Thursday, 28 October 2010

Curious case of SEBI's Misguided IPO Missile-Perspectives of a Retail Shareholder

The Securities and Exchange Board of India (SEBI) on the 25th October 2010 decided to double the maximum application size for retail individual investors to Rs 2 lakh across all  Intial public issues(IPO) by companies, without changing the retail quota. Currently, individual investors are classified as retail investors only if their investment is INR.1 lakh or less in an IPO. 

Presently in all IPOs, approximately 35 per cent is reserved for retail investors, 15 per cent for high net worth individuals(HNI) and 50 per cent for qualified institutional buyers(;QIB) it is suggested by SEBI that due to the previous low investment limit, very often the retail portion is undersubscribed. 

Addressing the media, SEBI Chairman Mr. C.B. Bhave said that “the complaint from both sides – the investors as well as the issuers of the IPO was that the quota for retail investors was insufficient thus causing under application.”
According to a discussion paper released by SEBI, large-sized public issues easily require between 1.5-2 lakh applications to meet their retail quota. This is much higher than the 35-70,000 applications received from retail investors in recent issues claims SEBI.  

SEBI also noted that in recent public offerings, approximately 75% of applications in the retail category have come in the size of INR.80,000-Rs1 lakh. The number of applications in the non-institutional category, which is used by high net worth individuals, is usually above Rs5 lakh, but retail investors avoid investing in this segment since the reservation of shares is only 15% against 35% for retail.

According to the regulator, the proposed increase in the investment limit is intended to keep pace with inflation and also the changing nature of market valuations. As per SEBI while inflation is close to double-digits, the market has risen over 125% since 2005. Rs1 lakh does not fetch the retail investor too many shares, given the bloat in share valuations.

Except for a few, almost every expert on the street is supporting the proposal on the grounds that it will attract more retail participation.

I beg to differ with the majority of the experts, for I strongly believe that all the changes proposed by SEBI would do is attract more money from some existing investors "who have the money " but who could not apply because of the previous limits, and not necessarily from new or small investors. 
This policy announcement singlehandedly creates a new investor category- sub-High Net worth Individuals(HNIs)," who would in all likely hood now eat into the share of the real retail investors. Because of the proportionate allotment system, and with the pie remaining the same, the allocation to the real small investors would go down substantially.

However, if the sub-HNIs are now being expected to be the saviours, let it be clear that  should the QIB response to an IPO not be enthusiastic, the sub-HNIs would not be there to bail out the retail portion.

It should be understood that it is not increasing the investment cap that would bring more retail investors participation, instead it is the quality of the company, the offer price, the market sentiments and the availability of shares, among others, that will.

SEBI has observed that in recent public offerings, approximately 75 per cent of applications in the retail category have come in the size of Rs. 80,000 to Rs.1 lakh, whereas in the HNI category, the number of applications in the size of less than Rs. 5 lakh is negligible. 

The above suggests that the retail who have the capacity and appetite to apply for securities worth above Rs.1 lakh were constrained from doing so because of the Rs. 1 lakh limit, nor do they make an application under the HNI category because the allocation there is limited to 15 per cent.

Now, nearly 60 per cent of the applications were below Rs. 75,000 and 55 per cent were below Rs.50,000. At the upper end, only 8 per cent of the applications were in the Rs. 75,000-Rs,95.000 block while 32 per cent were at the Rs. 1 lakh level. These 32 per cent are the rich individuals and almost all of these would now move straight to Rs. 2 lakhs (and not to Rs. 1.25 lakh or Rs. 1.50 lakh).

If there is a concentration at the Rs.1 lakh level, it is because the few richer individuals, normally leveraged, are applying to get allotments which are difficult to get in the HNI category. 

In 2005, the cap was increased to Rs.1 lakh from Rs.50,000. This had a negative impact on allocation to the real small investors, as the richer guys started applying for Rs. 1 lakh and eat into this pie. The assumption that the existing investors have a larger appetite and are not able to fill it is, therefore, misguided. In the proposed move, it is also the IPO financing firms who will benefit the most.

Majority of the retail investors struggle to arrange the Rs. 1 lakh to put in an application, with SEBI having increased the limits to Rs.2lakhs, it will only benefit applicants with huge cash, the small real retail investor will suffer, now even the retail category will most likely be played by the richie richs of the country, the problem will increase even more when good issues are bunched together, the rule if implemented would work against the interest of the real small investor.

SEBI's move would make it harder for small investors to obtain shares through IPOs. Investors who subscribed to only the minimum number of equity shares in an IPO will now get fewer shares whenever there is an over-subscription. 

For retail investor to have a better chance of allotment, the percentage allocated to retail category should have been raised. 

As stated above raising the capital limit works well for retail investors with lots of money. Since with the same percentage of IPO shares, bigger lots will get more shares and small investors who cannot put in full application will lose out on allotment, this will crowd out small investors.

The decision is likely to deprive shares to smaller retail investors bidding in IPOs of companies with mass appeal and good track records. 

Policy, in any case, should not favour the HNIs at the expense of the retail, especially at this time when we are talking of increasing the retail investor base and of financial inclusion. If HNIs, in fact, need to be encouraged, let 5 to 10 per cent be taken out of the QIB quota and be given to them.

Good companies with right price will always see phenomenal response from retail and Coal India's IPO is a case in point. 

Why should anyone be bothered if the retail portion goes undersubscribed in bad issues; it should actually make everyone happy.

In particular why on earth should I be bothered, I will always have the money to make a full application be it Rs.2 lakhs or even Rs.5lakhs if SEBI decides to increase the limit further. 

It is my belief that the policy was wrongly based around the concern that large IPOs might not elicit sufficient retail response, if it was SEBI’s intention to increase small shareholders participation in the IPO’s then the percentage allocated to retail category should have been raised. 

Kind Regards


1 comment:

  1. Good observation.

    What about retail investors who go in for multiple applications in their relatives' names, etc? Wouldn't this move of SEBI benefit them? (even if they comprise of only 25% of the chunk)