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Don't Borrow Money For IPOs – They Are Loser Loans

Dont borrow money for ipos

Anyone going for IPO financing, in times like these, seems to be at the receiving end of the stick. Let’s take the future capital ipo for instance, an IPO that was over-subscription a few gazillion times (editor: this translates to 131 times). From the Basis of Allocation chart, let’s take a look at how people would have fared, had they borrowed money to invest in this fan dangled IPO.

I’m going to assume the cost of funds was about 12%. Typical rates are 19%, but let’s just say 12% (because you will put some of your money and borrow the rest). 12%, for 1 month (the time it takes to get your refunds back, so you can return the money you borrowed) translates to about 1%. Note that the IPO was priced at Rs 765 and the listing price on Friday closed at 909.

Retail bidders
For a 1 lakh bid, the basis says allocation was 8 shares for 6:19 – meaning about 1/3rd of applications got 8 shares each.

For the poor fellows who were part of the 2/3rd that got zilch, the loss is Rs. 1000 (interest), plus all the headache.

For the remaining 1/3rd, they got 8 shares. Profit per share was approximately Rs. 150, so they got Rs. 1,200 as profits. Of which, they’ll pay about 1% of total cost (1 lakh) = Rs. 1000 as interest. So real profit = Rs. 200 for all the trouble and the hope that refunds happen within a month.

HNI bidders
These are the real bakras. The banks have really squeezed them on IPOs. Let’s take a bid of say 16 lakhs. The allocation was 28 shares, FIRM – meaning all bidders for this size got allocation. The profit is 28 * 150 = Rs. 4,200. The interest cost is 16,000 (1% of the bid). The net LOSS for this is Rs. 12,000.

Let’s go higher. For a 65 lakh bid, allocation was a firm 112 shares. Share profit 16,000, interest cost 65,000 – net loss of about 50,000.

Even higher. 11 crore bid, got 1900 shares (approx). Share profits of 3 lakhs, interest cost 11 lakhs – net loss is 8 lakhs.

Simply put: It makes ZERO sense to borrow money to buy IPOs at this time.

Does it make sense to put your own money into IPOs? The return at the 1 lakh level is Rs. 1,200 if you’re lucky enough to get allocation – just about 1.2% for about a month. In general that is not bad, but there is too much risk for too little return. If I can get a 9-10% arbitrage return (on arb funds, post tax) I would not bother with something like IPOs; in fact if a stock lists well, you can buy on listing instead and even a small move upward will give you better returns.

(To compare – if I bought Future Capital today at 909, I will break even with the person who subscribed to the IPO for Rs. 1 lakh, if the price goes up just Rs. 15 from here. Net return at 1.5% is about the same as that)

Now this is why I don’t subscribe to IPOs anymore, and this is the reason why I did not apply to the Reliance Power IPO. It makes no sense whatsoever.

  • Vishal Pipraiya says:

    >I kept wondering why you were against the Reliance IPO, but I see your point now.

  • Anonymous says:

    >Please pardon me for my naiveness, but you of all people I know, bought Future Capital!?!#%&$$? Could you please share the logic behind it — surely this is not a fundamental call. I for one felt that this is a call on one’s investing intelligence and it’s best to stay away from such stocks.

  • Deepak Shenoy says:

    >anon: No, I don’t own Future Cap, and didn’t apply at the IPO either. My point was that investing in IPOs today through financing is a loser, and for any reason if you thought the stock was worth it, you should buy at listing because the gains in percentage basis (on your capital) can be much higher for a smaller increase in size.

    Note that there is very little fundamental plays at the end of a bull run – most stocks are overvalued by fundamental parameters. Look at stocks like TV18 – they quote at P/Es of around a 100, with negative EPS growth! I think investors would either have to get out of the market or think really short term to make money at such times.

    Still, buying IPOs is not the way to go. Better returns are possible using technical cues in the market directly.

  • madhu says:

    >Deepak, did your analysis take into consideration that retail investors needed to pay only 25% of the amount while applying and they also get a discount of Rs.20 on the issue price. Even HNI’s pay only 10% margin money with application. So i suppose your calculations are wrong. But anyways i am also of the opinion that borrowing money to invest in IPOs is not worth it if you have to pay the full amount while applying.

  • சாமான்யன் Siva(stocksiva.blogspot.com) says:

    >Thanks for your info/calculation.I too dont subscribe to IPOs for the same reason.If I really needs,I can buy it in secondary mkt.

  • Deepak Shenoy says:

    >madhu: For the RPower ipo the stats are even worse. Even with 25% on retail, the allocaiton stats are going to be so bad that just getting anything will be considered ultra lucky. So if you’re really really lucky you may get 15 shares, for an application of Rs. 25K. THe profit on that is likely to be about Rs. 150 per share or so, which translates to a Rs. 2,200 profit, a good 8% or so, but hte absolute figure is so low, with the huge risk of no allocation. In all cases you have to wait and pray for the refund!

    HNIs pay only 10%? I thought they are supposed to pay the full amount. Only institutions need to pay the 10%, HNIs pay full amount upfront.

  • anil says:

    >hi this is anil.Note that there is very little fundamental plays at the end of a bull run – most stocks are overvalued by fundamental parameters. Look at stocks like TV18 – they quote at P/Es of around a 100, with negative EPS growth! I think investors would either have to get out of the market or think really short term to make money at such times.

    anil.

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