IPO Cyclones and Raining Offers for Sale

The growing practice of coating OFS with IPO should be highlighted as a risk factor. The regulator should also engage the industry and debate whether a cap on percentage of OFS could better serve the investors.

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A cataclysmic event happened on November 8, 2016. Celebrating this economy-ravaging process, Paytm minced no words on the morning of November 9, 2016 and through front page advertisements in all major dailies congratulated authorities for “taking the boldest decision in the financial history of India!”, while exhorting the battered citizens to “Ab ATM nahin, #PaytmKaro!”.

The move catapulted Paytm into front position as a mode of payment in the country. It was no coincidence that on the same day five years later another history was created when India’s biggest ever IPO opened for subscription. A few days later when the most awaited IPO of One 97 Communications – the parent company of Paytm – debuted on the stock market, it almost instantaneously eroded investors’ wealth by a whopping Rs 32,000 crore within minutes of listing. While the investors were still licking their wounds, the external entities 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 year that has just gone by will go down in the history of the capital market history in the country as a period when record amount of equity – Rs 1,19,881.8 crore – was raised by 63 companies on Mainboard and another Rs 796.74 crore was raised on SME platforms of NSE and BSE by 56 units. According to a recent EY report (December 16, 2021), “in India, YoY IPO activity increased 156% and 314% by deal numbers and proceeds, respectively. By proceeds, 2021 represented the best IPO year in the last 20 years. Ample global liquidity, strong earnings and increased retail participation were among the main factors driving the markets in 2021. Several startups completed their IPOs in H2 2021, opening a new horizon for domestic capital markets. There are many companies that have planned an exit, which include key PE-backed and government companies.”

Also read: Nykaa Has Listed. Now What?

The year 2021 also experienced a good number of cyclones on India’s coasts. Every cyclone was accompanied by rains. At times it is these rains which cause more damage to the standing crops and human habitation than the cyclone itself. India’s IPO cyclone of 2021 has a similar pattern. Out of the total amount raised, as much as Rs 61,585 crore was raised from the public through the OFS route. Now, many, if not most, do not realise that the IPOs are in fact majorly offer for sale (OFS) where the funds raised do not flow to the issuer company but enrich the early investors and partly the promoters themselves.

When introduced in 2012, the OFS mechanism was widely adopted by listed companies, private and state-owned, to reduce promoters’ holdings. And the issue period for an OFS does not exceed more than a single trading day. However, the OFS in 2021 provided an exit route to the promoters, private equity investors/venture capital funds, etc., that had invested when the company was unlisted. How far can this route be used by promoters to divest their stake in a big way and still remain in saddle to generate confidence in the minds of new investors is a big question. More so because the new investors invest in IPOs mainly due to the confidence in the promoters. 

It is generally perceived among investors’ community that the existing or new companies hit the IPO road when they are in expansion mode, need additional capital for investment in the new plant and machinery and higher working capital. But the year 2021 has proved that companies can go public to encash their early sweat and to provide a release mechanism for their benefactors with whom they have bi-partite agreement, probably for certain assured rate of return. This has resulted in a situation where major chunk of investors’ money is not flowing into the company’s coffers but to promoters’ private pockets and their hand holders. 

In fact, the growing practice of coating OFS with IPO should be highlighted as a risk factor. The regulator should also engage the industry and debate whether a cap on percentage of OFS in an IPO could better serve the investors’ community. Alternatively, a minimum stake by the promoters for a prescribed period from IPO could be considered. With the growing influence and confluence of anchor investors, qualified institutional buyers, foreign institutional investors, mutual funds, etc., on the eve of a public issue, an average investor goes by the number of times an ongoing issue is oversubscribed in the first two days before assigning his hard-earned savings. Added to this phenomenon is the grey market premium (GMP) which determines the ‘yes’ or ‘no’ for an IPO.

Also read: Stock Markets 2022: There’s Fog on the Windshield 

One of the reasons for startups’ unreasonable valuation, at times, is due to opaque valuation methodologies dictated by the early stage investors and consented to by the promoters. Even here, the valuation logic undergoes changes at every level of early fund raising (A, B, C….series funding), finally catapulting a struggling startup to the unicorn club. And then the IPO fever takes over, buoyed by the growing appetite of mostly first time retail investors to be part of new-age growth companies, premium-ising losses and ignoring profits. A recent report published by UK-based investment data platform Prequin suggests that the bulk of the venture and private equity investments in startups flowing into India in 2021 were directed towards pre-IPO financing rounds in companies such as Zomato, Ola, Policybazar and Paytm. Thus, the link between high valuations and successful exits through OFS should now be on agenda for the market regulator.   

While speaking at the Annual Summit of the Association of Investment Bankers of India held recently, the chairman of SEBI captured the prevailing concerns on pricing of new age companies this way: “Appropriate pricing of the issue is a crucial aspect. A proper balancing act between the issuers’ aspirations and investors’ interest is required.” He cautioned the merchant bankers by stating that “the responsibility cast upon them includes protecting interests of investors, conducting business with fairness and integrity, ensuring true disclosures to investors in a timely manner” and “it is incumbent upon the merchant banker community to not only follow the regulations in letter but also in spirit.” Charity must begin at home. When the capital markets regulator is of the opinion that merchant bankers are failing to follow regulations in spirit, what hinders SEBI to mandatorily introduce a safety net mechanism which is a part of the IPO guidelines but has remained only on paper? 

Ours is not a market where ‘caveat emptor’ can be followed like a gospel. Especially when promoters of fledgling unicorns are making a beeline before the altar of listing mechanism to consummate their one-to-one agreement with the early investors and enriching themselves by passing on the shoes of venture capitalists to retail investors, the market regulators should take notice. The mechanism of having a price band was mandated in the interests of price discovery of companies accessing the market. It is time to review whether this has resulted in ringfencing the entry investors. The regulator could prescribe some formula to transparently decide the price band. Norms such as the age of the company, promoters’ stake in pre-IPO and post issue capital holding, track record of profitability, restrictions on promoters offering share under OFS for buying back the shares for three years post-IPO, etc., could generate some assurance for the nouveau investors. If all these yardsticks fail to arrest the slide in a stock by more than 20% post-issue, the mechanism of safety net should kick in.  

Retail investors are turning into nano venture capitalists by deciding to put money on companies whose capacity to earn profits is unknown, to say the least. Even allowing a time span of 10-12 years for the investment to start paying returns in the form of dividend is premised on a static view of technology and popular taste which is ever changing. And there lies the paradox of investment in new-age companies.

The startup ecosystem, a benign regulator, surfeit of liquidity injected by central banks, irrational valuations, rush of first generation investors, hope of ‘doubling’ money quickly, governmental promotion of anything by the name of startups and overall a largely unidirectional secondary market are all conspiring to scrap the Indian capital market. OFS under the guise of IPO has turned venture capitalists and promoters into vultures seeking phenomenal returns on early investments and pains.

The current IPO market can be described what Chuck Prince, ex-CEO of Citigroup famously said during the 2007-08 financial crisis : “But as long as the music is playing, you have got to get up and dance.”

Ganga N. Rath is former central banker. Views expressed are personal.