IPOs may burst the bubble

Wed, 6 Jan Pre-Open

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"It's almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors)."

These words from Warren Buffett can prompt any investor looking to make a killing on an initial public offering, to rethink. IPOs are notorious for being over priced. However, over the past few months business dailies have done a good job of updating their readers on the 'red-hot' IPOs coming their way. Be it of government banks or mining companies. Or cement and steel companies getting into power. Or insurance companies debuting on the bourses.

We are not just referring to India. As per Bloomberg, this year emerging markets are expected to raise more money through IPOs than developed nations for the first time. And if you are wondering whether the dream run in stocks seen in 2009 is set to continue this year as well, here is a warning. As per Mark Mobius, the record rally in the shares may turn into a 20% decline. Mr Mobius who oversees US$ 34 bn of emerging market assets at Templeton Asset Management, has had a cautious view for long. But this time he has been very specific. And backed his concern with very good rationale.

As per Mobius, it seems to be a simple case of economics where supply will outstrip demand. The result will be that existing assets will face pressure on prices. As emerging markets have millions of new shares being offered on their bourses, the investors will be spoilt for choice. Whether they are foreign investors with higher risk appetite or conservative domestic investors. As a result, the existing stock prices will have to compete with the new offerings to retain their valuations. Stocks where the valuations have run ahead of medium term fundamentals will have few takers. And despite continued fund flows into emerging markets, a lot of money will move from secondary to primary markets.

To take a stock of IPOs scheduled this year, China will top the list. Shanghai Stock Exchange IPOs may raise more than double the funds raised last year. Chinese companies are expected to seek upto 380 bn yuan (US$ 56 billion) of IPO funding this year. For companies based in Hong Kong, the figure is HK$ 370 bn (US$ 48 billion). India may raise Rs 256 bn (US$ 5.5 billion) selling stakes in 10 state-run companies. Companies in Brazil and Russia are also warming up to seek fund for aggressive growth plans.

Investors in developed economies have little to complain. For stocks in emerging markets can offer them returns that no asset back home can fetch. However, they are unlikely to lose sight of value. If the new offerings are reasonably priced, the investors will not resist exiting from their current holdings.

Hence, Mr Mobius' concerns are not unfounded to say the least. While his prediction of 20% correction cannot be timed, its possibility cannot be ruled out.

We have so far cautioned readers about subscribing to overprices and over-rated IPOs. At times there are cases of no prior operating history or huge execution risks. But this time the risk is not just about subscribing to over-priced IPOs. It also the risk of these IPOs eroding value from your current portfolio. Hence, readers must not only be wary of the super-hyped IPOs featuring in the pink papers. They must also take a harder look at the valuations of their current holdings. Else they may be left with little solace.