Ipo grading
Upcoming SlideShare
Loading in...5
×
 

Ipo grading

on

  • 641 views

 

Statistics

Views

Total Views
641
Views on SlideShare
641
Embed Views
0

Actions

Likes
0
Downloads
41
Comments
0

0 Embeds 0

No embeds

Accessibility

Upload Details

Uploaded via as Microsoft Word

Usage Rights

© All Rights Reserved

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
    Processing…
Post Comment
Edit your comment

Ipo grading Ipo grading Document Transcript

  • IPO GRADING - 1 -
  • IPO GRADING DECLARATION I, Miss SHRADHA VADIA Student of T.Y.Bcom (Banking & Insurance) Semester V, SHRI CHINAI COLLEGE OF COMMERCE & ECONOMICS. Hereby, declare that I have completed this project on “IPO GRADING” in the academic year 2007-2008. The information submitted is true & original to the best on my knowledge. Signature of the student (Shradha Vadia) CERTIFICATE I, Professor VINITA PIMPALE hereby certify that Miss SHRADHA VADIA of T.Y.Bcom (Banking & Insurance) Semester V, SHRI CHINAI COLLEGE OF COMMERCE & ECONOMICS, has completed project on “IPO GRADING” in the academic year 2007-2008. The information submitted is true & original to the best of my knowledge. Signature of Project Guide (Prof. Vineeta Pimaple) - 2 -
  • IPO GRADING PREFACE Change is a natural phenomenon. Time cycle necessitates a change in perception because almost all of us don’t venture to go against the wind. It is said that the equity market is more risky than any other investment alternative, but also high return. So the phrase HIGHER THE RISK, HIGHER THE RETURN is suitable for equity market. Yesterday, the scenario of the market was different compare to today, where investors blindly invest in IPO. Today investors are more conscious about their investment plans in IPO. Also SEBI plays very important role in money market. As per the rules and regulation of SEBI ACT 1992, there are many steps which a company has to follow in order issue IPO to the investors. One of them is IPO GRADING which is very important. After introducing IPO grading the risk of bogus IPO is minimized. This has the whole concept of IPO. Sky is the limit. Whatever the perception we perceive today regarding even tomorrow. The increasing safety measurement taken by an investor and SEBI has been found playing a big role in shaping the IPO. We don’t find a boundary for perfection. I have made best of my efforts to make this project, to view on newly concept IPO Grading. We find sky the only limit for quality; whatever the lapses and short coming identified would be welcome. - 3 -
  • IPO GRADING ACKNOWLEDGMENT I take immense pleasure to thank a number of people who have supported & helped me throughout the completion of my project on IPO GRADING. It gives me heartily pleasure and satisfaction to present this project. I have endeavored to present this project in most suitable and lucid form. First I would like to take the opportunity to thank my very own coordinator Mr. NISHIKANT JHA who encouraged and showed me the value of time. I would also sincerely thank my project guide Mrs. VINITA PIMAPLE, and of course Mrs. MALINI JOHRI our Principal. Providing me with his valuable time from his busy schedule, I would like to thank Mr. MOHAN KRISHANAN, Manager of CRISIL and Mr. ARUN, Assistant Manager of CRISIL. I would like to thank Mr. PARSHOTTAM PATEL, Director of ARP Stock broking Pvt. Ltd., who helped me to provide all kind of information while doing my survey. And finally I like to thank my Daddy who helped me in giving the final touch up to the project. - 4 -
  • IPO GRADING INDEX  Initial Public Offering (IPO) 1-3 • Introduction to IPO 1 • Pricing of IPO 1 • IPO basis 2  Initial Public Offering (IPO) Grading 4-9 • Need for grading 4 • Introduction to IPO Grading 5 • The grading process 7 • Contents for IPO grading reports 9  IPO grading methodology 10-14 • Introduction to grading methodology 10 • Grading methodology 10 • IPO grading scale 14 • IPO grade is not 14  Grading criteria 15-32 • Criteria for banks and financial institutions 15 • Case study 29 - 5 -
  • IPO GRADING  Advantages and Oxymoron to IPO grading 33-39 • Advantages 33 • Oxymoron 36  Primary data 40-47 • Survey of IPO grading of the investors 40 • Analysis of survey 41 • Annexure 46  Secondary data 49-54 • IPO grading: Help or Hindrance 49 • IPO’s need to be rated before launch 54  Executive summary 55-56  Conclusion 57 - 6 -
  • IPO GRADING  Bibliography 58 - 7 -
  • IPO GRADING INITIAL PUBLIC OFFER (IPO) An initial public offering (IPO) is the first sale of a corporation's common shares to investors on a public stock exchange. The main purpose of an IPO is to raise capital for the corporation. The term only refers to the first public issuance of a company's shares. If a company later sells newly issued shares again to the market, it is called a "Seasoned Equity Offering". When a shareholder sells shares, it is called a "secondary offering" and the shareholder, not the company who originally issued the shares, retains the proceeds of the offering. These terms are often confused. It is important to remember that only a company, which issues shares, can make a "primary offering". Secondary offerings occur on the "secondary market", where shareholders (not the issuing company) buy and sell shares from and to each other. Pricing of IPO Historically, IPO’s both globally and in the US have been under priced. The effect of under pricing an IPO is to generate additional interest in the stock when it first becomes publicly traded. This can lead to significant gains for investors who have been allocated shares of the IPO at the offering price. However, under pricing an IPO results in "money left on the table"— lost capital that could have been raised for the company had the stock been offered at a higher price. IPOs can be a risky investment. For the individual investor, it is tough to predict what the stock will do on its initial day of trading and in the - 8 -
  • IPO GRADING near future since there is often little historical data with which to analyze the company. Also, most IPOs are of companies going through a transitory growth period, and they are therefore subject to additional uncertainty regarding their future value. IPO BASICS • An initial public offering (IPO) is the first sale of stock by a company to the public. • Broadly speaking, companies are either private or public. Going public means a company is switching from private ownership to public ownership. • Going public raises cash and provides many benefits for a company. • The dotcom boom lowered the bar for companies to do an IPO. Many startups went public without any profits and little more than a business plan. • Getting in on a hot IPO is very difficult, if not impossible. • The process of underwriting involves raising money from investors by issuing new securities. • Companies hire investment banks to underwrite an IPO. • The road to an IPO consists mainly of putting together the formal documents for the Securities and Exchange Commission (SEC) and selling the issue to institutional clients. • The only way for you to get shares in an IPO is to have a frequently traded account with one of the investment banks in the underwriting syndicate. - 9 -
  • IPO GRADING • An IPO company is difficult to analyze because there isn't a lot of historical info. • Lock-up periods prevent insiders from selling their shares for a certain period of time. The end of the lockup period can put strong downward pressure on a stock. • Flipping may get you blacklisted from future offerings. • Road shows and red herrings are marketing events meant to get as much attention as possible. Don't get sucked in by the hype. • A tracking stock is created when a company spins off one of its divisions into a separate entity through an IPO. • Don't consider tracking stocks to be the same as a normal IPO, as you are essentially a second-class shareholder. - 10 -
  • IPO GRADING NEED FOR GRADING If you are finding it hard to make an investment decision on the various public issues being floated in the IPO market Sebi's primary market committee may have just found the answer to your dilemma. The committee is evolving a rating concept for mandatory grading of equity offerings. Sebi will probably be the first regulator in the world to make mandatory rating of equity offerings. At present, only debt issues are rated ahead of offers. The need to rate equity offerings emerges from the fact that majority of retail investors do not read the offer document and even where they do they may not fully comprehend the implications of all the disclosures made in the document. Ratings from independent agencies are aimed at helping investors separate good floats from risky ones. - 11 -
  • IPO GRADING IPO GRADING In a situation where public issues are priced aggressively, retail investors often suffer the most due to lack of knowledge and research. In order to avoid this and restrict bogus listings (like we saw in the early 90s), the SEBI last fortnight made it mandatory for all companies raising money through the equity route to get their IPO’s graded by an independent credit rating agency. The views and feedback of the regulator, market participants, investors and investor forums have been core inputs in the development of IPO grading. The debt market has benefited on immensely from the availability of such an assessment in the form of “credit rating” – a representation of a relative assessment of the fundamentals of the debt security i.e., likelihood of timely repayment of interest and principal. Investment decisions for IPO’s are at present based on voluminous and complex disclosure documents, which pose challenge to investors to arrive at decisions. Though seemingly there is a lot of information available on IPO’s through free research on websites, media and other sources, investors often look for structured, consistent and unbiased analysis to aid their investment decisions. Moreover, information available on new companies varies with the size of the issue, the market conditions and the industry that the issuing company belongs to. IPO grading aims to bridge this gap and facilitate more informed investment decisions. - 12 -
  • IPO GRADING Grading includes an assessment of business and financial prospects, management quality and corporate governance. IPO grading is based on the assessed future performance. The assessed future is based on the business plan of the company’s management as understood by rating agency. Rating agency will subject the business plan to extensive reality checks based on its understanding of industry and market dynamics, future management capability and the management’s track record of translating intentions into action. - 13 -
  • IPO GRADING THE GRADING PROCESS Agency starts the IPO Grading process on receipt of a formal request from the issuer company. Agency then sends a questionnaire seeking information on the company’s existing operations as well as proposed projects. This is followed by the site visits and discussions with the key operating personnel of the company concerned. Apart from official of the company, agency also meets its bankers, auditors, merchant bankers, and appraisal authority (if any). If the case so merits, agency also obtain the views of independent expert agencies on critical issues like, for instances, the technology proposed to be used. Once all required information has been obtained, agency’s team of analysts presents a detailed Grading Report to agency’s Rating Committee which assigns the Grade. Usually, the assignment of Grade takes three to four weeks after all the necessary information has been provided to agency. Once the Grade is assigned, the issuer company is required to disclose the same and also publish it in the Red Herring Prospectus (RHP), which is filed with SEBI and other statutory authorities. Agency does not carry out unsolicited Grading; the process involves the full cooperation of, and the interaction with, the issuer company concerned. IPO Grading is one a one-time exercise, not subject to subsequent surveillance. - 14 -
  • IPO GRADING - 15 -
  • IPO GRADING CONTENTS FOR IPO GRADING REPORTS The report for each IPO grading will contain a summary and a detailed report. • Summary- One page report highlighting the key elements of analysis • Detailed report- Comprehensive commentary on the assessment parameters. This report will be a one-time assessment based on the information disclosed in the draft prospectus filed with Securities Exchange Board of India (SEBI); rating agency understanding of the industry and company fundamentals; and interactions with the issuer management and other stakeholders. The report will comprise our assessment on the following parameters: • Management quality • Business prospects: Industry and company • Financial performance • Corporate governance • Project related factors • Other factors:  Compliance track record  Litigation history  Capital history. - 16 -
  • IPO GRADING IPO GRADING METHODOLOGY IPO grading is a service aimed at facilitating assessment of equity issues offered to the public. The Grade assigned to any individual IPO is a symbolic representation of Credit rating agency’s assessment of the “fundamentals” of the issuer concerned on a relative grading scale. IPO Grades are assigned on five point scale, where IPO Grade 5 indicates the highest grading and IPO Grade 1 indicates the lowest grading, i.e. a higher score indicates stronger fundamentals. An IPO Grade is not an opinion on the price of the issue, pre- or post-listing. GRADING METHODOLOGY The emphasis of the IPO Grading exercise is on evaluating the prospects of the industry in which the company operates, the company’s competitive strengths that would allow it to address the risks inherent in the business and effectively capitalize on the opportunities available as well as the company’s financial position. In case the IPO proceeds are planned to be used to set up projects, either Greenfield or Brownfield, agency evaluates the risks inherent in such projects, the capacity of the company’s management to execute the same and likely benefits accruing from the successful completion of the projects in the terms of profitability and returns to shareholders. Due weight age is given to the issuer company’s management strengths and weakness and issues, if any, from the corporate governance perspective. Normally, grading agencies methodology examines the following key variable: - 17 -
  • IPO GRADING  Business and Competitive Position • Industry prospects: Typical factors which are assessed here includes the growth prospects of the industry, the extend of cyclicality, competitive intensity, vulnerability to technological changes and regulatory risks inherent in the business. • Market position: A company’s Market position is indicated by its ability to increase/ protect market share, command differential pricing and maintain margins at par with, or superior to its peers. Factors evaluated would include the sources of competitive advantages like brand equity, distribution network, proximity to key markets and technological superiority. • Operating efficiency: The emphasis here is on evaluating the factors which could give rise typically includes areas like access to raw material sources, superior technology, and favorable cost structure and so on.  New Projects-Risks and Prospects • Key issues evaluated here are the company’s ability to successfully execute the project that is being undertaken and the potential upside to the shareholders on completion and commissioning of the project. Agency carries out a detailed risk assessment of the project with respect to issue like availability of finances, technology tie-ups in place, ability to execute the project without time or cost overrun, market risks - 18 -
  • IPO GRADING arising from capacity additions and the mitigates in place to counter those risks.  Financial Position and Prospects • Ability to generate sustained shareholders’ value as reflected by trends in profitability margins, EPS growth, Returned on Cpatital Employed (RoCE) and the Return on Net Worth (RoNW) are evaluated by the grading agency. While the absolute levels and the trends are important, agency also compares it with peers operating in the same industry to understand a company’s relative position. Complementing this is an analysis of the company’s ability to generate free cash flows in the long term. The capital structure for shareholders’ and the financial risks associated with higher leverage.  Management Quality • The assessment is designed to evaluate a company’s management depth, the profile of its key operating personnel, the adequacy of the organization structure and systems in place as well as the management’s stated plans and policies towards earnings growth and shareholder returns. Grading agency also evaluates the management’s approach towards risks and long term business plans in place. - 19 -
  • IPO GRADING  Corporate Governance practices • While IPO grading is not intended to be detailed evaluation of a company’s corporate governance practices, broad issues like apparent quality of independent directors, quality of accounting policies and type of transactions with subsidiaries and associates is looked into.  Compliance and Litigation History • The IPO Grade assigned is the outcome of a detailed evaluation of each of the factors listed, and is a comment on the fundamentals of the company concerned and its growth prospects from a long term perspective. The assessment involves combination of both quantitative factors as reflected in financial numbers, market shares etc as well as qualitative factors like risks associated with new projects, or the managements’ ability to deliver on the promises made. A grading agency IPO Grade does not comment on the valuation or pricing of the issue that has been Graded, nor does it seek to indicate the likely returns to shareholders from subscribing to the IPO. - 20 -
  • IPO GRADING IPO GRADING SCALE • IPO Grade 5: Strong fundamentals • IPO Grade 4: Above-average fundamentals • IPO Grade 3: Average fundamentals • IPO Grade 2: Below-average fundamentals • IPO Grade 1: Poor fundamentals IPO Grade Is Not: • It is NOT a recommendation to buy sell or hold the securities Graded • It is NOT a comment on the valuation or pricing of the IPO Graded • It is NOT an indication of the likely listing price of the IPO Graded • It is NOT a certificate of statutory compliance • A forensic exercise that can detect fraud • An audit of the issuer - 21 -
  • IPO GRADING GRADING CRITERIA FOR BANKS AND FINANCIAL INSTITUTION AS PER CRISIL  Market position CRISIL factors in the size of an entity in the financial sector and looks at its positioning in the industry. A larger size enables the entity to withstand systematic shocks and determines the extent of system support that can be expected for the entity. Diversity in product portfolio, business lines and customer base are also positively factored in by CRISIL. The ‘CRAMEL’ model comprises the following:  Capital adequacy  Resource-raising ability  Asset quality  Management and systems evaluation  Earnings potential  Liquidity/Asset liability management No one factor has an overriding importance or is considered in isolation and all the six factors are viewed in conjunction before assigning a rating.  Capital adequacy An entity’s capital provides it with the necessary cushion to withstand credit risks and other risks in its business. While assigning a rating, CRISIL analyses the capital adequacy level and its sustainability in the medium to long term. This assessment is significantly influenced by the - 22 -
  • IPO GRADING perception of relative profitability, the entity’s risk profile and its asset quality. The analysis encompasses the following factors: • Size of capital The absolute size of capital imparts flexibility to a bank/FI to withstand shocks and thus, an entity with higher absolute capital is viewed favorably. • Quality of capital (Tier I capital) The proportion of Tier-I capital or core capital is the primary indicator of the quality of a bank or FI’s capital. The level of Tier-I capital is given primary importance when assigning a rating on the capital adequacy parameters. Although the presence of Tier II capital does provides some cushion in the short to medium term, such capital needs to be periodically replenished. CRISIL also analyses other issues, like the presence of hidden reserves and the percentages of the investment portfolio that is marked to market. These issues help in streamlining accounting policy differentials across various entities and have a bearing on the capital’s quality. • Sustainability of capital ratios and flexibility to raise Tier I capital An entity has the flexibility to raise Tier I capital either through internal accruals or through the capital markets. The rated entity’s ability to access the capital markets to meet its Tier I capital needs and its ability to service the increased capital base is considered while evaluating its flexibility to raise capital. A bank or FI’s ability to support the increased asset base through earnings is an important parameter in assigning the sustainability of - 23 -
  • IPO GRADING its capital adequacy. An entity that is able to sustain asset growth through internal generation without impairing capital adequacy is viewed favorably. • Growth plans CRISIL factors the rated bank and FI’s future growtrh plans while analyzing its capital adequacy (even if it at high levels currently) would be regarded as unsustainable if the entity purses a high-growth strategy.  Resource-raising ability CRISIL analyses the resources position of the bank/FI in the terms of its ability to maintain a low-cost, stable resource base. In the domestic context, the resource composition of banks and FIs is very different. Banks are significantly deposit-funded whereas FIs have to depend on wholesale funds. Although some FIs do raise retail funds, compared to the banking sector, they are at a natural disadvantage while raising retail deposits in terms of the restrictions on the minimum tenure and interest rates, the absence of a cheque-issuing facility and a relatively smaller branch network. In general, the dependence on wholesale funding attaches a degree of risk to the funding profile of FIs. These risks (especially stability of resources) are partly mitigated by the access that the All India Financial Institutions (AIFIs) have to resources from provident funds and the insurance sectors. Such resources have a retail origin. Given this basic distinction in their funding profiles, the funding risk profile of baks and FIs too are evaluated distinctively. The following issues are considered while analyzing the resources position of a bank: - 24 -
  • IPO GRADING • Size of deposit base A large deposit base provides stability to a banker’s resources position by diversifying the depositor base and ensuring a continuous stable source of funds. • Diversity in deposit base and the geographical spread The diversity of the deposit base in the terms of the number of small deposits, the geographical spread and the optimal rural/urban mix lends stability to the resources position of a bank. The number of branches and their geographical spread lend diversity to its deposit base. Thus, a bank with a large number of branches dispersed all over India and with an optimal rural/urban mix is viewed favorably. • Deposit mix A bank’s deposit mix has an impact on its cost of deposits. A high proportion of savings and current deposits lead to a low-cost resource base. CRISIL also analyses the trends to in deposit mix to form an opinion on future stability and costs. • Growth in deposits Accretion to deposits in the main source of funding asset growth and managing liquidity risks in banks. CRISIL compares the growth in deposit of a bank with industry trends to make relative judgments. - 25 -
  • IPO GRADING • Cost of deposits Cost of deposits is a function of the bank’s deposit mix, its region of operations and its ability to attract deposits at lower rates. Banks that have a low cost of resources not only benefit through higher profitability but also have greater flexibility to increase deposit rates in order to maintain their resources position.  Asset quality A bank or FI’s asst quality is a measure of its ability to manage credit risks. Besides studying the bank’s credit appraisal mechanisms, portfolio monitoring procedures and problem asset resolution strategies, CRISIL analyses asset quality on the basis of the following parameters: • Geographical diversity and diversity across industries Geographical diversity of asset base and diversity across industries, along with single risk concentration limits, are important inputs in determining the assert quality of banks/FIs. Regional banks with limited operations and branch network have lesser flexibility to diversify their advances portfolio than banks with a national presence and are thus susceptible to adverse economic conditions in a particular region. The industry exposure and single risk concentration is monitored by the central bank, that is the Reserve Bank of India (RBI), through exposure guidelines. However, some banks/FIs show a high degree of exposure to certain industries, making themselves vulnerable to downturns in those - 26 -
  • IPO GRADING industries. To ascertain the importance of individual borrowers, CRISIL reviews the rated bank’s largest credit exposures. • Client profile of the corporate asset portfolio The credit quality of a bank’s corporate portfolio (funded as well as non-funded) is an important input in analyzing asset quality. CRISIL analyses the profile of clients in the asset portfolio to make a judgment on portfolio quality. The ability of a bank/FI to attract better credit quality clients is an important indicator of its future credit quality. The size (of capital) of a financial sector entity lends considerably flexibility in attracting larger and better quality clients given its sheer ability to take on larger exposures on its balance sheet. Also, a bank or FI’s ability to attract and retain good quality clients by providing value-added services would enhance asset quality in future. • Quality of non-industrial lending Banks in India have an obligation to lend a proportion of their funds to the priority sector that primarily encompasses agriculture and small- scale industries. To this extent, FIs are better placed than banks because they do not have any such obligations. CRISIL analyses the credit quality of this non-industrial portfolio in arriving at a judgment on the overall asset quality of a bank. The credit quality of the asset portfolio is also indicated by the segment-wise non-performing asset (NPA) levels of the portfolio, revealing the performance of the bank in each segment. This helps in gauging the bank’s relative strength in each of its loan segments. - 27 -
  • IPO GRADING In recent times, banks as well as FIs are increasingly focusing on retail consumer loans, primarily vehicle and housing loans. CRISIL looks at the quality of retail consumer credit growth, the underwriting standards and recovery mechanisms to arrive at the asset quality implications of the retail foray. • NPA levels The asset quality of a bank depends not only on the credit quality of its clients but also on its ability to manage its asset portfolio. The gross NPA level helps to benchmark the bank/FI’s ability to manage its asset portfolio on a relative scale. Gross NPA levels are an indicator of the inherent quality of the entity’s asset portfolio and thus, of its credit appraisal capabilities. Net NPA levels are an indicator of the balance-sheet strength of the bank, the proportion of earning assets held by it and the potential credit loss. The proportion of earning assets and the potential credit loss would have a bearing on the bank’s future earnings capability. • Movement of provisions and write-offs Some banks/FIs follow a practice of writing off a large portion of their bad loans in order to clean up their balance sheets. Thus, the present NPA numbers are not a true indicator of the inherent credit quality of a bank’s asset portfolio. Hence, NPA levels alone cannot be a criterion to assess a bank’s future asset quality. Average provisioning, including write-offs, over a five-year time frame is an indicator of the level of cleaning up done by a bank over a period of time. This average provisioning level and its movement is an - 28 -
  • IPO GRADING indicator of the portfolio’s credit risk and the expected future write-offs and provisioning, which would further affect the bank’s earnings capability. • Growth in advances High growth rates in the financial sector bring the risks associated with the establishment of collection systems, tracking of asset quality and lack of seasoning of the lending portfolio. CRISIL closely analyses the pattern and nature of such growth, studying entities with higher growth rates more carefully to look at nature of the growth, the reasons for it and its implications on the asset quality. An entity that has grown by attracting good quality clients from its competitors would be viewed more favorably than one that has grown just by increasing its geographical presence or diluting credit criteria.  Management and systems evaluation CRISIL believes that the quality of management can be an important differentiating factor in the future performance of a bank/FI. The management is evaluated on the following parameters: • Goals and strategies A bank’s future goals and strategies are evaluated to take view on its management’s vision. The bank’s ability to adapt to the changing environment ant its ability to manage credit and market risks, especially in a scenario of increasing deregulation of the financial markets, assumes critical - 29 -
  • IPO GRADING importance. CRISIL also has extensive discussions with the bank’s managements on their philosophy with regards to diversification, asset growth and maintenance of capital, provisioning and liquidity levels. • Systems and monitoring CRISIL studies credit appraisal systems and the systems and the systems for managing and controlling credit and market risks at a portfolio level. Significant emphasis is laid on risks monitoring. Most Indian banks face the challenges of enhancing the coverage and quality of their information systems and reporting. The degree of acceptance of new systems and procedures in the bank, data monitoring systems and the extent of computerization is gauged on the basis of the extent of business covered by computerization, computerization in branches and of the money market and foreign exchange desks. CRISIL attaches significance to the operating systems for data capturing and MIS reporting in a bank. A bank’s balance sheet that has a large volume of transactions pending reconciliation reflects its lack of operating systems and is viewed negatively. CRISIL also analyses expenses made on technology during the recent period and the bank’s strategy of using technology effectively as a delivery platform to reduce costs and improve service levels. • Appetite for risk - 30 -
  • IPO GRADING CRISIL also analyses the bank management’s attitude towards risk and the level of interest rate, foreign exchange and equity risks in the balance sheet. A high risk propensity typically reflects in higher volatility in earnings in both the fund-based and the fee businesses. A management with a higher propensity to take risks is viewed cautiously. • Motivation levels of the staff Employee motivation levels could be a function of remuneration, management involvement and job satisfaction. Such motivation levels would directly affect a bank’s service levels, which is a key success factor in a market-driven environment.  Earning potential CRISIL analyses a bank/FI’s earning on the basis of the level, diversity and stability of earnings. • Level of earnings The level of earnings as measured by the return on total assets (ROTA) provides the bank/FI a cushion for its debt servicing and also increases its ability to cover its asset risk. ROTA is a function of interest spreads expense levels, provisioning levels and the non-interest income earned by the bank. The size of net profit is also factored in while raring the entity’s earnings. - 31 -
  • IPO GRADING Earnings of banks/FIs have been affected due to volatility in interest rates. Thus, the trend in profitability at gross profit levels is examined over the past years to take a view on the sustainability of earnings. The various elements leading to profitability like interest spread, fees levels, expense levels and provisioning levels are also analyzed to take a view on the profitability trend and the sustainability of profits in the future. • Diversity of income sources Diversity of income sources is an important input in analyzing the stability of earnings. Diversity in fund-based income is achieved by focusing on different borrower segments like industries, trade and retail. Banks also diversify their income streams through non-interest or fee income like guarantees, cash management facility, service charges from retail customers and trading income. Fee income provides a cushion to probability, especially in times of pressure on interest spreads. CRISIL also views the composition of interest revenue streams while analyzing the earnings position of a bank/FI. Banks relying on short- term, non-repetitive income sources like bills financing and trading income are viewed less favorably than banks with long term credit relationships with companies through cash credit or term loan exposures and the like. CRISIL also analyses the composition of the non-interest income while evaluating a bank/FI’s earnings. Non-interest income also includes income from trading activities, which tend to be volatile. A closer analysis of the competition of revenue streams helps in forming an opinion on the sustainability of the earnings. - 32 -
  • IPO GRADING • Efficiency measures CRISIL looks at the levels and trend of operating expenses and degree of automation in the bank/FI. CRISIL looks at salary expenses and total non-interest expenses as a proportion of total income and average assets.  Liquidity/Asset liability management CRISIL assesses the asset liability maturity profile of the rated entity to form an opinion on the liquidity risk as well as the interest rate risk. The entity’s general philosophy of asset and liability management is discussed. • Liquidity risk The liquidity risk rating factors in the bank’s resources strength and the liquidity support available to it in the form of access to recall/repo borrowings and the extent of refinance available from the RBI. Banks are the primary channelisers of retail savings into the economy. Most public sector banks having a widespread branch network act as conduits for mobilizing retail savings. CRISIL views most of the public sector banks favorably on these parameters due to stable accretion to deposits and the liquidity support available to them. An FI’s liquidity position is a position is a function of its management’s policy of maintaining treasury portfolios to meet asset and - 33 -
  • IPO GRADING liability side liquidity demands. However, on account of their significance to the domestic financial sector, FI’s enjoy a high degree of financial flexibility that reduces liquidity risks too fairly low levels. The specific liquidity parameters analyzed by CRISIL are: • Liquid assets/ Total assets To arrive at this ratio, CRISIL looks at the percentage of sovereign investments in an entity’s books to its total assets. This can also be roughly derived from the credit-deposit ratio. • Proportion of small deposits CRISIL looks at the proportion of deposits below Rs. 150 million to the bank’s total deposit base. This small sized retail deposits tend to be inherently more stable. • Interest rate risk The rating factors in the volatility of the bank/FI’s earnings to interest rate changes. CRISIL analyses the entity’s asset liability maturity profile to judge the level of interest rate risk carried by it. In the Indian banking systems, the interest rate and maturity profile of the assets and liabilities have an inherent mismatch. The floating rate advances portfolio (linked to prime lending rates) and the relatively long duration investment - 34 -
  • IPO GRADING portfolio are funded through short to medium tenure liabilities, which exposes the bank to an element of interest rate risk. FIs score over banks in this regard due to the wholesale nature of their operations and policies that link the nature of borrowing (fixed/floating) with correspondingly matched lending. On an overall basis, FIs carry relatively fewer interest rate risks compared to banks.  Government support CRISIL positively factors in government support for specialized entities in the financial sector, which have a policy role to play in the national economy. Further, public sector banks benefit from the high likelihood of support arising from government ownership. In CRISIL’s opinion, the likelihood of support is underpinned by strong economic and moral imperatives provide assistance, given the role that the banking system plays in the Indian economy. Banks are primary agencies for channeling of savings in the economy and the government has used the banking system as a vehicle to fulfill its economic and social agenda through priority sector lending. While the authorities have stepped in to rescue troubled private sector banks in the past, CRISIL believes that the support to public sector banks would unquestionably be of a higher order. The assets of public sector banks represent 80% of the banking system. Moreover, government ownership and control of banks is a politically sensitive issue and the government will find it difficult to deny support to public sector banks in the event of difficulty. In fact, the government has made substantial capital infusions into banks during the 1990s. This is evident from the fact that the - 35 -
  • IPO GRADING government not only made substantial capital infusions into banks during the 1990s but it also continues to have a capitalization programme for some weak banks. - 36 -
  • IPO GRADING CASE STUDY GRADING OF CENTRAL BANK OF INDIA By Capital Market Tuesday, July 24, 2007 Central Bank of India (CBI) is entering the capital market with an initial public offering of eight-crore equity share of Rs 10 each at a price to be decided through a 100% book-building process. After the issue, the shareholding of the Union government in the bank will come down to 80.20%. The main objective of the issue is to augment its capital base to meet Basel II standards. End March 2007, CBI’s capital adequacy ratio (CAR) stood at 10.4% (Tier I CAR: 6.32%) as against Reserve Bank of India (RBI) stipulation of 9%. The bank also intends to grow its assets in sync with the growth of the Indian economy, primarily the loan and investment portfolio. CBI plans to expand significantly the number of branches to 1,000 under central banking solution (CBS) so as to cover approximately 80% of the business by the close of financial year ending March 2008 (FY 2008). Also, the bank has set a target to increase its ATMs to 500 from 261 (end March 2007) by end of this fiscal.  Strengths • Has pan-India presence with branches in 27 states and three Union Territories. End March 2007, the bank operates with 3,194 branches - 37 - CM RATING 2/5
  • IPO GRADING and has the third largest network of branches in India: 1,341 rural branches, 759 semi-urban, 575 urban and 519 metropolitan branches. • The low-cost deposit current and savings accounts (CASA) constitute almost 42.09% of the total deposits end March 2007. The bank stands next only to SBI in maintaining a high CASA in its books. Going forward, it aims to further increase the low-cost deposits by leveraging the branch network and customer base, particularly in the rural and semi-urban areas.  Weaknesses • The gross NPA to gross advances stand at 4.81% and the net NPA at 1.70% of the net advances end March 2007. These are relatively higher compared with industry peers. • Huge exposure to priority-sector lending, historically carrying high NPAs compared with non-priority sectors. This is evident from the fact that gross NPAs comprised 7.99% of priority sector advances, End March 2007, priority sector lending stood at 43.55% of the net credit. Of this, loans to agriculture and small-scale industry borrowers stood at around 17.91% and 6.58% of the net credit. • Business per employee stood at Rs 3.76 crore in FY 2007. This is one of the lowest among comparable PSU banks. This indicates excess staff or low productivity of staff. • End March 2007, central banking solution had been implemented in 324 branches and 29 extension counters covering only 35% of the business. This is far below many other banks. - 38 -
  • IPO GRADING • The financial track record is not encouraging. Profit fell between FY 2004 to FY 2006. Even in FY 2007, net profit jumped only because of fall in provisions. • Current paid-up capital stood at Rs 324.14 crore. This is after restructuring its capital base on March 2002, by netting off accumulated unabsorbed losses of Rs 681.31 crore against paid-up capital. End March 2007, the balance capital of Rs 1124.14 crore was restructured to convert Rs 800 crore in perpetual non-cumulative preference share capital and Rs 324.14 crore in equity share capital. So, the current book value of around Rs 77 is earned not because of good operational performance in the past, but largely because of the restructuring of equity.  Valuation EPS for the year ended March 2007 on post-issue equity works out to Rs 12.3. Nevertheless, profit for FY 2007 includes recovery / writeback of provisions of Rs 163.33 crore, and a repeat of such recovery every year seems difficult. The price band of Rs 85- Rs 102 gives P/E band of 6.9 to 8.3 times FY 2007 EPS on post-IPO equity among the comparable banks, Allahabad Bank and Syndicate Bank trade at P/E lower than the lower band. Other comparable banks like UCO Bank and Indian Overseas Bank trade within this band. Only recently-listed Indian Bank and Oriental Bank of Commerce are trading above the upper band P/E. The price band gives price (P) / book value (BV) band of 1.1 to 1.2 times post-issue BV and 1.5-1.7 times P/adjusted BV (after deducting NPAs). Currently, Allahabad Bank, - 39 -
  • IPO GRADING UCO Bank and OBC are trading around P/BV of around 1.1. Allahabad Bank and OBC are also trading at lower than P/adjusted BV of 1.5 though other comparable banks are trading around or above 1.7 times P/adjusted BV. Overall pricing has been done to keep the offer interesting, though the valuation is not as low as it appears. Central Bank: Issue Details Sector Bank – Public sector No. of share on offer 80000000 ( face value Rs. 10) Price band (Rs.) 85 - 105 Post-issues equity (Rs. crore) Rs. 404.14 crore Post-issue promoters stake (%) 80.20 Issue open date 24/07/2007 Issue close date 27/07/2007 Listing BSE, NSE Grading 2/5 - 40 -
  • IPO GRADING Advantages of IPO Grading  A powerful guidance tool Sebi's proposal to make the IPO assessment available to investors is a step in the right direction. Though the move to make IPO assessment mandatory has drawn some critical comments, the need for a tool to help investors make better- informed decisions and judge the quality of issues hitting the market is undisputed. An IPO assessment brings four major pluses. Firstly, it improves information content through a professional and independent assessment. Secondly, it is relief for individual investors from information overload. Thirdly, it provides disincentives for weak companies to come to the market in the hope of raising easy capital. And fourthly, it brings about greater level of investor sophistication.  Professional and independent assessment The public issue report, which is part of the IPO assessment will provide focused company information to investors and will create awareness about the fundamental strengths and weaknesses of the company. Dissemination of fundamental information will help investors allocate resource better. The report will be a key input in the investment decision, in a manner similar to what a credit rating is for a debt investor. - 41 -
  • IPO GRADING  Relief from information overload In a situation where issues are bunched in the pursuit of optimum market timing and disclosures are voluminous and complex, a service that analyses and interprets these disclosures independently, quickly and in manner that facilitates a comparative study will be extremely useful in cutting through the clutter. The usefulness would be particularly high for small investors as it will serve as a guide on the strengths of the company coming out with the issue.  Disincentives for weak companies Given the improved quality of information content in the marketplace after the introduction of IPO assessments, there will be a stratification of the market on fundamental lines. Fundamentally sound companies will command commensurate valuations, while companies whose fundamentals are not very strong will be impeded in building up speculative demand among investors, and will need to offer pricing, which will adequately compensate investors for the risks they take.  Increased investor sophistication - 42 -
  • IPO GRADING In today's markets, with free pricing, it is just as easy to lose money on listing as it is to make it. An independent and informed opinion on the fundamental quality of the company, along with clear and concise information, will go a long way towards making the process far more scientific. With a clear view on the quality and risk drivers of the company the investor is getting into, he can choose the level of risk he is comfortable with. He will then take investment decisions, which reflect his outlook on factors such as product prices and input costs and are in line with his target portfolio composition. Such analysis is today beyond all but the most sophisticated investors. The assessment is not a recommendation to buy - or not buy - a stock. It is, instead, a powerful tool to assist the investor in making up his mind about the quality of a company offered as an IPO investment option. - 43 -
  • IPO GRADING OXYMORON TO IPO GRADING However, there are several arguments against the proposal. Equity, by its very nature, is ’risk investment'. 'Caveat emptor' or 'buyers beware' hold true especially for equity investments. Pricing of shares is the most critical factor in evaluating IPO’s. By refusing to comment on pricing, the rating's value is immediately diminished. Markets do not always take the rating on its face value. For example, in the case of debt instruments, instruments with same ratings have different prices/YTMs.  Issuers to pay A strong case exists for reducing issue expenses drastically right from the preparation of the offer document (prospectus) to the allotment stage. Regulatory measures since the advent of SEBI in the early 1990s have in fact taken note of the disproportionately large bill that issuers of capital have to meet. At the same time, insistence on fuller disclosures, a key area of regulation, cannot be wished away. Simplification of the offer document and incorporating its key provisions in an easy-to-read format in the application form has been major steps forward. But it is difficult to see how a rated IPO will enhance investor protection further. However, it appears that all major investor associations have pitched for equity ratings. Initial opposition, according to them, is mainly from merchant bankers and others who are now directly involved with the public issue. Their role could be threatened by the new development. - 44 -
  • IPO GRADING A rating exercise is specific to a scheme or instrument. The company issuing the security is not rated. Its fixed deposit schemes, debentures and other debt instruments are. It will be wrong to read larger meanings applicable to the whole company from the rating for any of its schemes. Debt instruments are more amenable to rating. Safety of the money invested in a particular scheme and correspondingly the company's ability to repay the debt are two of the key factors covered by the rating exercise.  Different exercise Though by no means fool proof, rating agencies have over time acquitted themselves creditably in rating debt instruments. Although it was regulatory rules that provided the impetus for the rating of debt instruments, the facts is that the grading given — 5, 4 and so on — are now easily recognized by investors. Rating agencies will naturally have to go through the learning curve before they get a handle on rating equities. Starting with the IPO, rating of a company's equity issue is likely to be a continuous affair. Hence secondary market investors too can use the rating in their decisions. Even granted that rating agencies can equip themselves soon, the question remains whether (a) a rating so arrived at is of much relevance to investors and (b) they will not induce a sense of false complacency among investors. - 45 -
  • IPO GRADING There is no way that a grading will obviate the need for looking at the offer document and the various disclosures, especially in issues by new promoters. For blue chip issues, there will be no need to look at either the disclosures or the rating.  Realty sector SEBI is on much stronger ground in asking real estate companies accessing the capital market to disclose more about the land they claim to possess. Land banks, as they are called, have been the key determinants in valuation of these companies. There has been considerable opacity about the professed extent of land holding as also the nature of ownership. Often real estate developers include in the prospectus agreements to buy as proof of ownership. In most cases, they are at best part owners. From now on, real estate companies will be forced to disclose full details of such agreements. These will presumably be included as material contracts and open to public inspection. One should not forget the larger picture. SEBI is already applying the brakes on some real estate companies' unrealistic valuations as the property market in the big metros is showing signs of a bubble. The Reserve Bank of India has for long been cautioning banks against reckless lending to the real estate sector. It has also asked them to treat lending to special economic zones as exposure to commercial property and incorporate more onerous terms in loan agreements. - 46 -
  • IPO GRADING  Short selling Short selling by institutions is an idea whose time has come. Institutions can go short if they are convinced that the price of a particular share will go down. At lower levels, they can buy the share and square the position. This is of course the opposite of what an investor does when he is betting on a higher price: he will borrow money, take a position and hopefully come out when the price is right. SEBI has made it mandatory for short-sellers to back their actual action by borrowing the relevant shares. That presupposes the existence of a vibrant stock lending mechanism to be operated by a depository or a custodian. Beneficial owners of the shares will of course be compensated. Institutional short selling, according to its critics, will aggravate, not minimize, volatility and will further tighten the hold institutions have in today's share market. Like many other recent moves of SEBI, this one too will need to be examined in detail. Conceptually, however, it looks extremely sound. - 47 -
  • IPO GRADING Survey of IPO grading of the investors SHRI CHINAI COLLEGE OF COMMERCE & ECONOMICS NAME : DESIGNATION : AGE: QUESTIONS 1. Does IPO grading help for investing in IPO? YES NO 2. Which credit agency you think is reliable in grading? CRISIL CARE ICRA FITCH 3. Do investors really follow the grading done by the agency? YES NO 4. Does IPO grading helps to investor at the time when there are many IPO issued in the market, in order to reduce confusion? YES NO 5. Do you think that IPO grading should be mandatory? YES NO Comments: Project Guide Survey done by: Prof. Vinita Pimpale Shradha Vadia - 48 -
  • IPO GRADING ANALYSIS OF SURVEY ON IPO GRADING 1. Does IPO Rating help for investing in IPO? YES NO Linear (NO) Linear (YES) YES 27 NO 3 Out of 30 Comment: Majority of the investors think that IPO grading helps an investor in order to invest in an IPO of any company. IPO grading avoids bogus IPO, is the main reason investor chooses option YES. - 49 -
  • IPO GRADING 2. Which credit agency you think is reliable in ratings? CRISIL CARE ICRA FITCH CRISIL 20 CARE 1 ICRA 8 FITCH 1 Out of 30 Comments: CRISIL – This agency has experience of more than a decade in this business. It provides ongoing analysis on the Indian economy and industry analysis on 45 key industry, infrastructure and service sectors in India. It stands first in India and fifth in world, have more experience. So the report given by CRISIL is more reliable than any others. CARE – New player in this field. ICRA – After CRISIL in India ICRA took active participation in this business. FITCH – Only 1% of investor says that it is reliable. - 50 -
  • IPO GRADING 3. Does investor really follow the rating done by the agency for the investment purpose? YES NO YES 19 NO 11 Out of 30 Comments: Yes – It tells the real scenario of the company No – Since investor still believes investing in IPO on tips basis. - 51 -
  • IPO GRADING 4. Does IPO rating helps to investor at the time when there are many IPO issued in the market, in order to reduce confusion? YES NO NO Comments YES 19 NO 2 NO Comments 9 Out of Comments: Yes – After grading is published, an investor can take its decision as per the company’s report. And finally go for that company’s IPO whose report is satisfactory according to investor. No – Because investors thinks that they can too analysis as per their knowledge. - 52 -
  • IPO GRADING 5. Do you think that IPO rating should mandatory? YES NO YES 28 NO 2 Out of 30 Comments: Yes – Because it will reduce an amount of bogus IPO issues in the market. No – Investor thinks that they are smart enough to take correct decision for investing in an IPO of a particular company. - 53 -
  • IPO GRADING ANNEXURE 1. Why do you think IPO Grading is necessary? Ans. There are various reasons for grading some of them are: a) to increase level of information among investors b) to improve discipline of the market 2. Why IPO Grading is not mandatory in India? Ans. There are many controversies going related to this topic. We think that majority of vote is in the favor of IPO grading should be mandatory. 3. IPO Grading is being launched recently, so what was scenario in initial days? Ans. In initial days there was institution called Capital Credit of India (CCI) was governed by Central Government of India. This institution was balancing the market. 4. Does IPO Grading helps to investor in order to invest in IPO of a particular? Ans. Yes. Because the results are unbiased, independent. It also helps to investor in order compare between companies. 5. Does Grading affect an investor’s mind for investment? Ans. Yes, because an individual even refers grading for movie whether to go for or not. So of course investing thousand of rupees in IPO, an individual obviously refer for grading. According to grades investor will react on that IPO. - 54 -
  • IPO GRADING 6. If the Grading of the company is not satisfactory then, do you think that company may suffer in managing enough of subscription for IPO? Ans. Of course, because it is a question of an investor’s hard earn money. If the grading is average or below average one will not invest in that IPO issue. It will create negative reflection on investor’s mind. 7. What you think how can a company arrange for the funds, if the subscription is not up to the mark? Ans. It is bit difficult for a company to arrange funds if subscription of IPO is not enough. If company has goodwill so can arrange from banks, issue debentures, or any private placement. 8. What is creditability of CRISIL? Are there any chances of fraud with investor by making wrong rating? Ans. No chance for any fraud. 9. What about developed countries whether they have IPO Grading mandatory? Ans. IPO grading in only done in India. 10.What is the future of IPO Grading in developing country like India? Ans. Yes we think that there is potential. 11. What different between IPO Grading and Credit rating? Ans. A credit rating assesses these factors from a debt-holders' perspective, which is very distinct and sometimes opposite to an equity-holders' perspective. For instance, some companies that raise far more equity than they - 55 -
  • IPO GRADING need in an IPO and hence suffer a depressed ROE are likely to be assessed unfavorably in the IPO grading exercise. However, they are likely to be assessed more favourably in a credit rating exercise, as equity cushions debt repayment. This distinction of objectives also means that the relative emphasis on the elements is very different in IPO grading and credit rating. For instance, the assessment of corporate governance while evaluating an IPO grading would tend to assume a much more pervasive character than credit rating where the emphasis of assessment is on estimating cash protection available to pay debt. It is for this reason that CRISIL issues IPO grading outside of its credit rating division. (Note: Above mentioned doubts is asked by me by Mr. Mohan Krishanan, Manager of CRISIL and Mr. Arun, Assistant Manager of CRISIL.) - 56 -
  • IPO GRADING SECONDARY DATA IPO grading: Help or hindrance? BS Smart Investor Bureau | May 10, 2004 Q: Do you want comment on that? Tandon: I have no doubt that any rating agency, with their track record, and with their own experience of various markets, will find ways of rating new companies. My fear is exactly is that is that the goalpost that we are trying to set for ourselves, is it the job of the rating agency to decide whether or not the business which you should invest in? As I said you come back to the basic purpose; purpose is to simplify give a one point - yes or no investment decision to the common man (aam aadmi). Ravimohan: No, that’s not the agenda and can’t be the agenda because if you take a very simplistic view all I am saying is all of this research that we all put is leading to very simplest some idea of the EPS and there are two investors with completely different outlook, different confidence levels, different philosophy of life, different liquidity position would come up with completely different PE ratios by with which you multiple the EPS to come to the valuation. I personally think valuation is dependent on so many factors other than fundamentals, fundamental is one part and where we are getting to with the IPO grading is to get a realistic estimation of where the fundamentals are and then leave it to the market to judge whether the EPS or the valuations that they want to put on that fundamentals to their own judgment. So we cannot go to the end result, which is where we are today which is to say whether to buy or not. - 57 -
  • IPO GRADING I think it is so customized, that even I will add one more twist to the question that raised Anand raised that it’s a great company but is the valuations stretched and then let say we have a third question that it is a great company valuation is not stretched but I still may not be right investor in that entity because I am a widow and I want to be more concerned about monthly income rather than equity upsides. So I think we cannot simplify equity investment process to a single point agenda it is a complex issue and I think more that we disintegrate into its components - fundamentals, valuations and investment advice I think we are better off and I think we will be able to give better service to the investors at large Q: How does that work exactly, doesn’t that leave more gray for an investor when you talk about the management quality or corporate governance, which might be great, the brand which might be great but the price might be completely out of whack? Ravimohan: I hope that is something, which will evolve faster. The fact of the matter is that fundamentals are one area which today gets subsumed in the overall equity research including the valuations. Whereas what I am saying is that once you have a good indications for where the fundamentals are. If the pricing goes out of whack, that is a good indication for investors to stay away from that issue at the IPO grade and hope to pick it up if he thinks the price is too high and is likely to fall after the listing and pick it up in the secondary market. - 58 -
  • IPO GRADING Q: Who is deciphering that for him because the investment banker isn’t, the rating agency isn’t, infact it seems the agency has no liability once it’s rated, so does that leave it clear for a retail investor? Tandon: If the idea is to simplify the investment decision, then you are talking about investors who are not ready to read the fine print or able to understand it. So if you get to a stage where you have a grading from say 5 to 1; ‘5’ being the best and ‘1’ being the worst, then it is relatively easy to say that if it means 1, then on various hygiene factors, it is not good enough and want to leave it out. But what does 5 mean - does 5 mean that it is a good investment? So my fear is that overtime, it is likely that one will use that as a marketing ploy as well as it will become a simple rule to say, ‘it’s a great issue, and CRISIL has graded it '5' and CRISIL is a great company, which means you should buy it’. This brings us to the point that what happens to the price? Great companies don’t necessarily make great stocks and vice-versa. In fact if it works this way, then what will happen is a company, which is in a transition stage and looking to raise capital for its new business will probably attract an E rating but will therefore command a price, which is so attractive that it will make a great stock. Q: What about things like new generation businesses, which do not have great earnings records or track records, which people buy on the strength of the prospect like retail companies which probably would be making losses, do not have much by way of return ratios or profitability track - 59 -
  • IPO GRADING records? How do you grade them and do you think rating agencies can therefore have the expertise to look forward into unfolding business with not too much of a historic track record? Ravimohan: I will come to that in a moment but I think Anand made a great point. Say, Crisil has graded it five but don’t you think even for a grade of five, the big pricing that Anand made - if let say, the prices over stretched. I think it’s a great way to analyze given one more benchmark and that is exactly the utility that I hope the grading will bring to. And over time, if you are able to establish some linkages between our grading, our correlation grading and EPS, then it is really the price earnings valuation that the collective wisdom of the market gives that will determine the IPO pricing. Therefore I think there will greater discipline to the market done, the fear that Anand raised. As far as the new sectors are concerned, we had a similar paradigm about five years back when mobile telephony was introduced into the market. At that time, we were asked to grade or rate their credit worthiness and we had fairly challenging first year where we were put to a lot of difficulty not only because it was a new sector and there has been no past history, but also the regulatory situation in the country was evolving. But I think we handled it well; there were transitions in our ratings, if you take our Bharti Airtel rates, we actually been rating it for the past seven years. And it’s a great story to answer your question that as clarity about this sector emerges, we at CRISIL use macro economic long-term trends and juxtapose it with micro competitive strengths to get a sense of what the long-term prospects are and what’s likely to happen between now and then for these various companies. We are hoping to use a lot of these learning’s for new sectors like retail, biotech. This morning, there was a news item about - 60 -
  • IPO GRADING Mumbai University wanting to get listed. So we will figure out good ways of finding fundamental strengths in these businesses (Note: Above discussion on IPO Grading: Help or hindrance? Is between Mr. R. Ravimohan Managing Director and Region Head, South Asia of Standard & Poor's and Mr. Anand Tandon of Gryffon Investment Advisor) - 61 -
  • IPO GRADING IPO’s need to be rated before launch THE TIMES OF INDIA 22 Mar 2007, 2359 hrs IST, TNN MUMBAI Sebi is taking steps to change the way companies tap investors for funds, way institutions trade and at cut down on cost and time for a number of market participants, M Damodaran, chairman, Sebi said. On Thursday, Sebi made it compulsory for companies going for IPOs to have their issue graded by one of the three rating agencies CRISIL, ICRA and CARE. This decision was taken to avoid situations like in the 1990s when a large number of companies had tapped the IPO market for funds but soon the companies as well as its promoters vanished leaving investors with worthless papers. Sebi proposed for a change of rules that will make disclosure norms for valuing land banks of real estate companies more detailed and strict. The Sebi chief also said the board had given its nod for institutions to short sell in the market and soon detailed guidelines will be in place. Sebi has also tried to take future projections and subjectivity out of realty IPOs. Of late a number of real estate companies have been rushing with their IPO plans, valuing their shares much higher than their listed peers. Sebi chief said real estate companies going for IPOs should value their land bank at present prices and not at prices going forward. Sebi also said that it was putting a cap on the regulatory charges that market transactions like large IPOs and big-size mergers & acquisitions attract. - 62 -
  • IPO GRADING EXECUTIVE SUMMARY In cricket, a flying start does not necessarily mean a good innings. Similarly, in the stock market, a good listing does not mean sustained performance. A successful IPO and subsequent listing are as much a mix of prudent judgment and right implementation as they are about meeting known and unknown market risks. Recently, capital market regulator Securities and Exchange Board of India (SEBI) has talked about grading initial public offers (IPO’s). But, wouldn’t that be a bit like trying to assess what a batsman will score, depending on his past records? Look at the last 14 months (January 2006 to February 2007). During the period, 79 out of 102 companies that made their debut in the market were listed at a premium, often as high as 75 per cent (Sobha Developers). But, now many of these scrip’s have collapsed, with over 60 per cent companies trading below their offer prices. The biggest loser from the lot is Sakuma Exports, which is down over 73 per cent from its offer price. There have been exceptions too. Companies like Tech Mahindra, Info Edge and GBN have made smart moves even in adverse market conditions and are enjoying gains of 290, 110 and 107 per cent, respectively, on their offer prices. - 63 -
  • IPO GRADING Investors who sold their allotment just after listing were the real winners. The portfolios of those who bought after the listing suffered a loss. If you had taken a position in Sakuma Exports at the time of listing, you would have lost over 73 per cent of your investment. Similarly, Parsvnath Developers is down over 44 per cent, Akruti Nirman 46 per cent and Sobha Developers 35 per cent from their listing prices. So in this case IPO Grading is very important, because in this process an agency scan the company from top to bottom. - 64 -
  • IPO GRADING CONCLUSION Price is an important factor for any investment. What this means is that a company listing at 10-15 times its price earning can be a good investment, but the same company at 40-50 price times earning can be a terribly bad investment. Secondly, a fundamentally strong company neither means too much of capital appreciation, nor absolute safety of investment in the market. If we look at the recent history of the IPO market, all real estate companies got huge responses at the time of the issue, but the sector could not sustain these high valuations. Price plays an important role in investments and the market itself throws enough clues periodically. It is necessary to catch these in time. - 65 -
  • IPO GRADING BIBLIOGRAPHY • Internet websites  www.crisil.com  www.capitalmarket.com  www.goggle.com  www.icra.com  www.moneycontrol.com • Magazines  Capital Market  India Today  Dalal Street • Newspapers  The Times Of India  The Financial Express - 66 -