All about IPOs and why India is being flooded by them

Date : 05/10/2021
Read: 10 mins

2021 could be India’s year of the IPO, says RBI

All about IPOs and why India is being flooded by them

A deluge of initial public offerings (IPOs) over the past year in India has led merchant bankers to predict primary market pickings in 2021 to top the $4.6 billion raised in 2020.

In fact, some say companies could end up raising twice as much funds as last year through IPOs. So much so that the Reserve Bank of India (RBI), in its bulletin dated August 17, said: “2021 could well turn out to be India’s year of the initial public offering (IPO).”

In an interesting tertiary development, the overwhelming surge in IPOs this year so stretched the resources of legal firms that they have now raised their fees for work related to new issues.

In the seven months up to August 2021, media reports say, at least 30 companies have come out with IPOs to raise an estimated Rs 5000 crore, while 34 more have approached market regulator SEBI (Securities and Exchange Board of India) with their offer documents for its green signal.

This apart, at least another 50 companies have said they plan to take the IPO route by the end of 2021. Consequently, says the Mint newspaper, legal fees for IPO-related contracts have gone up by as much 25%-30% this year.

Companies planning to issue IPOs hire law firms for preparing draft initial share sale documents and provide legal guidance in complying with regulations laid down by SEBI. But why are so many companies taking this path, which has actually goaded law companies to raise their fees for their services for new issues?

To understand the sudden interest in IPOs among the companies, one must first understand what an IPO is, and what purpose it serves.

What is an IPO and what is its relevance?

An IPO happens when a private corporation feels it needs more capital to finance its growth, and decides to raise this from the public by offering it new shares – hence the term ‘initial public offering’.

When this is done, the company is said to have ‘gone public’, with its ownership having changed from privately-held to publicly-held.

The following examples highlight how a company can successfully raise capital via an IPO:

Reliance Power raised Rs 11,700 crore from its 2008 IPO;
General Insurance raised Rs 11,257 crore in 2017 taking the same route;
Also in 2017, HDFC Standard Life raised Rs 8695 crore.

But India’s biggest IPO will happen this year, and will be from the state-owned insurance giant Life Insurance Corporation (LIC), which will raise at least Rs 70,000 crore.

Investors subscribe to an IPO in the hope that as one of the first shareholders of the company issuing the initial public shares, they will rake in profits over the years as that company grows and the price of its stock rises.

For instance, when Dhirubhai Ambani went public in 1977 with Reliance Industries, the company’s shares were priced at Rs 10 each; today, the price is over Rs 2400 a share.

However, not all promoters are Dhirubhai Ambani and not all companies are Reliance Industries. There is always the chance of investors backing weak companies, which puts the invested money at risk. Also, there is the risk of stock market upheavals.

But while SEBI cannot do much about market fluctuations, it can always check the credentials of a private company that wishes to issue an IPO; this it tries to ensure by laying a few requirements that such companies are required to meet.

The following section explains the process that an IPO involves.

The IPO process for companies

As per the guidelines laid down by SEBI, the first thing a company planning an IPO must do is to get registered with the market regulator. After this, it needs to submit an application, along with the requisite documents, with SEBI for its approval for the proposed IPO.

Once this is done, the company can start preparing its draft prospectus, which also has to be to be submitted to the market regulator, even as SEBI evaluates the application.

This prospectus, called the Draft Red Herring Prospectus (DRHP), must contain background information of the company promoters as well as the company itself, such as information on its line of business, state of its finances, state of the sector the company is in, its shareholding pattern, details of the issue size and the issue price, and the type of risks posed to investors.

The DRHP, which is required to state that the SEBI approval for its application is pending, also has to explain the reason for mobilising funds from the public and spell out how the company intended to use the funds raised.

SEBI can either okay the document, or ask the merchant bankers handling the IPO to make certain changes.

The company has the option of two types of IPO issues:

Fixed price IPO, which involves determining the price of the shares to be issued in advance;
Book building, where the company offers a range of prices for its shares and investors make their bids within that range. The cut-off price is arrived at on the basis of the demand after completion of the bidding process, following which shares are allotted, refunds undertaken, and the final prospectus filed with the registrar of companies (ROC).

As per SEBI norms, the subscription list for fixed price public issues are to be kept open for a minimum of three working days and never in excess of 10 working days.

In case of book-built issues, bidding is open for at least three working days, and not more than seven working days – though this may be extended by three days in case the price band is revised.

Once its shares are allotted, the company stocks lists on the stock market on a pre-fixed date.

What explains the rush for IPOs this year?

It is this process explained above that a rash of companies is going through in India this year as they tap the primary market. But what explains the IPO deluge?

There are two main factors behind the IPO boom: an increase in liquidity in the economy, and an increase in the number of investors. RBI’s August 17 bulletin adds a third: the FOMO factor or the Fear Of Missing Out.

Ironically, at the bottom of the pile is COVID-19, the single-most important reason for India’s economy to shrink 7.3% in the last financial year, though this year, looser pandemic curbs meant a GDP growth 20.1% for the first quarter, compared to a year earlier.

Increased liquidity

The current flush of IPOs has ridden the heightened liquidity in the economy that came in the wake of a slew of measures that the government and institutions took in response to the pandemic.

For instance, the government announced relief and stimulus packages on three occasions last year, which saw over Rs 20 trillion flow into the system:

26 March 2020: Relief package worth Rs 1.7 trillion (about $22 billion);
15 May 2020: COVID relief package worth Rs 20 trillion (about $260 billion);
14 November 2020: Comprehensive stimulus package worth Rs 2.65 lakh crore.

This apart, RBI also announced a clutch of relief measures on March 27 and April 17 last year to boost liquidity. These measures, which included rate cuts and special concessions for the MSME and NBFC sectors, are estimated to have infused liquidity to the tune of Rs 4.74 lakh crore (about $63 billion) into the economy.

An increased money supply in the economy is bound to spill over into the markets, and the IPO sector has benefited from this. As Mrinal Singh, CEO and CIO of InCred Asset Management, told the Indian Express: “IPOs are money-raising tools and companies line up with their public issue when the liquidity in the market is high.”

Swelling investor numbers

Another way COVID-19 contributed to the IPO boom was by boosting India’s army of retail investors by creating investment time due to lockdowns and enforced work-from-schedules.

This is clear from the data with the Central Depository Services Limited (CDSL). The pre-pandemic number of investor accounts with CDSL was 2.01 crore (January 2020), but by 30 June 2021, their number had almost doubled to 3.96 crore.

CDSL has added 1.07 crore accounts in six months between December 2020 and June 2021, by when the government’s liquidity programme had started making an impact on the economy at large. The State Bank of India believes more than 1.42 crore new individual investors have been active in the capital markets in 2020-21.

These new investors are not only tapping the buoyancy in the secondary market; they are also propping up the IPOs.

COVID-19 and social distancing norms have forced the ordinary Indian to turn to apps for a variety of reason, and this is also quite apparent in the investment sector. In fact, swelling investor ranks have coincided with the COVID-19 outbreak and the emergence of app-based trading platforms such as Zerodha, Upstox, 5paisa and Paytm Money.

Available on Google Playstore and iOS App Store, these platforms have led to the rise of the tech-savvy young investors in the 21-27 age group, who may or may not understand stocks, but definitely know how to use tech-driven apps to invest.

New-found love for technology is driving IPO investments

This familiarity with technology seems to have rubbed off on the Indian investor’s IPO-related decisions as well. For instance, of the top 10 IPOs that investment advisory firm IIFL Securities says “are getting investors excited and optimistic”, seven are tech stocks (or represent businesses driven by technology): Flipkart, Paytm, Byjus, Ola, Delhivery, Zomato, and Policybazaar.

Of these, at least four companies – Paytm, Ola, and food delivery businesses Delhivery and Zomato – received a leg-up due to the lockdown and social distancing concerns. The other three stocks on IIFL’s list are Kalyan Jewellers, LIC, and Bajaj Energy.

Even RBI noticed this new-found love for tech stocks, noting in its August 17 ‘State of the Economy’ bulletin that “debut offerings by Indian unicorns [unlisted start-ups] have set domestic stock markets on fire and global investors in a frenzy.”

In this connection, it alluded to the IPOs of Paytm and Zomato without naming them, and argued that though investors were “without an established set of plain vanilla financial metrics to value these businesses”, they still backed the start-ups, thereby showing a willingness to be open-minded.

“This is a great positive development for the domestic ecosystem of start-ups,” RBI said, adding, “It showcases the strength, maturity, and scale of domestic equity markets.”

List of upcoming IPO's in 2021

Last words

Despite all-round giddiness surrounding start-ups and tech stocks, it is wise to not forget the age-old dictum: If the stock you are buying is of a company that fails, you will lose your money. Basically, no matter what business a company is in, your returns will depend on that company’s fundamentals.

However, when it comes to investing in IPOs, you will be constrained as unlisted companies are not required to publish their financials; this means, you cannot analyse their track records. Also, IPO investments are vulnerable to market fluctuations, which means you have to exercise caution when investing in these companies. So, be sure to consider all aspects of the sector and the company’s business model.