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Oversubscription In IPO May Not Necessarily Be Linked To Fundamentals

Monday, April 16, 2018
By Clifton Desilva

Clifton Desilva, Director, Altina Securities

There is a myth amongst investors that oversubscription in an initial public offer (IPO) would signify that the company is fundamentally strong. However this is a myth as on several occasions there appears no link between the oversubscription and the company’s fundamentals. The oversubscription is generally linked to the situation prevailing in the grey market where there are quotes for unofficial premiums and based on the unofficial premium and the expected return the oversubscription is determined.

How does it work?
Let us assume that company ABC has planned an IPO @ Rs.20/- and the unofficial premium is quoting at Rs.5/-. The expectations are that the issue would be oversubscribed by 5 times. An application for 1000 shares @Rs.20/- would amount to Rs.20, 000/-. The investor in question sells 1000 shares at a premium of Rs.5/- in the grey market and thus locking in a gain of Rs.5000/- (1000*5). As the expectations are that the issue would get  oversubscribed 5 times he would be required to apply for 5000 shares to get an allotment of 1000 shares which he has already presold and locked in a profit of Rs.5000/-.

An application for Rs.5000 shares would entail an investment of Rs.1, 00,000/- (20*5000)

The investor borrows an amount of Rs.100000 for a period of 15 days with an interest of 15%.

As per expectations the IPO is oversubscribed 5 times and the ratio of allotment is 1:5 and accordingly the investor is allotted 1000 shares which he delivers against his sale done earlier. By this transaction the investor has earned an annualized return of over 100 % as follows:

Investment –    Rs 1, 00,000/-
Gain –    Rs 5000/-
Less Interest Cost –    Rs 500/-
(Rs 1, 00,000 @15% for 15 days)
Profit –      Rs 4500/-
(For 15 days)
Return –                       108%

Therefore the investor in question has earned an annualized return of over 100%

Another classic case of oversubscription / under subscription and thereafter price performance can be viewed in the case of Infosys and Reliance Power.

Infosys made an initial public offer in February 1993 and the issue was undersubscribed but was bailed out by Morgan Stanley by picking up 13% at the offer price of Rs.95 per share.

Reliance Power made an initial public offer in January 2008 at a price of Rs.450 per share with an offer to retail investors @ Rs.430 per share.

The company received a record subscription of Rs.750000 crore ($190bn) at that time against the issue size of Rs.11560 crore which is the largest subscription in an IPO in the global capital market. The issue was oversubscribed 73 times garnered $ 190 billion with 5 million applicants and approx.42 lakh shareholders. In the IPO market the largest issue so far is by the Alibaba group garnering $ 25 billion which is likely to be surpassed by Saudi Arabia’s Aramco which is planning an IPO of $ 100 billion. A review of the price performance as of today reveals a striking contrast as in Table 1 & 2.

On 2.06.2008 Reliance Power issued bonus shares in the ratio of 3:5 to non promoter shareholders

This is not the lone instance but there are several more instances where it is proved that massive oversubscriptions are not necessary linked to fundamentals but in many cases are a function of the unofficial premium prevailing in the grey market.

Infosys (Table 1)

Reliance Power (Table 2)

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