What Ails India's IPO Market?

Some numbers do suggest aggressive pricing. Based on the issue price, Emaar MGF would have a P/E (price/earning ) ratio of 165 at the lower end of the price band against 73 for DLF and 49 for Unitech, the established leaders in the real estate sector. At the Wockhardt Hospitals P/E of close to 200, it was looking at a valuation around Rs. 2,700 crore ($710 million), when its older and larger listed peer Apollo Hospitals commands just Rs. 2,500 crore ($658 million).

Reliance Power, of course, doesn't have a P/E; it has no earnings . As its prospectus explained: "We currently have no power plants in operation or other revenue -generating operations, and we have no significant operating history from which you can evaluate our business and future prospects and viability... Commercial operations at our first power plant -- Rosa Phase I -- are not scheduled to commence before December 2009..."

For many it is not overpricing that is the norm but underpricing. Gupta of ISB says that this is not just an Indian phenomenon. "One of the stylized facts about IPOs that are universally verified is initial underpricing," he says. "What we have observed in the Indian IPO market so far is not very different."

Gupta explains the reasons for the underpricing. "An IPO is different from a secondary offer as investors know little about the fundamental prospects of the project," he says. "Since investors cannot distinguish bad quality projects from good quality projects, the good quality project has to be sold at a discount (underpricing) so that investors are attracted to invest in the IPO." Gupta says the issuing firm also may not know the actual prospects of the project, and improves its understanding from institutional investors as the IPO gets listed.

Gupta says IPOs in emerging economies could be under priced by as much as 100%; this means the price doubles on the first day. "Even in the U.S., generally known to have a transparent financial market, in 1999-2000 (the Internet boom), the first-day under-pricing was 65% on an average," he says

Adds Ramesh of Kotak: "IPOs are typically priced by leaving a discount to the realizable price at listing. It is always a good idea to leave a discount to motivate investors to subscribe."

Regulatory Urge

Market watchers recommend other measures to regulate the behavior of investors, merchant bankers and promoters. SEBI has been looking at putting a price band on the movement of the share on listing day. But nobody is quite sure how that will help, except to stop huge volatility. All it may succeed in doing is moving the volatility from day one to week one, say some investment experts.

"I don't think the regulator should set the price of issues," says Allen, who has other, longer-term suggestions. "Make the markets efficient. As long as there are enough knowledgeable investors, promoters who try to overprice won't succeed."

Another suggestion is to make the bankers more accountable. If the bankers are made to function as underwriters, too (which means that they will have to pay out the money for the unsubscribed portion of an issue), they are likely to be more circumspect about pricing. But this means that they will always opt for caution and the promoters will never get the best deal.

There are other suggestions floating around, which many consider unworkable. The State Bank of India (SBI) has suggested to Parliament that the agencies that currently rate IPOs should be allowed to give an independent view of the pricing. But market participants don't think anyone will give pricing a second look in a bull market, when they aren't likely even to read the IPO ratings. In a bear market , they are not going to be investing in IPOs, anyway.