The past year and a half have been marked by several Indian companies going public, that is, offering their shares to the public for the first time, hence an initial public offering. Essentially, the ownership structure transitions from private to public and then gets listed on a stock exchange where its shares can be traded freely.
IPOs have the potential to generate stellar returns, but they also have risks involved which are often overlooked. Understanding the due process of an IPO and the risks associated are paramount to be able to generate wealth by investing in IPOs.
From an undersubscribed Infosys IPO in 1993 to several heavily oversubscribed IPOs in 2021, to the largest Indian IPO – Paytm, the Indian IPO space has matured. This year has also been the coming of age for tech companies, finally able to list on Indian stock exchanges, allowing Indian investors to participate in the growth of some of their favourite tech start-ups like Zomato, Nykaa, Paytm to name a few. However, just as the IPO is the beginning of a new phase for a company (because a company does not go public to raise money just once), similarly listing is the beginning of the journey for a public market investor.
Many investors apply for IPOs for listing gains after obsessively tracking grey market premiums and subscription levels on day 1. However, the point of an IPO is not just listing gains but to catch the company early in the next phase of its growth cycle, creating wealth together.
IPOs often have two parts to the issue:
Offer for Sale (OFS) by existing investors, including promoters, strategic partners or financial investors like PE/ VC or hedge funds.
The fresh issue is money directly infused into the company, helping it fund its growth and expansion or reduce debt, whereas the OFS portion gives an exit to current investors.
While many critics give the justification “if the company is so good, why are existing investors selling their stake?” it is hardly ever as straightforward as that. But, it most certainly impacts the future prospects of the company and helps a shrewd investor work out whether the future projections can be achieved basis the capital available.
Listing norms have undergone dramatic changes over the decades with SEBI stepping up to protect small investors by improving disclosure norms. But a lack of awareness and willingness to study the Draft Red Herring Prospectus (DRHP) means retail investors miss out on glaring red flags sitting in plain view which would help avoid mistakes.
A flurry of IPOs are a sign of strong investor appetite and the past 18 months have seen a number of new records being created for the Indian IPO market. Given the IPO mania, it may be prudent to pause and reflect that in almost 40 per cent of IPOs this year, investments are currently quoting lower than the issue price (as per Care Ratings).
The reason most smart investors avoid the hype and conduct their due diligence carefully is because they value their capital as highly as Rahul Dravid valued his wicket. IPOs are the mirage which can offer quick returns but just as easily cause you to crash and burn. On the one hand, Infosys was the biggest wealth multiplier between FY95 to FY20, compounding at an astonishing 30% CAGR. On the other, Paytm wiped out about 35% of its shareholders’ wealth in two days.
