The Chicken And Egg Dilemma Of IPO Financing Returns

What came first? The rush of interest in initial public offerings leading to demand for IPO financing? Or was it the easily available funds in a market flush with liquidity that led to the feverish interest?

That familiar question has returned to the Indian primary market. As more companies line up to go public amid upbeat sentiment, non-banking financial companies are lending into that boom and perhaps fuelling it to new heights.

This week has been especially busy as six companies—Anupam Rasayan India, Laxmi Organic Industries, Craftsman Automation, Kalyan Jewellers, Suryoday Small Finance Bank and Nazara Technologies—hit the primary markets with their debut issuances.

Since January, 15 companies have raised Rs 14,538 crore from the equity markets, according to data from primary market tracker Prime Database. Some of the issues have seen eye-popping subscription levels.

A number of the recent IPOs have been heavily over-subscribed in the high net worth individual category that’s usually kept at 15% of the overall book. MTAR Technologies saw an over-subscription of over 650 times in the HNI category, while Easy Trip Planners was over-subscribed 382 times, Heranba Industries 271 times, Indigo Paints 263 times, Laxmi Organic about 218 times, and Anupam Rasayan about 97 times.

IPO financing is a short-term loan, usually 6-8 days, that investors avail from NBFCs from the time of the IPO till the listing day, after furnishing a small proportion of margin money upfront. During the period, the lender charges an upfront interest. The facility is commonly used by high-net-worth investors.

“The recent slew of IPOs in the market has led to a significant increase in IPO funding from NBFCs, as a large part of these subscriptions are still met through leverage financing by investors,” said Ravi Dharamshi, founder and managing director at investment advisory firm, ValueQuest Investments.

“The financing levels have also been higher considering many high-net-worth investors over-subscribe to increase their chances of a higher final allotment,” he said. “The same trend may be prevalent, but in a very small way, among retail investors as well.”

The leveraged bet can go wrong in two ways. In cases of over-subscription, the final amount of allotted shares is lower, resulting in lower net gains for the investor. If the listing price is equal to or below the issue price, then the investor will be at a loss and would have to cut off his position. If the investor chooses to hold on to the shares beyond the period of the loan, they would have to arrange funds to repay the loan.

“Depending on the quantum of over-subscription, investors have to take a hit on their final acquisition cost of shares as the interest payout gets divided for a much lower number of allotted shares, compared to the number of shares the loan is initially applied for,” said Satyen Shah, head-investment banking at Edelweiss Financial Services.

The IPO financing rush becomes more pronounced when markets are flush with liquidity and rates are low. That seems to be the case right now with a host of NBFCs raising short term CPs for on-lending to HNIs.

NBFCs ranging from Tata Capital Financial Services, Bajaj Finance, Aditya Birla Finance, JM Financial Products, Motilal Oswal Finvest, Edelweiss Financial and ECL Finance, Kotak Mahindra-owned Infina Finance and Sharekhan BNP Paribas have all borrowed funds through the month from the commercial paper market for 7-13 days at rates between 5% – 6%, shows data from the Clearing Corporation of India Ltd.

These NBFCs in turn are lending at rates ranging from 12% to 18%, according to market participants.

When contacted, Motilal Oswal Finvest, Sharekhan BNP Paribas and Tata Capital Financial Services declined to comment, while Edelweiss Financial and Bajaj Finance didn’t reply to BloombergQuint’s queries.

“With six IPOs in place, the financing levels are very strong. As more IPOs come, I expect the last day commercial paper-based financing to keep going up, until RBI draft NBFC regulations become a reality and bring this down,” said Deepak Shenoy, founder at Bengaluru-based investment research and wealth management startup, Capitalmind.

In its draft guidelines for the NBFC sector the RBI proposed to fix a ceiling of Rs 1 crore per individual for any NBFC funding share purchases during IPOs. The rules are yet to be finalised.

The absence of any curbs on NBFC financing of IPO subscriptions is leading to mispricing of shares, said Deven Choksey, managing director of KR Choksey Investment Managers.

“A large part of the recent IPO subscriptions have come through financing from NBFCs, leading to mispricing of these shares,” Choksey said. “Most of the numbers on over-subscription are unnatural as they’re heavily funded using margin financing from NBFCs, and that eventually results in traders flipping the bought position post listing or trade in grey markets and most of these stocks trading below their listing price or underperforming the benchmark Nifty indices.”

“The excessive leverage created by flipper (a trader who trades out the stock on the listing) needs to be checked and a mechanism needs to be put in place by SEBI in consultation with RBI as it shores up valuations and creates a false perception of the stock attractiveness and the overall market sentiment,” he said.

The trend of leverage financing, however, is mainly restricted to HNIs and has not seen much uptake among retail investors, according to Nithin Kamath, founder and chief executive of online broking firm Zerodha, which caters to retail investors.

“We have seen some investors opening accounts in the name of family and friends to increase their chances of getting a higher allotment, but considering retail investments are capped at Rs 2 lakh per individual, the option of financing is usually not available to them and isn’t preferred by many due to its complicated nature,” he said.

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