Finding an IPO’s Potential

The expedited listing of IPOs within a mere three days of closing the issue underscores a prevalent trend among investors who are eager to capitalise on profit opportunities quickly. This trend often involves a heavy reliance on easily accessible factors, primarily focusing on financial metrics. However, what if an investor is looking to identify a promising IPO investment opportunity that transcends conventional financial metrics? Mandar Wagh highlights the importance of incorporating qualitative factors alongside financial metrics to make informed investment decisions, underscoring their crucial role in shaping IPO outcomes 

In the latter half of September 2023, the Indian benchmark indices came close to nullifying the gains made during the initial half of the month, marking the end of their longest winning streak since 2007. This downturn was primarily influenced by weak global cues, concerns about heightened inflation rates, surging crude oil prices, and an elevated 10-year Treasury yield. Additionally, the situation was compounded by foreign institutional investors offloading over ₹ 25,000 crore in the cash markets. Conversely, in the primary market, a different trend surfaced – one that remained exceptionally robust and vibrant.  [EasyDNNnews:PaidContentStart]

It highlighted the unwavering optimism among investors, exemplified by the launch of 14 mainboard IPOs and numerous SME IPOs throughout the month of September. The Indian capital market experienced a noteworthy total of 36 mainboard IPOs throughout 2023, resulting in companies raising over ₹ 27,000 crore. Impressively, approximately 65 per cent of the funds raised in 2023 were concentrated in the July-September quarter. The majority of these IPOs not only attracted enthusiastic investor interest but also delivered impressive returns, defying the prevailing bearish sentiment. 

The rapid listing of IPOs within just three days of issue closure has highlighted a trend among investors who seek to exploit these opportunities promptly. Investors in a rush to seize opportunities for profit frequently depend solely on readily accessible factors, such as the grey market premium (GMP), when making their investment choices. These factors may not consistently support sound decision-making. Such a situation can potentially perplex genuine investors, especially when faced with a multitude of simultaneous IPOs, the majority of which come with enticing GMPs. Let’s explore how financial parameters aid in evaluating IPOs to seize potential investment opportunities.
 

Financial Metrics : A Common Approach to Analysing IPOs 

Any investor engaged in the evaluation of an IPO and seeking in-depth insights into the offering can obtain the necessary information from the Red Herring Prospectus. When a company seeks to secure capital from the public via an IPO, it is obligatory for the company to formally file and present a ‘Draft Red Herring Prospectus’ to the Securities Exchange Board of India (SEBI). After receiving the necessary approval from SEBI, the Registrar of Companies (ROC), and the prominent stock exchanges, it transforms into a ‘Red Herring Prospectus’. 

Investors can delve into this prospectus to uncover comprehensive information about the issuing company, including its vision, promoters, financial performance, growth prospects, corporate structure, and more. Most of us are familiar with the financial aspects that we typically consider when making investments in a company. We frequently seek out companies that have demonstrated consistent and robust revenue growth in recent years, as this is a positive indicator of a promising financial outlook. Additionally, we prioritise assessing the company’s profitability and profit margins, which provide insights into pricing power and operational efficiency. Positive operating cash flows are equally crucial as they guarantee the company’s ability to cover operational expenses and fund future growth initiatives. 

Simultaneously, we assess the company using a range of financial ratios to determine whether the offering is priced reasonably when compared to industry peers. Financial factors are crucial when analysing any company as they offer valuable insights into the company’s financial health, performance, stability and potential for growth. But what if an investor seeks to identify a promising IPO investment opportunity that goes beyond mere financial metrics? Evaluating an IPO beyond financial parameters involves considering various qualitative and strategic aspects that can impact the company’s long-term potential and the investment opportunity it presents. Let’s consider in detail how these non-financial factors can impact the growth potential of an IPO. 

Evaluating an IPO Beyond Financial Metrics 

Key Architects of IPO Triumph:

Strong Parental Group, Visionary Management and Efficient BRLMs

It is commendable to observe the comeback of corporate giants such as the JSW (Jindal) Group and TVS Group with the launch of the JSW Infrastructure and TVS Supply Chains Solutions IPOs, respectively, marking their return to the market after a significant absence. On the final day of subscription, the JSW Infrastructure IPO witnessed a remarkable oversubscription rate of 37 times. The TVS Supply Chains Solutions’ IPO also garnered remarkable interest and participation from retail investors. When an IPO is orchestrated by a subsidiary of a well-established, esteemed parent company, it has the potential to bolster investor confidence. 

The parent company’s historical achievements, financial solidity and track record can cast a favourable light on the subsidiary’s IPO. A robust parental group can offer invaluable resources, expertise and financial support to the subsidiary as it embarks on a journey to go public. This assistance can prove instrumental in the IPO’s preparations and execution, as well as in adeptly navigating any unforeseen challenges. It has the capacity to captivate investor attention and potentially pave the way for a more prosperous IPO. The management team’s wealth of experience and their proven track record are of paramount importance. 

Investors place a premium on evidence that the leadership has effectively steered the company in the past, yielding tangible results. Equally crucial is the management team’s vision and strategy for the company post-IPO. Articulating a clear path for the company’s growth and transparently outlining the utilisation of IPO proceeds can instil a strong sense of confidence among investors. Book Running Lead Managers (BRLMs) assume a pivotal role in driving the success of an IPO, entrusted with the comprehensive management of the entire IPO process, spanning its inception, pricing strategy, flawless execution, and efficient distribution. 

Leveraging their keen market acumen, BRLMs possess the capacity to discern prevailing market dynamics and investor sentiment. This proficiency empowers them to ascertain the ideal IPO price, a cornerstone element in captivating investor interest and securing the effective execution of the offering. The indispensable role of BRLMs extends to ensuring meticulous adherence to the legal and regulatory prerequisites, shielding the IPO from potential legal snags that could obstruct its prosperity. With a network of associations, BRLMs are uniquely positioned to secure unwavering commitments from substantial, longterm investors, bolstering the IPO’s prospects. 

Interpreting Subscription Levels
A North Star for IPO Investors

The Plaza Wires’ IPO witnessed a remarkable level of investor enthusiasm, garnering subscriptions that were 160 times the offering size on the final day. Particularly noteworthy was the overwhelming response from the retail category, with a subscription rate of 375 times, and the NII category at 388 times. The outcome was equally impressive, as the shares made a robust debut, listing at a 55 per cent premium over the issue price on the very first day of trading. Subsequently, the shares were locked at a 5 per cent upper circuit on the following trading session, underlining strong demand and investor confidence in the offering. 

Subscription levels serve as a crucial guide for investors assessing whether to participate in an IPO, offering valuable insights into investor sentiment and demand. Robust subscription levels are a positive sign, indicating strong demand for the IPO. This suggests that investors are eager to acquire the company’s shares, often due to their confidence in the company’s growth prospects. A detailed breakdown of subscription levels among retail investors, high-net-worth individuals and institutional investors can provide additional insights. A well-balanced interest from these investor categories is an encouraging sign, reflecting broad-based demand. 

In cases where an IPO is oversubscribed, it signifies high demand for the offering, potentially leading to a shortage of available shares. This can result in the stock trading at a premium in the secondary market, offering early gains to investors. Conversely, if an IPO is under-subscribed, it may suggest lower investor interest. This could be due to various factors, such as market conditions or concerns about the company’s perceived weaknesses, potentially leading to a less favourable post-IPO performance. 

The correlation between the extent of subscription and subsequent listing gains usually hinges on the subscription level and the demand for the shares being made available. In instances where an IPO experiences substantial oversubscription, it frequently results in notable listing gains. As evident from the graphical representation, the dominant line, marked in red, reflects the total subscription levels, providing a comprehensive view of the overall demand. Notably, the subsequent line, depicted in blue, underscores the significance of the subscription from the Qualified Institutional Buyer (QIB) category, highlighting its pivotal role in the success of an IPO. 

The QIB segment typically comprises shares designated for institutional investors, including mutual funds, insurance companies, foreign institutional investors (FIIs), and other accredited financial institutions. When the QIB portion of an IPO garners substantial oversubscription, it serves as a strong indicator of heightened interest among institutional investors. A high level of QIB subscription not only conveys a sense of institutional enthusiasm in the company but also has the potential to attract retail investors, thus further bolstering demand for the IPO shares. Given that institutional investors often possess the capacity for significant capital deployment, their involvement can result in substantial price appreciation when the shares commence trading on the stock exchange.
 

The Lock-In Period
A Stabilising Force in IPOs

The lock-in period is a defined timeframe during which specific shareholders, often including company insiders and early investors, face restrictions on selling their shares in the newly listed company. This strategic mechanism serves as a stabilising influence during the early trading days of the stock. By imposing these restrictions, the lock-in period ensures that a significant volume of shares does not flood the market immediately following the IPO, a scenario that could otherwise generate unwelcome price volatility. This stability, in turn, fosters enhanced investor confidence in the overall offering. Moreover, an extended lock-in period can symbolise the company’s unwavering dedication to its long-term success. 

It communicates to potential investors that insiders are willing to commit to their shares, thus aligning their interests with those of the broader public shareholder base. However, it’s worth noting that an overly prolonged lock-in period can deter certain investors who prioritise liquidity and flexibility in their investments. It has been observed that in the cases of One 97 Communications Ltd (Paytm), PB Fintech Ltd. and Zomato Ltd., anchor investors hurried to sell their shares as soon as their lock-in period ended. Conversely, in the case of certain companies, anchor investors choose not to exit their positions because the businesses are seen delivering exceptional performance. 

Understanding the Dual Pathways of IPO Success
Offer for Sale versus Fresh Issue 

An IPO can take two primary forms including an offer for sale (OFS) and a fresh issue. With an OFS, existing stakeholders, including the company’s founders, or early investors, divest their shares to the public. Notably, the company itself does not accrue any proceeds from these sales. Instead, it’s the selling shareholders who benefit. OFS often serves as an exit strategy for early investors to realise their investments in the company. Conversely, in a fresh issue, the company introduces new shares to the public, and the capital generated from this offering goes directly to the company. 

This inflow of capital can be directed toward funding ongoing business operations, reducing debt, fuelling research and development endeavours, or pursuing various growth opportunities. Fresh issues are pivotal for raising capital to bolster the company’s development and expansion. A company might incorporate both an OFS and a fresh issue. Investors keenly observe the allocation between OFS and fresh issue to glean insights into the company’s intentions and its financial health. A fresh issue typically instils a more positive outlook among investors as it signifies that the company is proactively amassing capital to fuel its future growth. 

However, an OFS should not necessarily be viewed negatively. It can provide a viable avenue for early investors to unlock the value of their investments, which is a common facet of a company’s evolutionary journey. A positive trend that has emerged recently is the dominance of fresh issues in the majority of funds raised through IPOs. This shift signifies that the raised capital is earmarked for the companies’ future expansion. In contrast, in the past, majority of IPOs consisted of OFS components, channelling the funds directly to the promoters of the companies. In 2023, the recent standout IPOs for substantial gains included Plaza Wires, JSW Infrastructure and Vishnu Prakash R Punglia, all of which exclusively comprised fresh issues. 

Decoding Market Dynamics
Understanding Market Mood, MMI and Influential Factors

The timing concerning broader economic conditions, alongside the prevailing market sentiment and investor appetite, holds a pivotal role in determining the success of the offering. A market mood is the collective sentiment exhibited by investors. It encompasses the prevailing mood, psychology and attitude of market participants, as reflected in the activities and price fluctuations of the traded securities. Market mood is not a readily measurable metric, yet it holds significant sway over market dynamics. This intangible aspect is frequently shaped by an array of influences, including economic data, geopolitical developments, corporate earnings reports, news headlines, and an assortment of other factors. 

A bullish market mood conveys the presence of investor optimism and confidence, typically linked to anticipations of ascending asset values. Bull markets are marked by robust buying activity. In contrast, a bearish market mood signifies investor pessimism and prudence, accompanied by expectations of falling asset prices. Bear markets frequently witness heightened selling pressure. Elevated market mood volatility often signals an environment of uncertainty and rapidly shifting sentiment. These conditions may result in pronounced price fluctuations. 

When a fearful market mood prevails, it can trigger panic selling and precipitate sharp market declines. On the other hand, a greedy market mood can manifest as heightened risk appetite, potentially leading to the overvaluation of assets, and in some cases, even precede market bubbles. Conversely, a cautious market mood reflects a mindset characterised by prudence and a strong emphasis on risk management. Under such conditions, investors tend to be more discerning and adopt a defensive approach when making investment decisions. 

Market Mood Index (MMI)

Certainly, a ‘Market Mood Index’ can be constructed using a combination of various factors, including FII activity, market breadth, volatility, momentum, and skew. Each of these elements contributes to a comprehensive assessment of market sentiment and can help investors better understand the prevailing mood in financial markets. Heightened FII participation, particularly when characterised by significant investments, has the potential to enhance overall market sentiment. It serves as an indicator that foreign investors recognise opportunities in the market, which can, in turn, influence domestic investors positively. Moreover, FII activity introduces liquidity into the market, resulting in increased trading volumes, thus fostering a livelier and more upbeat market ambience. 

Changes in FII behaviour can mirror shifts in the global risk landscape. When FIIs divest from investments, it may signal apprehensions regarding economic or geopolitical uncertainties. Market breadth serves as a critical yardstick for investors to assess the extent of market participation and whether the market’s momentum is primarily steered by a select group of prominent stocks or a more diverse range of assets. It quantifies the prevalence of stocks that have seen price increases versus those that have seen declines. A robust market breadth is indicative of a greater number of advancing stocks, typically regarded as a favourable indicator for the broader market. 

Volatility pertains to the extent of price variation in a stock over time, serving as a gauge of how much an asset’s price fluctuates and revealing the level of risk and uncertainty in the market. Metrics such as the Volatility Index (VIX) for the stock market and implied volatility for options are commonly employed to quantify this measure. Skew characterises the absence of symmetry in return distribution. A positive skew implies an increased likelihood of experiencing minor gains and a decreased probability of substantial losses. In contrast, a negative skew signals a heightened potential for significant losses and a reduced chance of encountering substantial gains. 

Conclusion

Investors analysing potential investment opportunities must recognise the critical importance of financial metrics. These quantitative measures provide valuable insights into a company’s financial health, performance and growth potential, serving as the foundation of investment decisions. However, it is equally essential for investors to look beyond financial metrics and consider a spectrum of qualitative factors that can significantly impact the success of an Initial Public Offering (IPO). Qualitative elements such as strong parental group, efficient Book Running Lead Managers (BRLMs), visionary management teams, subscription levels, lock-in periods, the type of issue, use of proceeds and the prevailing market mood together play a pivotal role in shaping the outcome of an IPO. Lastly, the timing of the IPO in relation to broader economic conditions and market sentiment is critical. The correct timing can significantly influence the IPO’s outcome. Incorporating these qualitative factors alongside financial metrics ensures a well-rounded analysis and enhances the ability of investors to make informed investment decisions. 

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