How Promoters Are Using Gullible Investors To Exit Business Through IPOs

How Promoters Are Using Gullible Investors To Exit Business Through IPOsNew IPO strategy.
Snapshot
  • Data shows that these IPOs are not concerned about raising funds, but are being used as an exit route for promoters and investors.

With multiple new initial public offerings (IPOs), corporate India is likely to witness the highest fundraise through share offers. So far, Indian companies have raised Rs 60,288 crore until August 2021. The year with the largest IPO was 2017, which witnessed IPOs worth Rs 67,147 crore in total. At the current pace, 2021 might be one of the best years for IPOs. The buoyancy of the markets has attracted strong investor interest from both retail investors and institutions.

But 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.

Data provided by Prime Database shows that IPOs have seen a shift over the last few years. From 1989 to 2009, the fresh equity portion of the IPO was always higher than the offer for sale portion of the IPO. Out of 20 years, 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.

In contrast, from 2010 to 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.

There is a stark difference between the previous bull-run in 2008 and the current bull-run. During the previous bull-run, companies were raising money to grow the business. In 2008, companies raised funds worth Rs 32,000 crore in fundraises in total, the highest-ever till date.

For the same year, OFS was limited to Rs 2,076 crore. In contrast, 2020 saw fresh issuances of Rs 3,531 crore and OFS worth Rs 23,081 crore. The current IPO pattern shows that the current bull-run might not be backed by fundamentals.

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.

However, with the IPOs of Zomato, Paytm, PolicyBazaar and other Internet startups lined up, fresh issuances might see an increase. The companies have been burning cash since inception and will possibly continue to do so for the foreseeable future. These companies are tapping into the public markets to raise capital.

Meanwhile, their existing investors get to exit the business at a rich valuation. Zomato’s stock listed on the exchanges at a valuation of 40 times sales. Other companies are likely to price their IPOs similarly.

Retail investors should remain cautious in today’s scenario as smart money might be using the high valuations to exit businesses. Perfectly-priced or overpriced stocks rarely outperform the market. The reversal in the OFS and fresh issuance numbers also indicates that capital expenditure has not picked up yet.

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