Spanish philosopher George Santayana is credited with the aphorism, “Those who cannot remember the past are condemned to repeat it.” It is true in all walks of life and investment world is no exception.
We saw last year (2021) many new-age companies made their way to the public markets on Indian and international bourses. Many of them were household names and were able to make stellar debuts. The performance of newly listed companies is well captured in the S&P BSE IPO index. This index is designed to measure the performance of companies listed at BSE after the completion of their initial public offering (IPO). The index is calculated using a modified market-cap-weighted methodology. At each rebalancing, the maximum weight of each constituent is capped at 20%.
For the calendar year 2021, BSE IPO index generated return of 55.6 per cent compared to 21.9 per cent by Sensex and 30.11 per cent by much broader index BSE 500. Even in year 2020 we saw IPO index outperforming these indices. For year 2020, Sensex gave return of 15.8 % while BSE 500 gave return of 18.41 per cent compared to IPO index 27.56 per cent.
Nonetheless, in last six months as tide is turning, IPO index has started to underperform the main indices. Since the mid of month of October 2021, BSE IPO Index is down by 21.7 per cent while Sensex is down by one third of it at 6.9 per cent.
The adjacent graph captures the performance of Sensex and BSE IPO index since the start of year 2020. It is clearly visible that after outperforming for most part of last two years it has started under-performing in last six months.
One of the reasons for such a fall in the IPO index is huge underperformance of new-age technology stocks. Last year several new-age stocks listed with a lot of ballyhoo at the peak of the bull market. Some of these stocks traded with at market cap of more than one lakh crore. Now these stocks are falling into a bottomless pit. The food delivery platform Zomato hits all-time low in the month of April and wipes out half of investor wealth in first 4 months of 2022. The scrip has dropped about 12 per cent in the month of April itself. Zomato’s stock price dwindled to the lows of Rs 71.6 on Friday, April 28 from the highs of Rs 141.35 on January 3, the first trading session of the year.
Investors who had placed high bets on new-age tech companies are now left regretting their decision as many of them are trading below their issue price. These include names like Zomato, PolicyBazaar and Paytm; all of them made stellar debuts and subsequently lost value sharply. The performance of new-age technology companies in the stock market has been a topic of heated debate of late after tech stocks tanked on bourses. In the wake of losses, the high valuation of startups for private placement at pre-IPO and IPO stage, and the issue pricing were subjected to close scrutiny.
There were voices raised earlier by few market participants whether the highly-trumpeted initial public offerings of new-age tech companies was a big bubble. The biggest criticism was that promoters and founders were rushing their loss-making entities to the market and dumping their holdings on public shareholders to earn a fortune. Take the case of one of the most awaited IPO of One 97 Communications – the parent company of Paytm. After debuting on the stock market, it almost instantaneously eroded investors’ wealth by a whopping Rs 32,000 crore within minutes of listing. Against the issue price of Rs 2150, shares of company listed at Rs 1955. While the investors were still licking their wounds, the selling shareholder who had offered their shares in the share sale (OFS) – mostly the external supplier of capital – walked away with a neat Rs 10,000 crore.
The Indian primary market was buzzing throughout the year of 2021. Data shows that 63 companies collectively raised Rs 1,18,704 crore (USD 15.4 billion) through IPOs during 2021. This is the highest amount of money raised through IPOs in a calendar year. The previous best year for IPO was 2017 when Rs 67,147 crore was raised. In fact, the money raised in the primary market in 2021 is 62 per cent more than the total amount of Rs 73,003 crore raised in the preceding three years (2018 to 2020). During 2020, the total money raised through IPOs in India stood at Rs 26,613 crore, which was nearly one-fifth of the mop-up during 2021.
The average issue size during the year 2021 stood at Rs 1,884 crore. The bullish trend at the stock markets buoyed the investors` interests in the IPOs. The benchmark indices of the Indian stock markets hit new highs during the year. Sensex of the Bombay Stock Exchange (BSE) hit a record high of 62245.43 points while Nifty 50 of the National Stock Exchange (NSE) touched its all-time high of 18,604.45 points on October 19, 2021.
The record fundraising from the Indian primary market was led by the new-age technology businesses. Most of these companies were loss-making, cash burning technology start-ups. They saw strong retail participation as many investors knew these companies and had used their products.
For example, Paytm’s, which was a household name after 2016; its IPO surpassed the long-standing IPO record of Rs 15,200 crore set by the state-run Coal India Limited in 2010. Paytm`s IPO got subscribed 1.89 times, and crashed 27 per cent from its issue price on the first day due to lofty valuation and skepticism about its business model. The second-largest IPO during the year was of online food delivery platform Zomato. The company raised Rs 9,375 crore through the IPO. It was a huge success with the IPO getting subscribed 38.25 times. Zomato also made a stellar debut at the stock markets making a debut at 53 per cent premium over its issue price. PB Fintech, the parent company of online insurance aggregator Policybazaar and credit comparison platform Paisabazaar, raised Rs 5,710 crore from the primary market.
A very simple analysis indicates that the promoters of these IPOs were not concerned about raising funds. They were using it as an exit route for themselves and investors. Thus, investors must stay away from such scrupulous existing investors and promoters of companies who are only trying to cash in on the high valuation.
It was a Sinister Move
What is masked in overall numbers is exiting or paring down the holdings from promoters. For example, in case of PB Fintech, out of total Rs 5710 crore of IPO size there was an offer of sale of Rs 1,960 crore by existing shareholders. Deep analysis of these IPO data shows that these IPOs are not concerned about raising funds but are being used as an exit route for promoters and investors. IPOs have seen a subtle shift in the recent years where the offer for sale (OFS) has outstripped the issuance of fresh capital. Offer for sale refers to the sale of existing shares by investors and promoters of the company.
In contrast, the issuance of new shares involves the creation of new shares that are allotted to new shareholders. The promoters do not have any immediate monetary benefit in the latter case.
Historically we have seen that the fresh equity portion of the IPO was always higher than the offer for sale portion of the IPO. Out of 20 years between 1989 and 2009, only a single year saw a higher OFS than issuance of fresh equity shares. The data clearly indicates that most companies were only looking to raise funds through IPOs.
Nonetheless, in last 11 years ending 2021, only two years saw higher fresh issuances than OFS. And the last eight years have seen OFS outstripping fresh issuances by a large margin. Evidently, existing investors and promoters are trying to cash in on the high valuation. 25 out of the 63 IPOs that hit the market in year 2021 had a prior PE or VC investment. Offers for sale by such PE or VC investors remained at Rs 24,106 crore accounted for 20 per cent of the total IPO amount. Offers for sale by promoters at Rs 31,704 crore accounted for a further 27 per cent of the IPO amount. On the other hand, the amount of fresh capital raised in IPOs in 2021 was at Rs 43,324 crore.
The previous bull market had resulted from a strong growth in the economy, with all sectors performing quite well. However, the current bull market is not fuelled by growth in the economy, but by liquidity in the system. With a slow economy and underutilised capacities, most companies applying for IPOs do not wish to raise money for expansion, unlike the companies in the previous bull market. Currently, promoters and investors are just looking to cash in on their gains. OFS under the guise of IPO has turned venture capitalists and promoters into vultures seeking phenomenal returns on early investments and pains at the expense of gullible retail investors.
OFS is Creating VulturesEarlier bull markets had resulted from a strong growth in the economy. However, the current bull market is not fuelled by growth in the economy, but by liquidity in the system. Most companies applying for IPOs do not wish to raise money for expansion, unlike the companies in the previous bull market. Currently, promoters and early investors are just looking to cash in on their gains.OFS under the guise of IPO has turned venture capitalists and promoters into vultures seeking phenomenal returns on early investments.
Lessons Learnt
This is not the first time it has happened in IPO history and certainly this is not the last one too. Circa, 1990’s we saw many NBFC came to raise money from primary market only to disappear in next few years. Similarly, before dotcom bust in year 1999-2000, there were many companies with ‘tech’ or ‘info’ attached to their name hit the IPO market at lofty valuation and whose domain name is also not known now. Last time we experienced such frenzy in the IPO market was during 2007-08 when companies engaged in power, infra and housing saw huge listing. Many of these companies are barely trading and gone into oblivion.
Even during recent IPO boom we saw companies changing their names. For example, the parent firm of Policybazaar and Paisabazaar was earlier named Etechaces Marketing and Consulting Pvt. Ltd. The company name was changed to PB Fintech Pvt. Ltd. in September 2020 to emphasize the nature of fintech businesses. PB Fintech IPO got subscribed 16.59 times. The company made its market debut at 17 per cent premium over its issue price.
It’s not that all new age companies IPO has made its IPO investors poorer. There are companies such as FSN E-Commerce Ventures, which operates online beauty e-commerce platform Nykaa; which raised Rs 5,352 crore through IPO. Falguni Nayar-led company`s IPO was a huge success. The IPO got subscribed 81.78 times. It had an issue price of Rs 1125 and is still trading above its issue price at Rs Rs 1694. Nonetheless, much below its listing price and high it reached after listing. For Q3FY22 its sales was up from Rs 808 crore to Rs 1098 crore on sequential basis, however operating profit was up from Rs 28.8 crore to Rs 69 crore and net profit from Rs 1.2 crore to Rs 28 crore. Calculating these figures the EPS for 9 months comes to Rs 0.70 paisa and after annualising it nine month earnings its PE comes out to be around and more than 1800 times and its price to book value is at around 175x. So sales are increasing aggressively but OPM is between 3-6 per cent although it is lone Unicorn listed in last few months which is at least making some profit. Compare its marketcap of Rs 81,000 crore with Cipla’s, BPCL, IndusInd Bank, and Brittania which are almost in the same range but clocking profit above Rs 2500 crore, Rs 18000 crore, and Rs 4000 crore respectively.
Certainly these companies calculatedly entered in the market when it was the best of times, but if you see the stocks on any valuation parameters do you think they deserve to be in your portfolio?
There are few things that do not change in investing. For example, invest in companies that generate operating cash flows, post profits, run by good management and has scalable business model. We saw last time during internet boom that anything which is based on eyeballs carries more risks. Therefore, you should always be more careful in this area. Historically, we have seen that one has to be much more careful in business models that are built not on earnings but topline.
According to a veteran and seasoned investor who had seen various markets cycle “one has to evaluate whether any of these new age technology companies are going to create moats over a period of time. There is going to be an entry barrier once they become bigger. If they are not going to create any moat and there are going to be an endless number of players entering the industry, then it is going to be very difficult. We are looking at whether the incumbents are going to effectively compete against new entrants. And if these two things are not there, then it’s not worthwhile to look at new-age business models.”
- Do not evaluate companies by fancy metrices as number of customers or gross merchandise value (GMV) processed etc. Check the finances, it should tell you if you need to invest.
- Check the cash generated by the operations, even though company is making losses, it should be generating cash.
- Company should have a robust business model that is scalable and run by a good management. It should be driven by bottom line and not topline.
- Finally, valuations, valuations and valuations. Even if companies satisfy all the conditions above and IPO is coming at lofty valuations, it is better to wait for right valuation to enter the stock.
