In recent months, a number of companies have submitted proposals for initial public offerings. The surge comes on the back of a strengthening market. What should you be cautious about before investing?
On May 17, five companies filed their draft red herring prospectus (DRHP) for an initial public offering (IPO) with the Securities and Exchange Board of India (SEBI). Between April and May, 20 companies have filed their DRHP, 12 of them in May itself. The sudden surge in the number of prospectus filings with SEBI to list and raise funds from the equity market comes on the back of strengthening benchmark indices, which are trading at all-time high levels and are likely to grow further following a declining trend in coronavirus cases and an uptick in economic activity going forward.
In 2020-21, as many as 69 companies raised close to Rs 75,000 crore through public issues, including IPOs. The figure is expected to more than double in 2021-22 as the LIC alone is expected to mop up around Rs 70,000 crore from the market.
While there is going to be a big rush of IPOs if the markets continue to trade strong, investors should not get overawed by the number of public issues; they need to be very careful about choosing a company that is available at reasonable valuation.
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What does the list look like?
Of the 20 companies that have filed their DRHP with Sebi between April and May, six belong to the healthcare space and include names such as Glenmark Life Sciences, Windlas Biotech and Supriya Lifescience. While Zomato is on the list, the list also includes Devyani Interational that is one of the biggest franchisees of Pizza Hut, KFC and Costa Coffee in India. The list includes Aditya Birla Sunlife AMC, Go Airlines (India) and Jana Small Finance Bank. Two chemical firms — Chemplast Sanmar and Clean Science and Technology — have also filed DRHPs with Sebi to raise funds.
The filings were high even in February and March, with 9 companies in February (the month when Sensex had hit its highest) and 6 companies in March. February and March witnessed high index levels and relatively lower cases of coronavirus cases. Several companies that filed their DRHP in February and March have either already got listed or are planning to launch their public offerings over the next few weeks.
Why the rush now?
If a good earning season, liquidity in the market, a decline in coronavirus cases and hopes of an uptick in vaccination and opening up of the economy are leading to a rise in benchmark indices at the Bombay Stock Exchange and National Stock Exchange, experts say that companies and their merchant bankers are looking to capitalise on the excess liquidity in the market, the rise in indices and good investor sentiment. That’s one of the reason for the rush. A bull market offers a high probability of listing gains, which is not only a big draw for many IPO investors but also leads to companies launching their issues.
A strong market means that a good company can command a higher valuation for its shares than in a subdued market environment. At the same time, even the not-so-good companies can see their issues sail through in a buoyant market.
Also, since market regulator SEBI has fine-tuned the primary market norms, enabling issuers to float IPOs and list their shares in a short period, companies look to capitalise on the bullishness in the market.
“Companies want to file their offer document with SEBI and be ready to launch their issue in the market when there is stability and uptick in the market,” said Pranav Haldea, MD, Prime Database.
Some say the rush in May is also on account of the fact that if the companies file their prospectus with SEBI by mid-May, they will have to show the December quarter financials in the offer document.
In 2021, eight companies have raised around Rs 12,720 crore through IPOs, and many have now lined up to get listed in the forthcoming months.
Does the money raised through an IPO go to the company?
While the equity on offer from a large number of companies is a mix of some fresh equity and mostly offer for sale (OFS) by existing investors or promoters, market participants say that an IPO is a good way for providing an exit to existing private equity and venture capital investors who would have supported the company during the initial years of its growth.
Data sourced from Prime Database shows that over the last eight years, of the total issue amount of Rs 1.94 lakh crore that was raised by 160 IPOs, more than 75% (Rs 1.46 lakh crore) was raised through offer for sale. Around Rs 48,000 crore was raised through fresh equity.
While money raised by offering fresh equity in an IPO goes to the company for its expansion and growth, money raised through OFS goes to the investor offering his equity for sale.
Experts say this is a sign of a maturing capital market. “It is not necessarily a bad thing. While PE and VCs provide capital to entrepreneurs to grow their business, IPOs provide exit to the investors. It is important for them to get exit as then they can churn and utilise it to fund new businesses. It is a cycle and this trend is the sign of a maturing capital market,” said Haldea.
What to look for before investing?
It is important to take a careful look at the company, its promoter, its management and financials before you invest. A good peer review is a must and investors should compare their growth and PE multiple (ratio of market price to earnings per share) before taking a call. If the company coming for an IPO is demanding a higher valuation, investors may choose to skip the issue.
Many say that retail investors should instead look for fundamentally strong companies in high-growth sectors that have a proven track record. Investors can look at good listed companies that are available at decent valuations. Such companies are a better bet as much more detail is available about the company’s promoter, corporate governance practices, management and growth trajectory.
Why should investors be cautious?
Experts say that promoters and merchant bankers nowadays don’t leave anything on the table for retail investors as they go for the maximum possible valuation. Besides, high levels of oversubscription lead to allotment of few shares, which makes the whole exercise futile.
“As stock markets are forward-looking, a number of stocks are already discounting future growth and showing a rapid increase in prices. An investor must be cautious in such situations and should invest in fundamentally strong stocks rather than trying to make quick money only through listing gains in any and every IPO. In fact, look for quality IPOs that will compound your wealth,” said Nirali Shah, Head- Equity Research, Samco Securities.
There are also concerns on valuation. Currently, markets appear to be in a long-term bull phase, and high liquidity and availability of cheap sources of money/credit are translating into expensive equity valuations. As interest rates are at rock bottom and there is no intention of the Fed to increase rates in the near future, the excess liquidity in the system is a key catalyst fuelling the IPO frenzy. In fact, as per Prime Database, the number of stocks with first-day gains on Indian exchange debut was the highest in at least three years. As many as 18 of the 23 IPOs so far this year saw first-day gains — 78% of the total stock listing in FY21.
The excitement in public issues is definitely due to liquidity. But there is no doubt that going ahead, it will be the growth of the firm and the economy that will drive the rally in some of these stocks, Shah said.
Some say that retail investors should stay away from IPOs as they feel IPOs are one of the riskiest asset classes to invest in. Unlike listed companies where there is higher disclosure and information available in public, very little is known about an unlisted firm coming up with its IPO.
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