Indian IPOs: a boost or a blow to Economic Growth?
Introduction
India aspires to become the fastest growing economy by 2016, ahead of China. Currently, a $2 Trillion economy, it is projected to become $20 Trillion economy by 2040 if it grows at a CAGR (compounded annual growth rate) of 10%, by 2045 at a CAGR of 8%, and by 2050 at a CAGR of 7%. Consequently, the Per Capita GDP would also grow to $12,500 considering yearly population growth rate of about 1%. Achieving such high growth rate consistently over such a long period is not an easy task. This becomes even more difficult considering that the economy is fairly open and linked to the world economy. Further, translating this growth into economic prosperity for large segment of population would be an even more impelling vision and a daunting task. This necessitates an efficient economic and financial system and financial inclusion of all sections of economy and society.
Exploring the possibility of achieving such stupendous objectives is an interesting study which in turn makes it imperative to study and understand the prevailing financial infrastructure and system, and its impact on evolving an inclusive society.
The main factors propelling the growth rate are gross domestic capital formation which stands at about 35% of GDP and the savings rate which hovers around 30% of GDP. For effective economic growth, higher mobilization of public savings into productive investments is a must. Savings from public is mobilized through banks and insurance companies, small saving schemes, capital market and private loans.
It is understood that the growth rate would be impacted negatively by systemic inefficiencies in the economy which may retard savings rate or deployment of savings into productive means. In fact, improper deployment of savings would result into not providing adequate return to the investors (public at large) to the extent of wiping of their investments in bad cases. This in turn would not only retard the savings rate, but also result into rising inequity as the capital raised would get concentrated into few hands. This paper makes an attempt to study one such inefficiency that seems to have plagued Indian capital market over last 20 years.
Major avenues of mobilizing public savings are banks, insurance companies, small saving schemes and capital market. These are over and above the traditional investment avenues in form of gold and real estate. In a developing economy, Capital market is expected to play an increasingly significant role in mobilizing savings in the form of equity. This is expected to be more efficient, less costly and less time consuming in converting savings into productive capital formation. An efficient capital market is expected to be robust enough to wither the ups and downs of economy and ensure a better than fixed rate of return over medium to long term, attracting more and more investors. This has made raising funds from the public by means of public offering of equity (primary equity market) a desirable avenue on the part of fund raisers as well as investors. However, it is understood that in a robust economy, common, un-suspecting investors cannot be taken for ride by the fund raisers; a proper legal framework, and an appropriate execution and control mechanism would be in place to provide a safety net and assure reasonable return.
The Study
Equity is raised in a few different forms: IPOs (Initial Public Offering), FPOs (Follow up Public Offering) and sale of equity by an investor or promoters. Initial Public Offer for sale of equity shares (IPO) through a book-building process is one of the important sources of raising equity finance from public and in turn would help companies to leverage their capital structure. It is imperative that the IPO provides better than market or at-least market return to attract investors at large. In general, Performance of IPOs in long run and short run is a well-researched area in stock markets world over with IPO valuations and subsequent pricing being the main area of interest. This topic is of particular interest in India since India is a developing capital market and the book-building process has been implemented over last 18 years under guidance and supervision by Securities Exchange Board of India (SEBI).
Literature Survey
Literature survey has been carried out to understand how and when India could become a $20 economy in the context of a dynamic and turbulent world economy, given the strong linkages. Also, what could be the driving factors? And how can the growth be inclusive?
In 2000 (Wilson, Purushathaman), the famous Goldman Sachs report stated Brazil, Russia, India and China—the BRICs economies—could become a much larger force in the world economy by 2050. The BRICs economies together could be larger than the G6 in US dollar terms. Projected GDP is $ 18.8 Trn in 2045 and it is expected to surpass $20 Trn in 2050 while Chinese economy would be $44.4 Trn in 2050, more than double. While Per capita GDP is expected to be $ 17,366 for India and $ 31, 357 for China by 2050. India would outstrip Japan by 2032. These figures could stand only if conditions for growth are fulfilled appropriately, like, macro-economic stability, efficient institution as a whole, openness for globalization and education vis-à-vis skilled labor.
Even if India manages to reach $20 trillion economy but idea is not about $ 20 or $ 50 Trillion Economy, idea is to understand how to achieve, challenges ahead and will this quantum leap leads to an inclusive growth? Hence, it is imperative to understand phenomena of inclusive growth. Over last two decades, the disparity has increasedwith the top 1 per cent of the population accounting for 50 per cent of the GDP, the top 10% accounting for 75% of GDP, and the rest 90% accounting for only 25% of GDP. In fact, the last 10% of population have negligible income accounting for only 0.2% of GDP. This shows that the benefits of growth have not trickled down.
Challenges pointed in 2010 by Malhotra regarding inclusive growth includes food, education, healthcare, social security, financial harmony, housing, employment, political participation and poverty eradication are the key areas needs immediate attention to bring about equalities and development. Need to strategize by giving more importance to agriculture, decentralization of governance, financial, political, social and cultural inclusion. In 2013, Parikh, Ghosh, and Mkhise pointed out that if India aspires for a double-digit growth rate then, agriculture will have to grow at least 4% annually in order to support GDP growth rates of more than 8%. Such agricultural growth can be achieved with a total factor productivity growth rate of 2%, along with developing the net irrigated area to 90 million hectares. But in the past two decades, agricultural growth has been less than 3% and productivity growth has been lower than 2%.
According to Surayanarayan and Das (2014), the estimates from four different NSS rounds for the agricultural years 1993-94, 2004-05, 2009-10 and 2011-12 provide us the result of exclusion of the poor indicating exclusionary growth of the better-off in the economy as a whole. At the national level, equalities across social groups have increased by involving a widening of the average consumption shortfall of the scheduled tribes, a decline for the scheduled castes, and marginal decline for the Other Backward Classes and an increase in the excess of average consumption of Other Social Groups with respect to the overall median.
Now the moot point is will this growth leads to higher disparities amongst the people? As defined economic development as a comprehensive process that includes improvements in all sections of the society and well-being of the total population on a sustainable basis, while minimizing abject poverty and economic deprivation for any section of the society by Rao (Development Finance, Chapter 2, page 29-32). Capital flows and economic growth, promotion of capital inflows, strengthening of capital markets for promoting efficient financial markets, financial deregulation and liberalization are considered macroeconomic features of an economy in efforts to boost economic, expand resources for development finance. Parallel to the role of money for exchange of goods and services, Financial Institutions have enabled mobilization of savings deposits, trading, resource lending, contracting and information processing for financial decision making. This concludes the economic development depends on financial resources, capital formation through savings and robustness of Financial Institutions.
Will this growth lead to higher inclusive which in turn would lead to higher savings that can be mobilized into investment leading to further growth and thus setting a positive growth cycle?
In international market, IPO has been used as an important means of financing new business since more than a century. The study of IPOs in international market reported the cases of under-pricing in short run and overpricing in long run. Under-pricing was reported to the extent of 11 from the study of IPOs in US during the period of 1963-65 by Reilly and Hatfield (1969). Subsequently, Ibbotson (1975), Reilly (1977), Aggarwal and Rivoli (1989), Ritter (1991), Loughran and Ritter (1995), Ritter and Welch (2002), and Ljungqvist and Wilhelm (2003) have documented under-pricing of IPOs in short run in the US market.
In Indian market, Shah (1995) documented a phenomenal 105.6 excess return over the offer price in a study of 2056 new listings during January 1991 to May 1995. A study by Madhusoodanan and Thiripalraju (1997) of IPOs offered on BSE during the period 1992 to 1995 shows that under-pricing was higher than the international experiences in the short run and also in the long run as they yielded higher returns compared to the negative long run returns recorded from the international markets. Kakati (1999) analyzed the performance of IPOs by taking a sample of 500 IPOs which entered market during January 1993 to March 1996 and documented that the short run under-pricing is to the tune of 36.6% and in the long-run the overpricing is 40.8%. Krishnamurti and Kumar (2002) working on a sample of IPOs between 1992 and 1994 demonstrated that the under-pricing is to the extent of 72.34% with respect to market adjusted returns.
Kothari, Mehta (September, 2014) discussed and researched, capital market in general and primary equity market in particular have always been a major area of research interest. Savings are mobilized in capital markets and one of the most important avenues is primary market. It is internationally observed, reviewed and proved time and again that primary market or Initial Public Offerings in most of the cases have not given good returns to their investors. Legal framework has not given appropriate safety net to the investors; there is an easy escape route for not justifying EPS. These are few loopholes pointed out in the research. And only 9 out of 60 sample companies have given returns more than that of Fixed Deposits, a safe investment. It has also highlighted huge amount has been wiped off from the capital markets amounting to Rs. 5505.05 Crs.
Kothari, Mehta (November, 2014), research on leverage of 60 samples of IPOs concludes that Equity is raised to be used as leverage for additional financing through banks. From the sample study it was found 57 out of 60 companies had leveraged the equity.
It is imperative to study the statute of Securities and Exchange Board of India (Disclosure and investors’ Protection) Guidelines, 2000: The companies eligible to make public issue can freely price their equity shares or any security convertible at later date into equity shares in the case of public/rights issued by listed companies, public issue by unlisted companies, infrastructure companies and initial issues by banks. Substituted vide SEBI Circular No. SEBI/CFD/DIL/DIP/14/2005/25/1 dated January 25, 2005 for “Clause 6.13.1(g)”. It mentions:
6.13.1 Following information shall be disclosed for all issues irrespective of the issue price.
a) Earnings per share i.e. EPS pre-issue for the last three years (as adjusted for changes in capital);
b) P/E pre-issue
c) average return on net worth in the last three years
d) minimum return on increased net worth required to maintain pre-issue EPS;
e) Net Asset Value per share based on last balance sheet;
f) Net Asset Value per share after issue and comparison thereof with the issue price.
It can be observed from the guidelines that SEBI has recommended a pricing guidelines based on present EPS of the issuer and industry P/E. It expects the future earnings and EPS to continue on increased capital more or less in a linear trend. There is no consideration about the viability of the new project or expansion being undertaken with the increased capital, industry and economic condition, management capability to upscale, and their impact on P/E ratio. This is where SEBI tends to fail in bringing in much needed transparency and justification for pricing (that is, premium to be allowed to be charged). Valuation information is not adequate and transparent; companies are supposed to disclose various risks but fail to quantify and factor them in pricing.
Research Methodology
This is an exploratory research based on empirical study of market data over last 15 years.a population of all IPOs that hit the Indian Capital market during 2000 to 2013. Research doesn’t include IPOs after 2013 as the objective is to evaluate performance in medium and long run. From2000 to 2013, a total of 448 equity issues hit the Indian capital market through Book Building process. We have excluded ‘Offer for Sale’ and ‘Follow on public offer’ and after exclusion only 369 issues fall in the category of IPOs listed on NSE (www.nseindia.com). This methodology includes finding Compounded Annual Growth Rate (CAGR) of various parameters like shareholders’ wealth (Stock price and Dividend), Sales Revenue, Operating Profit, Profit after Tax, Dividend, EPS debt equity ratio, quantum of debt, Interest paid, PAT % of Income, PAT % of EBIDTA, PAT % of Capital Employed, PAT % of Net worth and PAT % of Total Assetsare calculated for assessing the performance of the company. To find returns (in terms of CAGR) to investors, IPO price and shareholders wealth (Closing price and dividend, as of 10th December, 2014) are taken into consideration. Further, leveraging of equity is studied through computation of parameters like borrowings, debt-equity Ratio and book value. Borrowings includes banks, financial institutions, commercial paper, public deposits, fixed deposits, debentures, deferred credit, foreign commercial borrowings, Inter-company borrowings, capital borrowed from RBI, etc. which are raised for long term.