Tuesday, December 7, 2010

Hike in Investors application amount in retail category : A Boon or Bane ?

SEBI has reserved 35 % of the IPO for Retail Investors. An Investor intending to apply under the category of Retail Investors can apply for not more than Rs 1 lakh. but Since November, 2010 SEBI has increased the limit to Rs 2 lakhs. Now Investors can apply in IPO under Retail category for up to Rs 2 lakhs.

The biggest appeals in applying under retail category are
a) Investors may get discount of 5% on IPO price in case of PSU IPO.
b) With recent SEBI guideline, IPO is open for one extra day for only retail Investors to apply. Hence Retail Investors can apply after looking at the appetite on HNI and Institutional Investors.
c) There is probability of getting higher allotment.

SEBI has increased these limits after 5 years, to cater to demand of investors for higher participation in IPO. 

The advantages perceived by SEBI with increase in Retail limit are

a) Higher amount of participation by Retail Investor.
b) Higher Allotment in retail category.
c) Wider appeal to Investors.
d) Option to Apply after closing of bids for HNI and Institutions.

But does it mean that doubling the limit will lead to doubling of absolute returns ?

Below is the application status of recent IPO with Retail  application limit of Rs 2,00,000/-. Along with is the  probability of allotment, in case the application amount would have been Rs 1,00,000/- only

Name of Co

Issue size (Retail)

Retail Limit

Subscription

Prob of Shares allotted

Cost of Fund @8% for 15 days

Retail Limit

Subscription

Prob of Shares allotted

Cost of Fund @8% for 15 days

MOIL

11524800

2lacs

32.86 times

17

657.53

1lac

18 times

17

328.7
SCI

29493547

2lacs

6.56 times

600
657.53

1lac

4 times

550

328.7


In above table, We find that increase in Retails limit leads to no increase in allotment or there is marginal increase, wherein there is also rise in interest cost whereas Opportunity cost is not considered.

I would request you to read below mentioned points for the answer

a) Who will take advantage of this limit hike ?

I think the Investors who were investing for Rs 1,00,000/- will only hike their limit to 2,00,000/-. We will get the rationale of this view by looking at the subscription pattern in retail segment. Most of the applications are at upper limit leading us to infer that most of such investors have surplus and they invest up to maximum limit and thus when the limit is hiked many of them would apply for higher amount.

I also don't think that Investors applying for Rs 2,00,000/- in HNI category will apply in Retail category (Because looking at past data , the returns by applying for Rs 1,00,000/- was more than applying in HNI for Rs 2,00,000/-.)

There is a grey market for application where the investor applying in retail category get lump sum amount irrespective of returns for IPO. The prevalence of such market indicates that there is appetite for higher amount of retail category. so if the limit is hike people would put in higher amount.

b) After inferring that people who were applying in IPO in retail category for Rs 1,00,000/- will in all probability apply for Rs 2,00,000/-.

But would that mean that allotment will be double with increase in limit. but I really feel that allotment would be somewhat more than half of what was allotted previously. To understand this rationale we will look at some examples

i) In past 6 months most of the IPO are over - subscribed by more than 1 time in retail category except in few cases where it was under subscribed because of lower quality of issue and not because the size was big and limits of Investors were exhausted.

ii) The MOIL issue was oversubscribed 32.86 times in retail category. The Investment limit in retail was Rs 2,00,000
iii) The SCI issue was oversubscribed 6.56 times in retail category. The Investment limit in retail was Rs 2,00,000
iv) The Claris Life Science issue was oversubscribed 1.60 times in retail category. The Investment limit in retail was Rs 2,00,000. This issue was not subscribed because of Higher IPO price, in fact they have reduced the IPO price.

In the above scenario if the Limit would have been 1,00,000 /- I guess the subscription times would be almost 50 % (Eg 18 times for MOIL, SCI at 4 times). but the number of shares allotted would have been same.

In fact we are blocking twice the amount and receiving the same quantity of shares thereby reducing our returns in percentage terms by 50%.


d) We should also consider the opportunity cost of extra 1,00,000/-. Funds are scarce resource, if that amount is invested in another issue,maybe the returns would be higher.

Does that mean Such Limits should not have been relaxed ?

No, The limits should have been relaxed in Slabs. If the Issue size is large enough to handle bigger amount, than only 2,00,000 / - limits should be applicable. For Example issue for more than Rs 2000 Cr or 3000 Cr in Retail category. Such Slabs will ensure higher retail participation for bigger issues and smaller issues will ensure lesser blockage of funds. Also leading to lesser logistical hurdles.

I welcome your critical comments and suggestions.