1. IPO GRADING
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2. 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)
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3. 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.
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4. 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.
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5. 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
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6. 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
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7. IPO GRADING
 Bibliography
58
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8. 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
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9. 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.
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10. 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.
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11. 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.
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12. 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.
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13. 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.
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14. 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.
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15. IPO GRADING
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16. 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.
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17. 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:
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18. 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
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19. 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.
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20. 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.
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21. 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
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22. 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
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23. 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
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24. 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:
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25. 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.
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26. 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
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27. 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.
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28. 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
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29. 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
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30. 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
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31. 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.
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32. 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.
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33. 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
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34. 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
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35. 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
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36. 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.
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37. 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
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CM
RATING
2/5

38. 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.
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39. 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,
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40. 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
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41. 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.
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42. 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
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43. 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.
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44. 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.
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45. 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.
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46. 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.
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47. 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.
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48. 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
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49. 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.
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50. 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.
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51. 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.
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52. 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.
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53. 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.
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54. 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.
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55. 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
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56. 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.)
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57. 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.
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58. 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.
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59. 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
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60. 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
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61. 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)
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62. 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.
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63. 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.
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64. 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.
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65. 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.
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66. 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
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