Guarding The Investor’s Interest

There is no reason why the chief economic adviser to Indian government V Anantha Nageswaran could be unaware that his expression of disquiet in an open forum that IPOs (initial public offerings) are increasingly being used by early investors to cash out would stir up a hornets’ nest. Nageswaran would rather like IPOs being used by companies to raise long-term capital. That, according to him, would uphold the “spirit of public markets.” When early investors, be they promoters or private equity (PE) or venture capitalists (VCs) use the mechanism offer-for-sale (OFS) to book profits by divesting a part or full of their holdings, the exercise does not create new capital for the concerned company.

All the recent OFS have been priced at considerable premium to the face value and on the offer being subscribed, the proceeds go entirely to early investors. The Nifty and Sensex staying tantalisingly high, those who have risked investment at early stages in the hope that the projects being funded will do well will have their justification to pare their holdings and pocket profits.

The Nageswaran dissonance of OFS in IPOs and stiff valuation of such offers has expectedly set off a lively debate on the broader purpose of primary market. As we will have it, the animated discussions on the subject have been joined by SEBI chairman Tuhin Kanta Pande, thanks to a long interview in the Economic Times, fund managers and other market participants. The subject has assumed importance as the underlying bullish sentiment continues to sustain IPOs at an elevated level. IPOs for the year-ending December are to mobilise close to ₹30,000 crore through 25 issues. This is coming on the heels of November mobilisation of ₹23,613 crore through nine offerings and October collection of ₹45,188 crore through ten launches.

Investor appetite for buying shares, if anything has remained unabated in the face of avalanche of new issues. A caveat here. Unlike in the past when investors in the primary market would easily fall prey to issues by companies destined to fail but marketed cannily, they are now found savvy in separating well managed companies with growth potential from the ones which will promise much but will deliver little or nothing. SEBI’s sustained investor education campaign and poor performance by any number of companies post IPOs have made investors increasingly discriminating in putting their investment bets.

Let’s consider the IPO of South Korean white goods giant LG Electronics which made a public issue in October to raise ₹11,607 crore by selling 10.18 crore shares. The offer, which created much excitement among investors, specially the qualified institutional buyers (QIB) was a pure OFS with the Korean parent selling a minority stake in the Indian subsidiary. Therefore, the entire proceeds go to the parent company in South Korea. But this need not be grudged. Over the years, the South Korean Chaebol has grown the business in India to a leadership position. The debt free Indian subsidiary is highly profitable and growing at a fair clip.

Whether institutions or individuals, their investment decisions are guided by expectation of capital appreciation, which happens when the targeted company continues to grow profitably and improve its share of the market. Both these are happening with LG Electronics. No wonder, LG shares on listing commanded a premium of 50 per cent followed by minor correction. LG is an instance where the company has fairly priced the issue leaving scope for capital appreciation afterwards. Everything from rich brand equity to be among leaders in its segment to strong financials ensured the issue being oversubscribed 54 times.

After having built the Indian subsidiary over nearly 30 years, the South Korean parent thought the time was right to sell a minority stake and take the proceeds home. This should be seen as a reward for all that has gone into building a successful venture in India. Post IPO, the parent is retaining 85 per cent ownership. Therefore, nothing material in terms of management will change in the Indian outfit.

A positive fallout of the OFS is that Indians will now be able to own LG shares and be the beneficiaries of the company’s continued success. In an entirely OFS-driven listing, the underlying fact remains the concerned company is not in need of fresh capital. This holds true for both the public and private sector companies. For example, the Union government diluted its stake by 3.5per cent in Life Insurance Corporation of India in 2022 when the IPO was purely an OFS. What that share sale by the government achieved? First, the listing as it broadened the market gave investors one more share buy option. Second, the government received ₹20,557 crore from 3.5 per cent disinvestment.

Being the chief economic adviser, Nageswaran will naturally be in favour of companies raising fresh capital through IPOs for building of new capacity, be it manufacturing, services or agro-based products. At the same time, private equity that includes angel investors and venture capitalists to invest in start-ups and in many cases mentoring promoters with ideas but without experience in building businesses. Against the investment of risk capital, private equity investors (PEIs) are given shares (or debts to be converted into equity) on tacit understanding that the shares will be held till the business has matured and once that threshold has arrived, the early investors have the option to cash out using OFS route.

As is known, PEIs will be supporting a number of ventures, which appear promising to them, simultaneously. Not all such ventures will turn out to be profitable. PEIs selling shares of successful ventures not only compensate for investments in the ones stumbling but the money they take out from the former allow them to support further new enterprises. And as SEBI chairman says: “There is no contradiction between a private equity investor exiting and the broader purpose of the primary market.”

While criticism of OFS is off the mark, the uneasiness of individual investors about the astonishing IPO valuations, particularly of new age companies merits scrutiny by SEBI whatever Pandey may say in defence of current regime. In a recent interview with the ET, Pandey argued that the company prospectus provides “extensive” information for prospective investors to make “informed judgements” as to whether the issue is worth subscribing.

The fact remains valuations in many cases have remained astronomically high. But companies even with negative cash flows will not be lacking in guile and often of course with the help of media to project tempting growth and profitability in future. In an environment like this, chances of individuals making wrong investment decision will remain high, notwithstanding the claims of investor maturity. An ET report says over 50 per cent of issues with sizes of ₹500 crore and above since 2023 are trading below issue prices. SEBI needs to deliberate on investors losing heavily being sold on wrong promises of future profitable working.