The Indian IPO market is red hot right now. In the first 6 months of this financial year, companies have raised around ₹63,500 crores through public listings and it could go up as high as ₹1,00,000 crores by the end of the financial year, with some big-ticket IPOs like Nykaa and Paytm on the cards. However, there is a small snag in the world of IPO financing and it has the potential to cool off the markets by a fair margin.

So in today’s Finshots, we talk about this and more

The Story

Money — It makes the world go round. But it’s “leverage” that offers the much-needed momentum.

Not following?

Well, take for instance the crafty way some investors use leverage to make money off of IPOs.

These investors — usually boasting a high net worth, call up their bankers and put together a neat little arrangement. They borrow lots of money for a week or so, by putting up a small deposit up front — it’s called a margin. Now the banker adds a multiplier and offers a massive loan — usually 70–80 times the value associated with margin. The HNIs (High net worth individuals) then use this money to subscribe to the IPO. They wait until the last moment because every day counts when you are borrowing such large sums of money. And after a week or so, when the stock begins trading, you sell all your shares immediately, pay the banker the interest and the principal and pocket the difference, if the stock lists at a higher price (compared to the price you paid when you subscribed to the IPO).

Simple.

And you could do all of this because you managed to access funds that you didn’t own — Which is why it’s called leverage.

For instance, look at what happened when Paras Defence and Space Technologies began trading for the first time earlier this month. The stock opened at ₹492 per share while its issue price was just ₹175!

You would think the Paras got such a rousing welcome because it was a poster boy of the much renowned ‘Atmanirbhar Bharat’ project. But that’s not the whole story. Paras saw massive oversubscription i.e. all kinds of investors wanted to participate in the IPO — so much so that they were looking to buy quantities much beyond what was actually on offer.

The retail portion was subscribed 113 times over and above what was available. These are regular folks with limited funds accessible to them. The institutional segment (banks, mutual fund types) meanwhile saw oversubscription to the tune of 170 times. But it was the HNI segment that really took the cake by oversubscribing 928 times. For context, HNI’s were willing to put up ₹25,000 crores when there were only ₹170 crores on offer.

And they could do this only because…..

Leverage!!!

So hypothetically you could go in there with a 10 lakh margin, borrow 60x the sum — say 6 Crores, subscribe to the IPO, wait for a week and see the stock zoom past all expectations on listing day. Now granted, if everybody is competing for the IPO, you’re not all going to get 6 crores. Maybe you’ll only get 60 lakhs worth of shares. But if the stock doubles in value, you’re still expected to take home a lot of money even after accounting for the interest cost. So there’s big money involved.

However, this is a high stakes game. If the stock dips in value on listing day, then you’ll have to make good on your commitment. You’ll still have to pay back the principal alongside the interest and if you don’t have the money, bankers could take you to court. Even worse, they may have to deal with similar bankruptcies across the board if there are many HNIs like you — Those who decided to gamble and squander away their wealth.

It could pose a risk to the banking system as a whole.

Which is why the RBI is now imposing a cap. They have decided to crack the whip and starting next year (FY23), no single investor can borrow more than ₹1 crore from non-banking financial companies (NBFCs) if they are using it to subscribe to an IPO.

The hope is that this will help alleviate some risks embedded in the public market ecosystem and shave that excess froth clearly precipitating at the top.

Until then...

Don't forget to share this article on WhatsApp, LinkedIn and Twitter