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India introduced a safety-net mechanism to bring back retail investors to the near-dead primary equity markets, but has not been able to test its efficacy as the economic slowdown is keeping away both issuers and investors.
“It’s a mechanism that would have ideally provided some comfort to retail investors. However, currently primary markets like the secondary markets are in a state of inactivity because of the economic slowdown,” Jagannadham Thunuguntla, head of research at SMC Global Securities.
The justification of the Securities and Exchange Board of India for the mechanism is a desire to boost confidence in new listings after a series of disappointments. Of the 117 new stocks listed between 2008 and 2011, 72 were trading below their issue prices six months after going public. Of those 72, 55 had lost more than 20% of their IPO prices.
Market participants said the safety-net scheme targeted only retail investors, who typically bought 10%–15% of any Indian IPO. The scheme is unlikely to make life easy for issuers that are finding few buyers for Indian equities from any investor base.
“Equity is all about risk taking and a regulator should be the last one to decide how much risk an investor can take.”
Under the scheme, a company will have to buy back shares from retail investors if its stock trades below the IPO price six months after listing. The safety-net period runs for 180 days from the date of listing, and the buyback is triggered if the volume-weighted average market price of the shares during the last 60 trading days of that period is below the allotment level.
The scheme is available only to retail investors, who have retained all or a portion of their IPO shares, and not those who bought in the market afterwards.
Sebi has been insisting on a safety-net mechanism, particularly in those instances where it feels the valuations are expensive. However, bankers question the market regulator’s wisdom.
“Why should companies provide protection to the wrong set of investors? If an investor is so risk averse, he should be buying debt or mutual funds and not IPOs. Equity is all about risk taking and a regulator should be the last one to decide how much risk an investor can take,” a banker said.
Directory search provider Just Dial first implemented the scheme for its Rs9.3bn (US$145m) IPO in May. The company priced the retail tranche of its 17.5m-share IPO at Rs483 each and the institutional portion at Rs530.
At the time of the IPO, some investors felt that Just Dial was also expensive at a forward price-to-earnings ratio of 29.
The stock, however, has done well since listing on June 5 and the chances of a share buyback look remote at present. The stock closed at Rs706.45 on September 5. Its all-time high was Rs737.10 and low was Rs605.15. Citigroup and Morgan Stanley were the bookrunners.
Just Dial’s IPO was India’s biggest since Bharti Infratel’s US$752m listing in December, which disappointed in the aftermarket.
Although Sebi had not formally required a safety-net provision for retail investors, bankers said, going forward, it planned to insist on a provision for all IPOs and the blueprint for it would be the mechanism Just Dial implemented.
Bankers have also criticised the current safety-net mechanism, where it is triggered at any level below the IPO price. An earlier discussion paper said the safety-net provision should trigger only in cases where the price of a share depreciated more than 20% from the issue price. Furthermore, the 20% depreciation shall be considered over and above the general fall, if any, in the benchmark index.
“The current safety-net mechanism doesn’t provide for the broad market moves, which any local or international factor can cause,” the banker said.
For example, shares of PC Jeweller fell to Rs86.90 from the December IPO price of Rs135 after the government restricted gold imports. The tock was trading well above the IPO price until early February. The safety-net mechanism is not applicable to PC Jeweller.
“Sebi doesn’t want investors to lose money, but how can it penalise a company for policies which are not of its making?” he asked.