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Are IPOs safe to invest in?
Today, as of March 2022, IPOs and the fluctuation in their share prices are a burning discussion. A lot of debate is going on over the fall in share prices of some really good start-ups of India, which are counted as the best, biggest, and great start-ups. They are all corrected by more than 50 % from their listing price, but why so? To understand this better, let’s go back to the history of India by a few decades.
India is a country with a history of more than 5,000 years, a rich heritage, and much more embedded in its heart like a treasure. India got its independence from British rule in 1947, but if we see from the industrialization point of view, India attained its independence in 1991. Speaking in terms of coherence with the stock market, we are talking about a country that is only 30 years old considering its economic development.
It's only after the 1990s, we were permitted to engage in capitalist activities since we were meant to be a socialist country otherwise. In socialism, a person is not required to earn a profit and take it home; if someone makes a profit, he must reinvest it, which was the reason why the taxation system was set up in such a way that 97 percent of profits were taxed prior to 1991.
Subsequently, it was only until liberalization and globalization occurred that companies started getting built and corporations began to grow in size, and every second or third company that survived provided a very generous return to its shareholders. As a result, the idea of investing in shares came into existence.
In reference to this, companies these days expand on account of general public investment after going public by releasing their IPOs and then utilizing the funds for the purpose of research and development (R&D) to make people's lives better.
Even Warren Buffett made an investment in one such start-up in India and that is Paytm. During the listing of Paytm, the CFO of Paytm said that they could price the shares of Paytm way higher than where it is priced as they wanted to leave some values for the investors which in itself is a very bold statement. It’s not about being judgmental, the fact is a fact.
Paytm got listed at Rs.18,300 crores (Rs.2,150 per share) and right now it is valued at only Rs.6,588 crores (Rs.775 per share) which is just a 10% correction by the market, not a 50% correction. Paytm not only released its IPO in the market but every common investor loved this idea so much that their application was oversubscribed by people.
Not just Paytm but Zomato, Car trade, Nykaa all are on the list of big start-ups with failed IPO. Not only did they get listed but the application got oversubscribed by 30 times.
These companies were not profitable on their books but still, they were able to release their IPO in the market to the public due to certain policy changes by the government and now their share prices are struggling in the market. It was not possible earlier to bring the IPOs if the company is going into loss.
But our policymakers tried to follow and copy the developed nations blindly where the company does not have to be profitable to bring the IPOs. The companies with failed IPOs only showed losses and more losses still entered the market by going public and are oversubscribed by people and this all is happening in a country where people have very minimal involvement in the market.
So, we are only trying to understand why people started imagining that these companies who are entering the market with their IPOs are so profitable that it is the right stage to be a part of it or grab a piece of it.
Why did this myth get created? Decoding the myth is absolutely necessary for all common investors.
How did the myth get established?
During the first leg of liberalization and globalization, new companies were built and they listed themselves at a very fair price. They kept their share prices reasonably low because these companies were run by entrepreneurs with extreme ethical personalities like Narayan Murthy or Aziz Premji who themselves are very hardworking, good, and ethical people.
During that period many people earned a handsome profit in the early stages of IPOs because at that time investing in equities in itself was a very revolutionary idea. Also, at that time very few people had some money and when someone was giving away some money then it was a big amount considerably as people actually did not have enough money to invest so whatever it is the people invested gave a good return.
But during the last 10-15 years, the news about the Reliance IPO, the Infosys IPO, and the Wipro IPO began to circulate on the internet, big-name companies surfaced on the web, stating that if you had invested Rs. 1 lakh in Wipro in 1991, your investment would have grown to Rs. 3 crores by now. The internet is full of these articles or news which became a sensation in a few days and thus such articles began to float even more.
At the same time, they did not show the data of the companies whose IPO got busted, how many went bankrupt or how many were closed, or how many suicides happen. People are literally unaware of the fact that a large number of initial public offerings (IPOs) were entirely halted during the Harshad Mehta case.
They named companies like TCS, Infosys, Wipro where the return is 1000 times greater than the early-stage IPOs to spread it like a fire breaking news. So, if someone checks the Nifty50 and picks 30 companies then definitely they will find companies providing this much good return. This is called conditioning.
The mental conditioning of people forces them to believe that IPOs will make them rich by giving good returns on their invested amount.
Now that this imprinted-on people's brains, they begin to believe that,
Busting the myth-
In theory, capitalism, communism, and socialism were all complete theories which were developed by great thinkers who were always concerned with the welfare of society. Little did they know that in the future someone will miss utilize the rules for their personal benefits.
In a capitalistic society, people have limited resources, and one would not be able to innovate if he has to borrow resources on personal liability. For example, Thomas Alva Edison would not have been able to pursue his innovations if he had not raised money from the public.
One cannot do R&D if everything is borrowed with its own 100% liability. There will be no decent good product that will be developed for the benefit of society, no medication, no innovation, and nothing that will improve the quality of our lives.
Capitalism allows a business-minded individual, an inventor, or someone who has the ability to improve the lives of others to form a private limited company, which will be a separate legal entity, and the law of the land will protect the individual.
In the idealistic world of capitalism, the company is a separate entity. Everything that the company borrows will become the company's asset, and you will not be liable for any situation. No one will be able to touch your valuables. You will not be held accountable for a single cent of damages.
In an ideal world, capitalism creates private limited companies so that society benefits from the risk-takers and people with genius minds.
With time, there were a lot of changes in the idealistic model of India. In recent years, our law had certain policy changes and the law has been more lenient and permissive. The policymakers believe that such changes are in the public's best interests.
Two very remarkable changes on the policymaking sides are-
1. Companies that are not even profitable may now go public via an initial public offering (IPO).
2. Companies are now allowed to file for the offer for sale (OFS) in conjunction with an initial public offering (IPO), which was previously not possible. It allows the company promoters, investors, and founders to sell their shares.
Earlier people had little knowledge and information that usually, every time money is raised via an IPO, it is added to the company's balance sheet, where it will be used to further the company's growth. But these days along with the IPOs, they also bring OFS where these investors and promoters can offload their shares and take the money in their personal account which is not linked with the company account anyhow.
And that’s why the common people have to be more cautious about judging the company and analyzing their IPOs.
The fundamentals of any business remains the same, you should be more vigilant and must check if the company is profitable or if it is showing any path for profit in near future and in what ways? If the company is not profitable consistently and doesn’t show any path of being profitable in its red herring prospectus then it needs to be checked, screened with more due diligence to it.
At the same time, one must check what portion of the IPOs is OFS? Is it 100% OFS?
If the IPOs are 100% OFS then the money invested by the general public will go to the personal bank accounts of investors and promoters and not a single penny will go to the company book.
People need to understand the difference between a company bank account and a personal bank account because if the company bears any loss in the future, these personal bank accounts of promoters, investors, and founders will be touched by the company to revive itself. It would be a loss for the common investors only. So, people really need to scrutinize these businesses all the time.
For example, A company consists of its employees, investors, promoters, founders, and a bank account in the company name where the company-related revenue is deposited. All the other entities have their own personal bank accounts which does not fall under the control of the company. Salary of all employees comes from the company account and deposited in their personal bank account.
Similarly, when the general public buys IPOs, the amount invested goes to the company book but in IPOs with more percentage of OFS, the money invested by the public does not go to the company’s account rather it goes to the personal bank account of the investors, promoters, and founders which are not in the control of the company.
So, in the future, if the company raises debt, undergoes loss, and goes bankrupt then no one can touch these personal bank accounts while the prospective Investors will be the ones whose money will be stranded. Even if the company belongs to only one person, still the company and the person are two separate entities and the person will not be touched by the authorities to cover the losses made by the company.
The irony of our country is the very poor financial literacy among the people.
People don’t fully understand the concept of IPO, let alone know the new practice of OFS.
It can be said in full confidence that not even all the members of parliament fully understand the difference in the concept of IPO and OFS yet the government officials have introduced this in the year 2016 and gave it a green signal where the company promoters can offload their personal shares along with company’s shares during IPO and the money raised will directly go to their personal bank account which company holds no control over.
The article has zero intention to question the government's decision to make such adjustments. But, with these developments, changes have happened, and after that, enough instances have happened with several cases in which IPOs have failed to provide a return to investors, and these IPOs were ones that included OFS.
The world has altered since the 90s. It's not 1991 anymore. We are living in the year 2022, in which we must constantly be on our watch, analyzing such businesses at all times.
CONCLUSION:
It is not only a matter of expressing oneself verbally. Here is some information to dispel all of the myths:
| Company | IPO releasing date | Pre IPO 1st Qtr. P&L (Cr.) | Aimed to raise via IPO (Cr.) | OFS % in IPO | Promoters share in IPO (Cr.) |
| Cartrade | 09-Aug-21 | -44 | 2998.51 | 100 | 2998.51 |
| Nykaa | 28-Oct-21 | 1 | 5352 | 88 | 4709.76 |
| Paytm | 08-Nov-21 | -395 | 18300 | 54 | 9882 |
| Zomato | 08-Jul-21 | -290 | 9375 | 4 | 375 |
| Company | P&L (as on 3rd Qtr. FY 21-22) Cr. | Market Cap (Cr.) | Profit percentage in comparison to Nykaa | Market (Factor) Cap in comparison to Nykaa |
| TCS | 9806 | 1303989 | 612.875 | 18.3 Times |
| HDFC | 10615 | 757610 | 663.4375 | 10.63 Times |
| HUL | 2300 | 474593 | 143.75 | 6.67 Times |
| ITC | 4118 | 277816 | 257.375 | 3.9 Times |
| Nykaa | 16 | 71275 | - | - |
IPOs are not a quick-rich opportunity. One of the riskiest asset classes to invest in are IPOs. You can end up in a bad investment even if the company is well known. Just because it has good market attention, you shouldn’t invest in it. Use your brilliant mind to decide if something is wrong or right.
Like Benjamin Graham said, “IPO is not Initial Public Offer but it stands for It’s Probably Overpriced.”
Corporations that are bringing OFS with IPOs or loss-making companies that are releasing IPOs are all within the jurisdiction of policymakers, and it is their responsibility to verify. It is our responsibility to double-check the facts and then make an informed decision based on evaluation of the company and its IPO.
Kundan Kishore
Curator of " A Complete course on Indian stock market".