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Is IPO Safety Net really SAFE?

Published on Monday, May 20, 2013 by Dilip Davda

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In a bid to protect the interests of retail investors, market regulator SEBI has framed draft norms for mandatory safety net mechanism in IPOs. According to SEBI, the safety net mechanism would be available for all securities allotted to original resident retail individual allottees that had made an application for up to Rs. 50,000. And the total obligation for such provision is capped at five to ten per cent of the issue size.

This Safety Net is now mandatory for all the IPOs hence forth and will be triggered in cases where the price of the shares has depreciated by more than 20 per cent from the issue price. The price for this provision shall be calculated as the volume-weighted average market price of such shares. Safety Net shall be effective for six months from the date of trigger.

Further, the 20 per cent depreciation in share price would be considered over and above the general fall, if any, in market index. The market index for this purpose may be BSE-500 or S&P CNX 500 and the index to be considered for this purpose should be disclosed in the offer document.

According to SEBI, besides disclosures, other measures are needed to bring in self-discipline in IPO pricing and one of the steps to protect the interests of small investors is a safety net mechanism. However, there is already a voluntary safety net mechanism in place for IPO investors.

It will be certainly one of its kinds where SEBI is trying to streamline the unregulated price of a stock for not a day or two but for 6 months. This goes against any basics of equity market investing. Investing for a fixed 6 months time period is not going to make anything better for equity markets. People will come in and dump the stocks in six months again never becoming a long term investor. But the watchdog is definitely misses the finer points on IPO pricing and the stringent guidelines for merchant bankers that are the deciding authority.

Safety Net of Just Dial:

The Safety Net shall be triggered, on the completion of the Safety Net Period, if the Safety Net Trigger Price (as defined below) is lower than the price at which the Equity Shares were Allotted to the Retail Individual Allottees (“Retail Offer Price”) in the Offer (the “Safety Net Trigger”). On the occurrence of the Safety Net Trigger, the Safety Net Providers will make an invitation to the Eligible Allottees (as hereinafter defined) to offer to sell the Equity Shares Allotted to them in the Offer (“IPO Equity Shares”), which continue to be held since the initial allotment in the Offer, as determined on the basis of the LIFO Method (as defined below) (the “Eligible Equity Shares”) to the Safety Net Providers at the Retail Offer Price.

The “Safety Net Trigger Price” shall mean the volume-weighted average market price of the Equity Shares during the 60 trading days preceding the Relevant Date, where the “Relevant Date” shall be the last day of the Safety Net Period. The “volume-weighted average market price” will be calculated by multiplying the number of Equity Shares traded on the relevant stock exchange with the price of each Equity Share and dividing this amount by the total number of Equity Shares traded on the relevant stock exchange. For this purpose, the “relevant stock exchange” shall be the stock exchange where the maximum volume of trading in the Equity Shares is recorded during the 60 trading days preceding the Relevant Date.

But with the “Safety Net” implementation, the merchant banker lobby and the promoters have changed the basics of offer from the earlier quota system of 50% for QIBs, 15% for HNIs and 35% for Retail to 75% for QIBs, 15% for HNIs and only 10% for Retail and surprisingly SEBI has endorsed this that has raised eyebrows in the primary market. This is again going in the favor of issuer and the merchant banker as their liability gets reduced to a maximum level of 10% of retail portion, which might turn out to be 2 to 5% of the overall paid up capital post issue. So unless SEBI turns tough on this aspect, all IPOs for a while will have the same quota of 75+15+10 respectively for QIB+HNI+Retail. And with this kind of treatment, retail investors will keep shying away from the market.

10% discount to retail investor is also insufficient as the “Safety Net” will trigger only if the share prices falls below 20% of its issue price and thus it fails to protect the retail investors in any way. For example, if we presume Just Dial’s price fixation on the lower end at Rs. 470 and though retail investors will get the shares at Rs. 423 (after upfront discount) the “Safety Net will trigger only if the share prices falls below Rs. 376, thus the discount lives no meaning. And while considering this fall, the general negative trends of the markets are ignored, and thus a loop hole left uncovered on this aspect. Secondly, the safety net offer also misses on interest part as investors are deprived of interest components for the tenure of their holding for the Safety Net period.

For Just Dial IPO, it being a offer for sale in toto with even promoters shading away few shares to create buffer for escrow account to meet their liability in case of safety net trigger, and as they have post iPO holding of around 35% are safe to honor the offer. But if we consider the case of Sai Silk, the first IPO with safety net, it reserved 55% quota for retail that got oversubscribed above 1.4 times and got no response for QIB quota of 10% had to cancel the IPO proceedings as it could have run in disaster for promoters with whooping safety net liability. Tracking this, market men fear that merchant bankers and promoters will do good homework to avid such recurrences and will play safe as far as promoters holding is concerned for fresh offer IPOs

The million dollar question here is, if “Safety Net’ triggers and as only promoters are responsible for buying back the shares, it is going to add such transaction in their ultimate holding and is thus becomes the violation of listing norm of 75% promoters holding for any listed company. After experiencing in many past issues where promoters have emerged a fly-by-night operators, why retail investor should trust such safety net from promoters alone. Seasoned observers feel that since promoters are well known to the merchant bankers and/or the bankers to the issue, their role also should be included in “Safety Net”. Why not the Market Making mechanism similar to that of SME is applied here thereby laying onus on merchant banker for market making of the issue for two years with their contribution in the issue process. Well, this argument is based on the success witnessed for SME listings and their performances. But, if this is implied, merchant bankers will oppose it in Toto as they are just keen to have big cake with aggressive pricing policy and not having retail or HNI investors’ fate at heart.

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About Author

DISCLAIMER: No financial information whatsoever published anywhere here should be construed as an offer to buy or sell securities, or as advice to do so in any way whatsoever. All matter published here is purely for educational and information purposes only and under no circumstances should be used for making investment decisions. Readers must consult a qualified financial advisor prior to making any actual investment decisions, based on information published here. Any reader taking decisions based on any information published here does so entirely at own risk. Investors should bear in mind that any investment in stock markets are subject to unpredictable market related risks. Above information is based on RHP and other documents available as of date coupled with market perception. Author has no plans to invest in this offer.

(SEBI registered Research Analyst-Mumbai).


About Dilip Davda

Dilip Davda, a freelance journalist

Dilip Davda is veteran journalist associated with stock market since 1978. He is contributing to print and electronic media on stock markets/insurance/finance since 1985.

Dilip Davda is a leading reviewer of public issues and NCDs in the primary stock market in India. The knowledge he gained over 3 decades while working in the stock market and a strong relationship with popular lead managers makes his reviews unique. His detail fundamental and financial analysis of companies coming up with IPO helps investors in the primary stock market. Dilip Davda has a special interest in analyzing the SME companies and writing reviews about their public issues. His reviews are regularly published online and in news papers.

Email: dilip_davda@rediffmail.com


2 Comments

SRK
2. SRK  Jul 9, 2013 11:18 Reply
Your analysis of Just Dial''s safety net is wrong. You have not understood it (for example, there is no 20% trigger). Also, you seem to be unaware of basic law relating to IPOs becayour analyses of 75%, 15% and 20% and failure of Sai Silks are also wrong.
KSK
1. KSK  May 21, 2013 11:14 Reply
The information about Safety net is really useful.
THANKS



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