Post - IPO Performance Drivers

Are you regretting your decision to exit on an IPO’s listing day with only small profits while it went on to perform exceptionally well? This is a common dilemma for many investors, stemming from uncertainty about whether to hold on to their IPO shares or rake in early gains. Mandar Wagh discusses the fundamental factors crucial for an IPO’s long-term success that investors should consider to achieve better profits 

We have all been part of conversations about securing IPO allotments, and most of the time the answer is a disheartening ‘no’. The unfortunate reality is that only a few lucky investors manage to get IPO shares as the demand often far exceeds the number of shares available. The BSE IPO index has significantly outperformed the Indian benchmarks over various time periods, highlighting the resilience of newly listed companies and robust investor sentiment. 

The BSE IPO index is one created by the Bombay Stock Exchange to track the performance of companies that have recently gone public through an Initial Public Offering (IPO). It includes companies listed on the BSE for up to two years post-IPO, calculated based on their free-float market capitalisation. This index serves as a benchmark for investors to gauge the market’s response to new IPOs, offering insights into the performance trends of newly listed companies. 

A more challenging situation than securing an IPO allotment is deciding what to do next once you have obtained one. Should you hold on to the shares for potential long-term benefits, or should you sell them immediately to capitalise on listing gains? Often, investors eagerly book profits on the IPO listing day, securing considerable gains but potentially missing out on stellar long-term returns if the IPO is truly promising. Here are a few examples of 2024 IPOs wherein exiting on the listing day may have resulted in forfeiting significant future gains by not remaining invested. 

While most brokerage houses and analysts provide recommendations before an IPO launches, very few offer guidance on post-IPO performance and the subsequent steps investors should take after a certain period. Let’s understand the fundamental factors crucial for an IPO’s long-term success and identify what you should continuously monitor to make informed decisions about your investments. 

Issue Types, Capital Impact and Objectives Achievement
The long-term success of an IPO hinges on several factors including the type of offering, the actual amount of capital the company receives, and how effectively the company meets its stated IPO objectives. An IPO can take two primary forms including an offer for sale (OFS) and a fresh issue. In an OFS, existing stakeholders, including the company’s founders or early investors, divest their shares to the public, with proceeds going to the selling shareholders rather than the company. This method often serves as an exit strategy for early investors to realise their investments. In contrast, a fresh issue involves the company issuing new shares to the public, with the generated capital flowing directly into the company’s coffers. 

These funds can be allocated to ongoing business operations, debt reduction, research and development, or various growth initiatives. Fresh issues are essential for raising the capital needed to drive the company’s expansion and development. Companies may opt for a combination of both OFS and fresh issue in their IPOs. Investors should keenly observe the balance between these offerings to gauge the company’s strategic intentions and financial health. Fresh issues generally inspire a more favourable investor outlook, as they signal the company’s active efforts to secure funds for future growth. 

However, an OFS should not be viewed negatively. It allows early investors to unlock the value of their investments, which is a typical phase in a company’s growth journey. It’s crucial to assess whether the company is meeting the objectives for which it raised capital. Investors can monitor this through various means. Quarterly and annual reports will show how the funds are being allocated. Additionally, regular updates from the company can offer insights into the progress of projects or debt repayments. Companies are also required to file updates with regulatory bodies, providing official statements on how the funds are being utilised. 

Lock-In Period and Perceived IPO Quality
The lock-in period is a designated timeframe when certain shareholders, typically including company insiders and early investors, are restricted from selling their shares in the newly listed company. This strategic measure is intended to stabilise the stock’s initial trading phase. By limiting significant sell-offs immediately after an IPO, the company can sustain a more stable stock price, benefiting both current and prospective investors alike. Lock-in periods can vary considerably but generally span from a few months to a couple of years following the IPO. 

The specific duration is typically outlined in the IPO prospectus and is influenced by regulatory mandates and the prevailing market norms. Having a lock-in period can bolster the perceived quality of the IPO, indicating the company and its stakeholders are dedicated to a measured and controlled entry into the public markets. This perception can enhance the company’s standing with investors and analysts. 

Moreover, an extended lock-in period can symbolise the company’s unwavering dedication to its long-term success. Investors should thoroughly review the specifics of the lock-in period, as often anchor investors may choose to sell their shares soon after the period expires, based on the company’s performance. Similar observations have been noted for One 97 Communications (Paytm), PB Fintech (PolicyBazaar), FSN E-Commerce Ventures (Nykaa) and Zomato, where share prices significantly declined following the sell-off. 

Impact of Ace Investor Entry and Exit
Similar to the lock-in period and the entry and exit of anchor investors, the entry and exit of ace investors is equally crucial for a stock’s performance post-IPO. When prominent investors, such as institutional entities or well-known individual investors, buy into a stock post-IPO, it often enhances the market’s perception of the company’s credibility and potential, leading to increased demand and a rise in the stock price. Their participation typically boosts trading volume, which enhances liquidity and results in more stable stock prices and narrower bid-ask spreads. 

Large investors usually have a long-term investment horizon, contributing to price stability. Additionally, they often seek active roles in corporate governance, advocating for strategies that enhance shareholder value. Ace investor Ashish Kacholia’s backing of Awfis Space Solutions Limited’s IPO resulted in substantial demand, evident from high subscription levels and a notable debut with a 10 per cent listing gain. 

Following its debut, the shares of Awfis Space Solutions continued to attract significant buying interest, surging more than 40 per cent within just one month to reach its peak. However, if these big investors decide to exit their positions, it can cause significant downward pressure on the stock price. Overreliance on such investors can make the stock vulnerable to large sell-offs if they reassess their investments. Therefore, investors should closely monitor such developments as they can significantly impact a stock’s performance, whether positively or negatively 

Subscription Levels, Listing Gains and Investment Strategy
Subscription levels are a vital indicator for investors evaluating whether to participate in an IPO, providing valuable insights into market sentiment and demand. High subscription levels signal strong interest, suggesting confidence in the company’s growth prospects. Analysing the breakdown of subscriptions among retail investors, high-net-worth individuals and institutional investors offers further insights. Broad-based interest from these categories indicates robust demand. 

When an IPO is oversubscribed, it reflects high demand, often resulting in a scarcity of shares and potentially leading to the stock trading at a premium in the secondary market, yielding early gains for investors. On the other hand, an undersubscribed IPO may indicate lower investor interest, which could stem from market conditions or concerns about the company’s perceived weaknesses, possibly leading to less favourable post-IPO performance. Significant listing gains typically indicate positive market sentiment toward the company and anticipation of robust future performance. Should the underlying factors supporting the stock’s rise persist, there could be further potential for value appreciation in the future. For investors with a long-term perspective, maintaining their investment enables participation in the company’s growth trajectory and potential for compounding returns over time. This strategy is in line with long-term investment approaches that emphasise holding on to high-quality stocks for extended periods. 

There are instances where companies fail to attract investor interest due to reasons such as poor financial performance, overvaluation, uninspiring business models, or other factors. This lack of interest is reflected in low subscription levels and can lead to the stock debuting at a discount. Stocks that debut at a discount often face challenges in gaining momentum and may remain in a lower trading range for an extended period. To regain momentum and foster growth, such stocks typically require a significant positive catalyst. While there are exceptions where a stock has performed well after an initial struggle, in a majority of cases, it is advisable to consider subscription levels as an indicator of demand when investing in any IPO. 

Critical Role of Post-IPO First Earnings Reports 

The first earnings report post-IPO is a critical milestone that can significantly influence a company’s stock performance and investor perception, setting the tone for its future in the public markets. This report serves as a validation of expectations, offering the company an initial opportunity to meet or exceed the expectations set during the IPO process. Successfully doing so can boost investor confidence and positively impact the stock price. A strong earnings report can generate positive momentum, attract new investors, and encourage existing investors to increase their holdings. 

Conversely, disappointing results can lead to a decline in investor confidence and a drop in the stock price. The first earnings report also establishes a benchmark for future performance assessments. Investors and analysts use this report to gauge the company’s ability to meet its growth projections and financial targets. Additionally, it provides insights into the company’s operational performance, including revenue growth, and profitability and expense management, helping investors understand the company’s business model and operational efficiency 

The management’s commentary and guidance in the earnings report can offer valuable information about the company’s strategic direction, upcoming projects and market outlook. Earnings reports also provide the management with opportunities to update investors on strategic initiatives, such as new product launches, market expansions or cost-cutting measures. A robust order book serves as a reliable predictor of future revenue. It enables investors to assess the company’s capacity for generating income in the upcoming quarters or years, facilitating more precise financial forecasting and strategic planning. 

Consistent and substantial orders indicate operational stability, ensuring companies can maintain steady production schedules, optimise resource utilisation, and achieve economies of scale. This operational efficiency collectively strengthens the company’s financial health. Furthermore, a well-populated order book reflects strong market demand for the company’s products or services, bolstering investor confidence. 

Moreover, maintaining a healthy order book supports effective cash flow management by providing predictable revenue streams. This stability helps in prudent expense management, timely debt repayment and funding new initiatives without undue financial strain. Providing detailed and transparent financial results can also enhance the company’s credibility. Consistently strong earnings reports help build investor confidence and support long-term stock price appreciation. Conversely, inconsistent performance can lead to volatility and reduced investor confidence.

Click to download - 2024 IPO Performance Scorecard

Valuation’s Role in IPO Success and Long-Term Performance 

For investors, the primary consideration when investing in an IPO is undoubtedly the valuation of the offering. However, this focus shouldn’t diminish over time. Investors need to consistently track the stock’s valuation, especially in comparison to its listed peers and the industry average. This ongoing analysis helps determine whether the stock is overvalued or undervalued, offering insights into its potential future performance. A company with a high valuation might underperform relative to its peers if it fails to justify its price with comparable growth metrics. 

When a company is overvalued at the IPO, its stock price may decline post-IPO as the market adjusts the inflated price. Conversely, if a company is undervalued at the IPO, its stock price may increase post-IPO as the market recognises its true value. Companies with fair IPO valuations and strong fundamentals are more likely to sustain long-term growth, while those with valuations that do not match their fundamentals often experience greater volatility. Investors who bought shares at the IPO price may incur losses, leading to negative sentiment and lower demand for the stock. 

Understanding Industry Dynamics
Understanding the company’s strategic positioning required for success involves evaluating the number of competitors, market share distribution, and the intensity of competition. Assessing the current market size and potential for growth provides a backdrop against which we can measure a company’s performance. Industry averages for financial metrics such as revenue growth, profit margins, and valuation and return ratios serve as benchmarks to evaluate a company’s financial health and efficiency 

Keeping up with technology trends within the industry indicates opportunities for innovation or threats from disruptive technologies. Investors should examine whether companies operating in highly technological sectors are investing in research and development or capital expenditure for emerging technologies. Different industries face varying levels of regulatory scrutiny, which impacts operational costs and legal risks. Monitoring potential regulatory changes helps predict future challenges and opportunities for companies within the industry. 

Understanding how an industry reacts to economic downturns and booms gives insight into the potential volatility of companies within that industry. The government’s announcement of capital outlay and strategic initiatives aim to ignite sectoral development, fostering a feasible environment that benefits companies through enhanced growth prospects and economic stability. Therefore, it is essential to analyse the industry’s strengths, weaknesses, opportunities and threats to forecast the future impact on the company’s performance and to seize any potential opportunities. 

Conclusion
As highlighted in the 2024 IPO performance scorecard, IPOs demonstrating significant demand through high subscription levels and robust top-line and bottom-line growth have achieved substantial gains to date. Conversely, those failing to attract investors due to inconsistent and poor financial performance experienced significant declines, even after the initial robust listing gains. In conclusion, factors such as the type of issue, objectives of the issue, entry and exit of anchor and ace investors, subscription levels, and strong and consistent earnings after the IPO launch significantly impact post-IPO performance. Therefore, when holding potential IPO shares, investors must consider these factors to gain valuable insights and make informed decisions for better profits.