afford not to have TCS in its India portfolio. Consequently, they would have been forced to buy the shares in the secondary market and would have set the stage for a spectacular listing and boosted retail participation in the primary market.


Admittedly, the TCS story is unlikely to be repeated in other IPOs, but it definitely makes a case for keeping the reservations for different categories for investors more flexible, to ensure fair allocation of shares.


Another aspect to institutions being wrong on price discovery process was that TCS’ lead managers had to work overtime to ensure a big response. This led to hectic lobbying for permission for participatory notes holders to bid through the lead managers. This is currently barred in order to prevent manipulation of market sentiment through institutional bids. Also, lead managers lose out on commissions if their PN clients apply through other firms.


The 10-times over-subscription to the TCS issue shows that the PN rule did not deter genuine investors. The government fell for the pressure tactics and scare created by investment bankers in the run up to the ONGC issue, but not for TCS.


This experience shows that regulators must not be swayed by lobbyists because their claims can often be wrong. If anything, the success of the Google issue in the international market is proof that there is nothing sacrosanct about so-called ‘international practices’.


The IPO market must be tailored to suit the Indian market structure and investor psyche. It also means that institutional investors can be prevented from distorting the issue response by forcing them to deposit a minimum margin of 10-15 per cent. They are unlikely to boycott good investment opportunities, merely because they have to cough up some money upfront.


At the same time, the SMILE committee suggestions to automate the IPO process and cut the issuance to listing time must be implemented speedily, so that neither retail nor institutional money is blocked up for a long time. 

-- Sucheta Dalal