Grading of IPO by Sri CA.N.VENKATESWARAN of Chennai

GRADING OF INITIAL PUBLIC OFFERS.

The concept of grading of Equity Initial Public Offers was introduced and mandated by SEBI from 1st May, 2007, after series of issues having failed to make a mark in the browses and struggled to reach their issue prices even till date. Between January, 2006 to April, 2007 retail investors in their greed have lost substantial part of their investments in IPOs without giving any heed to the counseling of knowledgeable persons negative views on these issues. This was the reason why some of the companies even with very low rating managed to show a stellar performance in the open offer. Such frequent failures of IPOs not only disturb the market dynamics but also restrain further participation by retail investors in the equity market. To set right this situation SEBI brought in the regulation of compulsory rating for Equity IPOs also for the first time the world. As per this regulation, every company after obtaining SEBI’s approval for an IPO it has to get graded their issues from one of the rating agencies.

Since implementation of this regulation, more than 60 issues have been rated in the last 15 months, but in the market tsunami followed after March, 2008, most of them have eroded in their value by over 50% irrespective of their grading. The Agencies awarded totally five grade starting from (1) Poor Fundamentals, (2) Below-Average Fundamentals, (3) Average Fundamentals, (4) Above Average Fundamentals and (5) Strong Fundamentals. From the above grading symbols it is clear and it should be understood that the grading is based fully on fundamentals and not on market euphoria. Many are of the view that once the rating for investment is positive, immediately it should command premium in the market which shows only their short tern intentions and greed. Fundamentally in an investment opportunity, the asset in which the investment has been made is to grow over the years and yield better return to investors, whereas to day, people do not have patience and expect return only through price fluctuations. Price fluctuations can arise only due to demand and supply and not due to performance of the asset in a short term. Hence it is most unfair to criticize grading by taking into account only the listing price in the browses.

Let us consider some of IPOs, their grading and their performance in the markets on listing.
Year Name of CO. Rating Agency Grade Issue Price Recent Market Price
2007 Precision Pipes & CRISIL 4-Above Avg. 150.00 46.60
Profiles
2007 Transformers & CARE 4-Above Avg. 465.00 373.30
Rectifiers (India)
2007 Jyothy Laborataries CARE 4-Above Avg. 690.00 122.30
2007 Central Bank of India CARE 4-Above Avg. 102.00 96.65
2007 Edelwiess Capital Ltd CRISIL 4-Above Avg. 825.00 413.15
2008 Gammon Infrastructure CARE 4-Above.Avg. 167.00 101.50
2008 IRB Infrastructure Dev FITCH 4-Above Avg. 185.00 176.00
2008 Reliance Power ltd ICRA/CRISIL 4-Above Avg. 281.25 * 155.50 * adjusted for
bonus
2009 Mahindra Holidays FITCH 4-Above Avg. 300.00 325.75

Source – SMC Capitals Ltd.

Let us now analyze the performance of the above IPOs. It can be seen from them that issues made in 2007-2008, when the market was in boom, have suffered most because of the subsequent deep fall in the market. This has happened in case of share prices of almost all the established companies also. Does it mean that all companies have failed? Are their future is uncertain? Are they not worthy of future investment? In spite of them being rated by different rating Agencies –and that too only as Above Average- all of them have gone below their issue price. Does that not lead us to think about wrong pricing rather than wrong fundamentals? SEBI having clearly mentioned that the IPO rating is for fundamentals and not for pricing of the issues, is it correct on our part to criticize the rating for the debacle of these IPOs? If the so called investors [who only speculate on prices and not concerned about fundamentals] who invest in IPOs don’t have the patience for the asset to perform but want to make profit at the listing of the issue, then we may have to go back to the age of Controller of Capital Issues who used to road roll on issue prices and not to free market regulators.

There are intelligent market players who argue that rating should take in to account the issue price also. It means that rating agencies must take into account the future trend in the market also. Is it possible for any one to predict the future of the market? If someone claims “he can” predict the future of the market, then it is my humble opinion that he will first invest in the market and make money rather than give advise to others and try to make money without putting his own money in that investment. The present rating takes into account fundamentals only including (1) background of promoters (2) capacity of promoters in converting their ambitions in to reality, (3) financial tie up (4) expected success rate of the project etc. Certainly a high IPO grade by itself will not indicate how market will receive that scrip. After all the market is never scientific, never rational and moves based on various considerations.

It is also argued by many learned market operators that equity is perpetual in nature and hence the grading is not required as investors are not concerned with return of their investment. There can not be more fallacy than this. Every investor is certainly concerned not only about his return of investment but more importantly about his return on his original investment. For example people invested in IPOs of Hero Honda, Maruthy, HUL, L&T, Ambuja Cement Ltd and so many other companies are getting dividends from these investments every year which will be more than their initial investment itself. It means more than 100% return year after year. That is the power of investment as these assets have grown to yield result. If one buys these shares now at present prices and want 100% return within short period due to change in prices alone, will it be possible? Can we conclude investments in these companies at present prices are not advisable? Even investment in these companies in the last year has given more than 50% return due to price changes but not due to dividend return. Hence it is very essential to understand the SEBI’s intention and efforts behind its regulation for the IPO grading.
It is for the retail investors and not for market specialists and speculators.
It is based on fundamentals of investment and not on market pricing of the scripts.
We can discuss about the failure of these grading only after their projects have been completed and not before even their commencement.
Merchant bankers are only responsible for IPO pricing and not rating agencies as it has been made very clear at the outset itself.
When it is clearly mentioned the IPO rating has been based only on fundamentals and grading is not related to pricing of the issue it is not correct to raise the issue of its price performance in the browses and that too immediately on listing. For the debacle of the prices of recent IPOs it is the Merchant Bankers who are responsible and the blame should squarely lie on their lap.