Hefty merchant banking fees: IPO could be a success but stock could well be in doldrums

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A hefty fee, which is significantly higher than the industry average, paid to a merchant banker may well ensure the success of an initial public offer (IPO) but it will not in any way guarantee the post-listing performance of a company, which is more linked to factors like fundamentals and governance among other things.

And if there was any proof needed then one need not look very far. The current calendar year has seen two mainboard IPOs in which the merchant banking fee was in excess of seven percent of the issue size – significantly higher than the industry average of 2-3 percent.

Even if one considers the smaller-sized issues of less than Rs 500 crore, the average merchant banking fee has been less than four percent for IPOs.

Take the example of Saraswati Saree Depot. The Kolhapur-based company launched its Rs 160 crore IPO in August and was subscribed nearly 47 times. Data from Prime Database shows that the company paid 7.82 percent as merchant banking fee.

Interestingly, the stock has fallen almost 17 percent since listing even though the benchmark Sensex has been up nearly three percent during the period.

While the financials of the company may look robust, analysts have certain concerns about the company. Saraswati Saree Depot's business is a high-volume and low-margin business and it is dependent on third-party suppliers for sourcing its products which is a major risk, said Swastika Investmart in a note.

The company operates exclusively in the wholesale segment and does not have any presence in the retail market. “The absence of ownership of any retail brands subjects them to a certain degree of risk due to a potential lack of visibility in the public domain and this would lead to a reduced market share for the company,” said Canara Bank Securities in a report.

Another company, BLS E-Services, launched its IPO in January this year to raise Rs 310 crore. The issue was subscribed a massive 83 times with the company paying the merchant banker 7.24 percent of the issue size as fees.

The stock of the company is down 27 percent since listing even as the Sensex gained 15 percent during the period.

Experts said that at times companies are forced to pay higher fees to the bankers if the financials and other fundamentals are not robust.

“If the company is difficult to sell, investment banking fees could be high,” said the head of a leading investment banking firm.

There could also be instances where bankers that are charging higher fees are providing more than listing services, says Nirav Karkera of Fisdom.

“These services could be creating enough demand by doing roadshows post listing, or through the listing also. Many companies are trying to go for an IPO, so the banker has the ability to squeeze higher fees in some deals where certain investment bankers are not willing to touch,” he said.

Another person, on the condition of anonymity, said, “If people are going to happily subscribe for an IPO, why should the company pay a higher fee to the banker? The company will pay more fees only if the general narrative towards the company is weak and the banker is incentivised to ensure high subscription.”

Incidentally, 2024 is not the only year which has such instances. Way back in 2005, Pyramid Retail paid 12.07 percent of the issue size as merchant banking fees. The retail chain was acquired in 2007 after which it went downhill and while there were efforts to revive the company by re-branding stores, the strategy did not work due to the poor financials as well as economic downturn.

Another company, Bartronics India, which listed in December 2005, paid 7.7 percent as merchant banking fee. The company was suspended from trading in 2022.

However, not every company which paid the highest fee in 2024 has shown poor performance.
Platinum Industries, which paid 6.31 percent as merchant banking fees, has seen its stock price surge 76 percent since listing in February as compared to Sensex returns of 12 percent.

Similarly, shares of J G Chemicals have surged 136 percent as compared to Sensex gain of 14 percent since its listing in March. The company paid 5.52 percent of the issue size as fees.

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