The Biggest IPO Failure ever: Case 1
When dreams of millions were shattered. What really happened?
A highly anticipated IPO.
Massive retail participation with new DEMAT accounts opened just for the purpose of investing in the IPO.
Questions about valuation, but submerged under euphoria.
Sounds familiar?
No, I am not talking about the much-awaited Zomato IPO. We all want it to succeed, don’t we? I am going to be taking you back to 2008 for this. The dreaded month of February when innumerable retail investors lost large chunks of their money, and haven't been able to recover it in the last 13 years.
THE BACKGROUND
January 15th, 2008.
The biggest IPO of India was launched.
Reliance Power.
It was hyped because of two primary reasons.
First, Reliance never failed. As simple as that. Right from 1977 when Dhirubhai Ambani brought Reliance Limited onto the stock market, almost all its subsidiaries brought a good return on investment for investors. In fact, Dhirubhai was credited for ushering India into the world of equity markets. After the passing away of Dhirubhai, Reliance Power was the first big IPO being listed by the Reliance group. This was almost a sure-shot money-spinner. Or so everyone thought.
Secondly, the power sector was being looked at as the sector to drive the country forward in the coming decade. Power shortage had always been a factor hampering growth in the country and with none other than Reliance taking it on, investors were extremely confident of success.
11th February, 2008
And the massive 11700 cr, the then-largest IPO was launched. As expected, the Rs 450 IPO surged 19% and reached as high as Rs 538. All the investors who had bagged the IPO were over the moon. But their excitement lasted just 4 minutes. Out of nowhere, the price started falling. Slowly, and then at a pace never seen before.
The Reliance Power IPO bombed. Massive selling took place. It was as though nobody wanted to keep the shares anymore. The price reached as low as Rs 355 and ended the day at Rs 372.50, 17% from its issue price.
But alright. This wasn't the first IPO that had closed at a discounted price. And it was Reliance at the end of the day. It was bound to make a recovery and get back on its feet right? That's what the innocent retailers who held onto the stock thought too. But it kept sliding further down. Day after day. So much so that owner Anil Ambani had to announce bonus shares in the ratio of 3:5 just a few days later.
But despite those bonus shares, investor confidence was never restored. The investors were stuck in limbo. Nobody wanted to sell off at a massive loss. But the price also kept falling every day. The result- instead of the stock compounding, it was their misery that did.
ANALYSIS
So what exactly went wrong for the giant Reliance. Where did all the euphoria vanish that too on the first day? These are the possible explanations offered by experts over the years-
Reliance Power had no assets and cash flow when it IPOed. There was great hype due to the Reliance brand name as well as the popularity of the “Power On, India On” slogan. But the fact was that it was a new company and it had nothing to show on ground or in its books. A lot of investors were looking at just listing gains, and once the stock opened higher, they all sold off their holdings.
It was impacted by the concurrent meltdown in Global Markets. When the IPO was launched on 15th January, NIFTY was at 6226. On its IPO day, NIFTY was at 5120, having crashed almost 18% in the preceding month. The housing bubble crisis in the US had exposed financial markets to a huge vulnerability and with the possibility of an impending global financial crisis, the sentiment in all markets was extremely negative.
The IPO price of Reliance Power was just not justified. This is linked to the first point. The IPO price of Rs 450 seemed exorbitant in comparison to NTPC’s(government’s power company) price of Rs 250. For comparison, Reliance aimed at setting up 28000MW capacity power plants by 2017 without having a single one in 2007. On the other hand, NTPC already had an operational power plant of 27350MW back then. Things just didn't add up.
The takeaways for you and me:
Avoid investing in companies that don’t have a business to show. It’s important to remember that there is a whole company behind the stock ticker you buy on an app. With assets, liabilities, people, a certain culture, and vision. It is important to be aware of these factors. Reliance Power is the perfect example to convince you to try and invest in the business, not the stock.
The stock’s movement will invariably be impacted by global events. While the global economy was on the rise, NIFTY doubled from June 2006 to Jan 2008. But with the onset of the global financial crisis, NIFTY was hit hard and shed almost 3000 points to go from 5800 in Jan 08 to 2800 in March 09. Your investments cannot escape the impact of macro events.
Valuation will catch up at some point. In Reliance’s case, it was on Day 0. For a few companies, it may be a few months or even years later. But it will catch up. Sure, each sector is valued differently and some businesses might be valued purely on the basis of future growth. But valuation is as much relative as absolute in the markets. If the numbers stop making sense beyond a level, investors will certainly move to different stocks. It is important to buy good businesses. But it is also important to buy them at the right price.
You must be wondering, the red flags were so obvious. Why did so many retail investors go for the IPO? But why blame the naive retail investors alone? The IPO was oversubscribed 73 times. Of that, Qualified Institutional Buyers oversubscribed 82.5 times, Non- Institutional Investors bid for over 159 times the shares marked for them while the part reserved for retail investors was oversubscribed just 13.6 times.
What does this indicate? The one thing I have realized and keep repeating. Nobody knows what is going to happen in the Stock Market.
THE AFTERMATH
So what exactly happened after the debacle? Did RPower ever recover? The tragic and bone-chilling truth is, it didn't. Now, why do I use such strong adjectives? Because while the Institutions and high net worth individuals may have bought wrongly, they sold off their stakes much earlier. But the retail investors held on in the hope of Reliance living up to its name and turning things around. They didn’t know any better. But it never did. Today the share is at a measly Rs 13. Yes, you read that right. 13. And it had gone as low as Rs 3 during the Covid crash. Wealth worth billions lost by investors.
But why did Reliance never recover? While it started off without assets, did it not build power plants and get into business going forward. As a matter of fact, they did. From an operating profit of 229 cr in 2011, it went up to as much as 4506 cr in 2017. But a deeper analysis of numbers would reveal they never really had a plan in place. While their profits went up, so did their debt. From 7334cr in 2011 to 32925cr in 2017, they could never utilize their profits for anything but to pay off their debts. It was a long, vicious cycle that kept going on. Hence, they could never re-inspire investors' confidence. And this is why Reliance Power went down in history as the biggest IPO failure ever.
Why did I discuss the event? What was the purpose of re-visiting Reliance Power? I mentioned in my last week’s edition(read it if you haven't yet :P) that I would be beginning a series. This is the first part of that. We often hear about stocks giving multifold gains and in some cases getting completely destroyed. But do we actually know the story behind those stocks? The key to finding great stocks is to know what are the factors that can lead to success as well as failure. And in this series, I’ll be discussing the stories behind multiple stocks. Not only would it give you a perspective on how to pick winners, but probably also help you avoid potential blunders.
I strongly believe, in the internet era, you don't always need to experience failure yourself to learn. You can learn from experiences of the past and avoid them too.
Hope you enjoyed this week’s edition. Back again with more next week!
(p.s if you would like me to discuss any particular stock, do let me know in the comments section)
Rivetingly explained. You don’t need to lose ur own money to learn in current digital times. Well said.