Why India’s IPO mania is similar to the dotcom bubble

I am at my grumpiest on humid and muggy mornings. Today is a muggy morning. Actually, afternoon. It’s 2 pm. But given that I woke up only around noon, my body clock is still in its morning phase.

I am trying to brighten my day by listening to Caribbean-sounding reggae songs. The Dualers, a Caribbean-sounding ska and reggae band from South East London, are singing ‘It’s a Wonderful Life’. Is it? I don’t know. But it definitely feels so for those in the business of selling shares of companies that are listed on the stock exchanges and those in the business of buying those shares.  

Let’s sample a few recent news stories.  

On 8 September, Mint reported that India’s primary market was set to witness one of its busiest weeks, with 13 initial public offerings scheduled to open and eight new listings. Citing  Pantomath Capital Advisors, the report said the outlook for India’s IPO market was promising and that domestic companies could raise more than ₹1.50 trillion through IPOs over the next 12 months.

Or as The Economist reported recently in its ‘The World in Brief’ newsletter: “In the first half of 2024 the money raised by IPOs globally fell by 16% year on year, according to EY, a consultancy. But in India the amount doubled during the same period, to $4.4 billion."

On 11 September came news of Bajaj Housing Finance’s IPO being massively oversubscribed. The company was looking to sell 727.6 million shares. It received bids for 46.3 billion shares, an oversubscription of 63-64 times. In terms of money, the company was looking to raise ₹6,560 crore but saw inflows of more than ₹3 trillion. Such is the level of India’s IPO mania.

A large part of my newsletter last week also dealt with IPOs. My On the Other Hand column in Mint was also on IPOs. I guess I have more things to say on this issue with the IPO mania that is currently on.  

1) The money that chases an IPO is money that doesn’t go into shares already listed on the stock market (that is the secondary market), at least not immediately. Hence, to that extent, a further rise in stock market indices, which reflect the broader state of the market, gets held back. Of course, once a stock lists and becomes a part of the secondary market, and if its IPO has been oversubscribed many times over, money does chase such a stock.  

2) Why are such huge oversubscriptions happening? The Business Standard in a recent report quoted Pranav Haldea, managing director of PRIME Database, as saying: “In 2024-25 thus far, on average, IPOs have been oversubscribed by 48 times with the average gain on the listing being a staggering 35%." So, given the huge demand for IPOs, there is a pop in price once a stock lists. And this price pop attracts more investors to invest in newer IPOs. This is how the loop works.   

As Robert Z. Aliber and Charles  Kindleberger write in the seventh edition of Manias, Panics and Crashes—A History of Financial Crises in the context of the dotcom bubble of the 1990s: “In 99.46% of the cases, the share price at the end of the first day of trading was significantly higher than the IPO price, and those fortunate enough to buy at the initial offering price would make a significant capital gain. One impact of this price pop was that more and more investors clamoured to buy at the IPO price." 

So what happened in the US during the dotcom bubble is happening in India as well.

3) Now, if IPOs are being oversubscribed to such an extent, then a question worth asking is why these shares are not being priced and sold to investors at even higher levels, given the huge demand for them. This is an interesting question. 

As Aliber and Kindleberger wrote in the context of dotcom companies that were looking to list on stock exchanges in the US in the 1990s: “The size of the price pop was like dynamite or nitroglycerine or maybe even a nuclear explosion. The investment bankers appeared to set the price for the IPOs to maximize the price pop on the first day of trading—rather than to maximize the cash received by the shareholders who were selling."

So why not sell shares at even higher prices and make more money? One reason can be that entrepreneurs listing their companies want to feel more wealthy than have more real money in the bank. 

As Aliber and Kindleberger write: “The entrepreneurs sold only a small part of their total shares at the IPO; they calculated that the larger the pop, the greater their wealth. They appeared to be more interested in the apparent value of the shares they owned at the end of the first day’s trading than they were with the amount of cash they might obtain from the IPO."  

Also read | Missed the Bajaj Housing IPO boat? There’s still time to get on deck.

But there is more to this. The post-listing pop essentially ensures that merchant bankers and investment bankers who get more companies to come up with IPOs can keep generating new business. Ultimately, IPOs can continuously be sold only if there is demand for such shares from investors. A post-IPO pop essentially ensures that the demand keeps coming, helping merchant and investment bankers get more and more companies to sell shares. This is a feature of their business model.  

4) That brings me to the next point. The real reason I wrote this newsletter. I just love going back to the books written by economist John Kenneth Galbraith and quoting from them. In last week’s issue, I quoted a Bloomberg news report that said Indian IPOs had failed to generate additional returns for investors over the long term.  

So what explains the current obsession with investing in IPOs? 

First, when it comes to retail investors, they are not looking at the long-term. They want to make the post-listing pop and sell. As Sebi said in a recent report: “Individual investors sold 50.2% shares (in value terms) allotted to them within a week after listing."  

Second, and this is the more important part, most of the investing decisions, irrespective of whatever people might say in public, are made looking at what has been happening recently or over the short-term. No one remembers or likes to be reminded about history. 

As Galbraith puts it in his lovely little book A Short History of Financial Euphoria: “Financial disaster is quickly forgotten… There can be few fields of human endeavour in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present." 

This works for the supply side of investment bankers and entrepreneurs looking to list companies and the demand side of investors looking to buy the shares.  

5) The next point I want to make is one I dealt with in detail in my previous On the Other Hand column in Mint. But I have a few more things to say here.  

Ashwani Bhatia, a whole-time member of Sebi, has rightly expressed concerns about the rising number of IPOs by companies seeking to list on the small and medium enterprises (SMEs) platform of stock exchanges. 

Bhatia pointed out that recent developments have exposed gaps in oversight, with insufficient checks and balances. He emphasised that the due diligence performed by chartered accountants, merchant bankers, and stock exchanges appeared lacking, and called for stronger efforts to address these shortcomings.  

Basically, Bhatia was trying to say that those in the business of selling shares should carry out proper due diligence on companies looking to list their shares on the stock exchange. While Bhatia said this in the context of smaller firms looking to list on the SME platform of stock exchanges, the same arguments can be made in the context of IPOs in general.  

In an ideal world, merchant bankers should conduct proper due diligence before taking a company public. But anyone sincerely believing this either has an inadequate understanding of the world as it is, with a limited understanding of how things have happened, or is just saying things for the sake of saying them.  

Financial history clearly tells us that stock market manias, where new shares of companies with limited business prospects have been sold at very high prices, have been very common. Of course, those selling these new shares weren’t always called merchant bankers or investment bankers, but, dear reader, you get the drift.  

In 1720, France experienced the Mississippi Bubble, which was closely followed by the South Sea Bubble in the UK that same year. In both cases, shares of many new companies with dubious business models were sold. 

In Lombard Street—A Description of the Money Market, Walter Bagehot details the dubious purposes for which businesses sought to raise funds: “To make Salt Water Fresh… For building of Hospitals for Bastard Children… For trading in Human Hair… For a Wheel of Perpetual Motion." But the most audacious was: “For an Undertaking which shall in due time be revealed." 

Even the great Isaac Newton, then the Master of the Royal Mint, lost money in the South Sea Bubble. After losing £20,000 he is said to have remarked: “I can calculate the motions of the heavenly bodies but not the madness of people."

The UK later went through a rail mania during the 1830s and 1840s. In the US, the stock market surged during the roaring 1920s before crashing and triggering the Great Depression. More recently, the dotcom bubble of the 1990s became a defining financial event. Then came the subprime bubble of the 2000s, when investment bankers sold dubious financial securities supposedly backed by home loans given out to individuals who weren’t in a position to repay.   

Closer home, in 1994, a wave of IPOs was launched, raising significant funds, only for many promoters to disappear with the money. Nearly all these bubbles and manias were marked by dubious practices, with shares sold at highly inflated valuations. 

So, what’s the point I am trying to make? The point is that those in the business of selling shares are incentivised to sell shares at the best possible price and keep the business going in a way that benefits them the most and leads to them earning the maximum possible bonus at the end of the year. The institutions in the business of selling shares are designed around this idea of individualistic thinking.  

As economist John Kay writes in The Corporation in the 21st Century—Why (Almost) Everything We Are Told About Business is Wrong: “The social instincts that are essential aspects of human behaviour—including economic behaviour—have been subordinated to an almost exclusive emphasis on response to incentives."  

He adds: “Investment bankers salivate at the approach of bonus season as Pavlov’s dogs did to the chiming of his bell; they learn to press levers, as Skinner’s rats did, to obtain their rewards. These assumptions about agency and motivation tend to become self-fulfilling when organisations are designed around them."  

This is how the business of selling shares actually works, and hence, proper due diligence isn’t always the order of the day. This is a point well worth understanding. As the old Hindi saying goes: “Ghoda ghaas se dosti karega to khayega kya? (If horses become friends with grass, what will they eat?)"  

The due diligence of the smart individuals who work for investment banks essentially involves “dressing up" and presenting improved figures in the lead-up to an IPO. Chartered accountants, investment bankers and merchant bankers play a crucial role in producing numbers that make many companies with weak business prospects appear much stronger than they actually are.  

6) It is worth remembering that as the IPO mania goes on and on, the quality of companies entering the market with the idea to list decreases. 

Again, the history of IPOs tells us this very clearly. William Quinn and John D. Turner write in Boom and Bust—A Global History of Financial Bubbles: “The median age of a publicly offered company in the 1999-2000 period was 5 years, compared to 9 years for the period 1990-4, 8 years for 1995-8 and 11 years for 2001-16." A lot of wealth destruction happened in the process.  

A similar dynamic played out during the subprime bubble of the 2000s. Financial institutions gave more and more loans to individuals who were in no position to repay the huge sums they were borrowing. Investment bankers turned those loans into financial securities and sold them to other investors. In many cases, the investment bankers knew fully well what they were doing. As Kay writes: “They not only were a shitty deal—they had been designed to be a shitty deal." 

Home loans were given to individuals who would soon start defaulting on their monthly repayments. There was no way the investors could have made any money from those financial securities, which were based on home loans that were likely to be defaulted.

7) When investment bankers take dubious companies to the market they follow the strategy known as leaving something on the table. 

As Quinn and Turner write in the context of the doctom bubble: “The most notable method of attracting investors, however, was under-pricing." This ensures oversubscriptions and keeps the game going. “Although under-pricing was already common, it was taken to a new level in the dot-com era. IPOs issued in the United States between 1990 and 1994 had an average first-day return of 11%, whereas the average first-day return in 1999 was 71%, and in 2000 was 56%. Issuers were, on average, selling their company for less than two-thirds of its market price." 

The listing day pop or the first day return of Indian IPOs in 2024 has been 35% on average,  and has been getting into the dotcom bubble kind of territory.  

Finally, as always, caveat emptor or buyer beware should be the order of the day. But then it’s easier to be a part of the herd than go against it, especially when the herd has been making money in the short-term. But as we know, neither the dotcom bubble nor the subprime bubble ended well. Of course, we only learn from history once our present becomes history. And then we forget it again. That’s how life goes on.

In all this hullabaloo, only Bob Dylan continues to make some sense. As I finish writing this piece, Dylan is singing Things Have Changed, with the following lines echoing in my ears:

“People are crazy and times are strange

I’m locked in tight, I’m out of range

I used to care, but things have changed".