NBFCs laugh their way to the bank as rich investors try to cash in on IPO mania

The other IPO which also received huge responses were Happiest Minds Technologies and Chemcon Speciality Chemicals, which was subscribed 150.98 times and 149.3 times respectively. Interestingly, both these stocks have seen bumper listing gained over 100 percent. Let's see how the IPO subscription and listing happened in 2020 so far, considered only IPOs issue size over Rs 100 crore.

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With the market for initial public offerings on a boil, non-banking financial companies (NBFCs) which fund wealthy investors to apply for shares, have had a fantastic 2017 so far.

Irrespective of whether or not the rich investors make money, NBFCs have been making money hand over fist in what now seems to have become a zero risk game for them.

With an overwhelming majority of the issues listing at a juicy premium to the issue price, the big investors have been increasing the size of the bets. And NBFCs appear only too willing to finance them.

That seems to have created a virtuous cycle of sort, where heavy demand for the issue from high networth investors (HNIs) triggers more demand from retail participants who do not want to be left out.

Some market experts say this is giving a distorted view of the actual demand for the issue.

At the same time, IPOs in which the HNI portion have been heavily subscribed have listed at a fat premium to the issue prime.

In theory, massive oversubscription reduces the return for HNIs, and there is even a risk of losing money, since the listing premium has to exceed the interest cost.

For instance, if the HNI portion of the IPO is subscribed 100 times, the HNI will have to apply for 100 shares if he expects to be allotted even 1 share. If the issue price is Rs 100 per share, he will have to bid Rs 10,000 (100 shares) to be able to get one share. Of this amount, the HNI will put Rs 100 (1 percent), while the NBFC will lend him the remaining Rs 9900 (99 percent).

At best, the HNI will be allotted one share, but he will have to pay the NBFC interest on the entire sum borrowed (Rs 9900) for the 6 days between the closing of the issue and the allotment of shares. In this case the interest cost per share at 7 percent for six days will work out to Rs 11.40. But if the HNI portion is subscribed 400 times, the interest cost will be around Rs 45 per share as he will have to borrow as many times more. For the HNI to make a profit on listing, the share will have to open above the interest cost.

To the delight of HNIs, the shares have been listing at premia good enough to cover interest costs even where the subscription has been massive.

For instance, IPOs of Avenue Supermart (HNI book 277 times subscribed), CDSL (563 times), BSE Ltd (159 times) and AU Small Finance Bank (143 times) have all made money for HNIs.

This trend is emboldening both HNIs and the NBFCs which finance them, to take even bigger bets.

The HNI portion of Salasar Techno Engineering’s IPO getting subscribed 478 times is an indicator of the prevailing mood.

In any IPO funding, NBFCs have nothing to lose as they collect the interest amount upfront from the HNIs. Even if the shares open below the issue price, the NBFC will still lose nothing because they have the 1 percent margin money which the HNI has put up with them. The NBFC will deduct the loss from the margin money and refund the rest to the HNI.

For now, it seems that nothing can stop the gravy train. But it is not as if there are no risks.

If too many applicants withdraw after the issue has closed, the allotment for the remaining applicants in the fray will be higher. If they refuse to cough up more margin, and the shares open way below the issue price, the NBFC could be in trouble.

In 2007, many institutional investors withdrew from the Cairn India IPO after the issue had closed for subscription. This rattled HNIs with many of them as well withdrawing their applications.

In 2008, many NBFCs burned their fingers when the Reliance Power IPO bombed. They had goaded their clients to borrow heavily without collecting adequate margin money, confident that the issue would list at a substantial premium.

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