What investors need to know about initial public offerings

Are retail investors buying more into the hype than the value in Initial Public Offerings?

From Eveready to Safaricom and now, on a global scale, to social networking site Facebook, retail investors have been left holding the wrong end of the stick from new listings.

They either buy the shares at high prices during primary issues or at the secondary market when the shares are unlikely to yield capital gains.

During IPOs, prices rise for the first few sessions, driven by the feel-good factor and take on a downward spiral as evidence from the eight stocks listed on the Nairobi Securities Exchange since 2006 shows.

Eveready and Safaricom have basically remained below the price at which investors bought them initially, falling to as low as Sh1.35 and Sh2.70 respectively in the last one year. In short, investors have lost 86 per cent and 46 per cent of the money they put in the shares.

The hype of the KenGen IPO in 2006 whose shares were floated at Sh11.90 each is a classic illustration of this cycle. The share rose to Sh49 on the first day but is now selling at Sh8.

“Retail investors are not able to distinguish between the marketing hype and worth of the business. In Safaricom, the revenues were reaching a plateau but many investors were stuck to its previous good performance,” said Einstein Kihanda, the principal investment officer at ICEA Asset Management Services.

In the past year, Eveready has reached Sh3.05 which is still Sh6.45 below the IPO price. With the company no longer a profitable operation, investors are crossing their fingers that the investment they put in will be recovered somehow.

“The rolling out of rural electrification throughout the country has made it very difficult to sell batteries. That is why the share price is so low,” said Faith Atiti, a research analyst at Sterling Investment Bank. She said the oversupply of Safaricom shares in the market make it difficult for the stock to rise.

But the IPO debacle appears not limited to Kenya. Facebook shares have lost 20 per cent of their original value two weeks after listing on the New York Stock Exchange.

Many investors are so angry about the IPO that they have sued the executives, including the investment banks, behind the offer saying they were duped into buying a share that was overpriced.

It is turning out that negative information was hidden from retail or individual investors by those arranging the offer but was disclosed to rich fund managers who rushed to offload the shares before the price crashed. The ensuing oversupply saw the price fall from $45 per share to $31, $7 below the issue price of $38.

Some gullible investors bought the shares at the higher price while analysts estimate their actual worth to be as low as $10 based on future earning prospects.

Various studies blame retail investors for being sentimental or overconfident about IPOs. A 2009 study focusing on retail investors in Germany noted that “retail buyers consistently overpay for initial public offerings (IPOs)” and further that “the observed willingness to overpay points to sentiment as a driver of retail trading decisions.”

Another study titled ‘Transparency in IPO Mechanism: Retail investors’ participation, IPO pricing and Returns’ concluded that retail investors were, on average, unlikely to make positive initial returns even in a setting where they do not have to compete with institutional investors