There is nobody in the system—promoters, lead managers, raters and regulator—who can be held accountable for the profit-pump and share-dump operation that seems common in IPOs

We had mentioned in our article "What ails the Indian IPO market-I that "that volumes of information in a public issue prospectus does not help retail investors with one crucial data—that is, expected profits, that determines the most crucial aspect of a public issue—valuation." Lack of knowledge about this data ensures that promoters and lead managers can price an issue exorbitantly and get away. That is why after listing, share prices of many stocks have simply crashed. Let's look at some examples.

In the calendar year 2010, 65 IPOs were launched. The 10 worst-performing IPOs turned out to be Emmbi Polyarns, Commercial Engineers & Body Builders Co, Tarapur Transformers, Midfield Industries, Cantabil Retail India, Aster Silicates, Tirupati Inks, Gyscoal Alloys, Sea TV Network ands DB Realty.

The worst among them were Aster Silicates, Tirupati Inks, Gyscoal Alloys, Sea TV Network and DB Realty, which fell 80%-84% from their issue prices. Could investors have avoided these issues? They certainly could have if they knew what the performance would be. Or they would have bought these stocks at a much lower price. Did the subsequent financial performance of the stocks show that these were horribly overpriced at the time of the issue? Well, DB Realty reported a net profit of Rs255.70 crore in 2011 which means that its EPS (Earnings Per Share) turned out to be Rs10.51. The issue was priced at Rs468 which means that it was offered to investors at a forward P/E of 44.52! Even if its key promoter Shahid Balwa was not cooling his heels at Tihar jail, the stock was not a great buy given its fundamentals. The lead manager for the DB Realty IPO was Enam Securities Private Limited. CRISIL had allotted 'IPO Grade 2' for the offering, indicating that the company had 'Below Average Fundamentals.'

Similarly, Sea TV Network reported a net profit of just Rs1.66 crore in FY2011 which means that its EPS turned out to be Rs1.38. The issue was priced at Rs100 —it was offered to investors at a forward P/E of 72.41! Gyscoal Alloys reported a net profit of Rs4.26 crore in 2011, which means that its EPS turned out to be Rs2.69. The issue was priced at Rs100; it was offered to investors at a forward P/E of 26.38. The current P/E is one-fifth of that.

Similarly, Aster Silicates and Tirupati Inks were offered to investors at a forward P/E of 59.65 and 30.30 respectively. Tarapur Transformers has slumped by 72% as compared to the issue price, which is not surprising since the company reported a loss of Rs4.83 crore for the year ended March 2011. But how was the pricing of a company done at the time of the issue?

None of this was known or knowable at the time of the issue—although as the ratings indicate, these companies had poor fundamentals. But the promoters and even the lead managers would have known that the pre-IPO profits were misleading—and based on the post-IPO profits, the shares would crash—given how expensively they were priced. These stocks should have been priced much lower, given the risks. That would have been possible if somebody in the system was obliged to commit a range of likely profits over the coming year. Today, thanks to the flawed rules we have imported from Wall Street, the company, the lead managers, the rating agency and the regulator remain unaccountable for what they say and what they do.

While equity is a risk investment, investors need not be open to incompetence or even legalese as a fig leaf or plainly fraudulent behaviour that is possible under the current hands-off system. Under the present system, IPO pricing and sales are often subjected to manipulation done by the promoters and executed by the lead managers, as Moneylife has pointed out several times in the past.