2022 IPOs: Investors learn profitability, not narrative, is the key

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Circa 2022 had some tough lessons for investors in initial public offerings (IPOs). One of them was that the success of previous IPOs does not guarantee a similar result for the next ones. So, those hoping for a repeat of Zomato and Nykaa-like listing day gains were in for a heartbreak.

The other lesson was that one needs to be mindful of valuations. A majority of the new issues this year were either fully priced or over-priced. That did not seem to matter much when the market was booming. But as globally sentiments for equities soured, investors balked at overpaying for new entrants, when there were tried and tested names available at a cheaper price.

Un-follow that narrative

Just 38 companies went public in 2022, compared to 65 last year, and the amount raised was down 50 percent to a little over Rs 60,000 crore.

“There was too much hype around new-age companies (in 2021) because the focus was on the narrative and not valuations. That has changed this year,” said Sanjay Chawla, head of institutional research, Emkay Global Financial Services, adding that investors were now looking at valuations first and then the narrative.

That said, some firms fared well on debut, because overall market sentiment was positive around that time. But business model and profitability mattered, too. For instance, Dreamfolk Services listed on September 9 when Nifty50 had gained roughly 10 percent in the preceding three months.

That helped Dreamfolk to list at a 54 percent premium. A positive outlook on the travel segment also helped. The company is into airport lounge access aggregation.

Electronics Mart, too, had a bumper listing, jumping 51 percent on debut, and continues to do well. Electronics Mart’s revenues have grown at 17 percent, compounded in three years beginning FY20, despite a challenging business environment in the wake of the pandemic.

That brings us to the key change in the attitude of investors towards IPOs this year, an eye on profitability rather than being taken in by lofty projections.

The brass tacks

A key reason why IPOs disappointed was the insecurity among investors when it came to the profitability path of companies. After the stinging wealth destruction by new-age companies, investors seem to have avoided them even as valuations were more sobering than in 2021.

This is a reason why companies such as Delhivery didn’t elicit much response. Sure, the IPO was oversubscribed but the subsequent listing and the movement in the share price was poor. Morgan Stanley analysts believed that the firm’s low cost structure and edge in logistics offer hope on profitability but even that was not enough to justify the IPO price.

The brokerage cut its target price for the firm to below its issue price and the 59 percent year-on-year (YoY) fall in net profit for the September quarter reported by the firm seems to offer enough fuel for an adverse turn in sentiment.

While the new-age frenzy dying off may be blamed for Delhivery’s woes, other established firms have also failed to hold up to investor expectations.  Life Insurance Corporation (LIC) of India made a rather tepid debut after the initial frenzy it attracted.

Sure, the sheer size of the IPO was too much for the market to handle but LIC’s shares failed to perk up even after listing despite the life insurer being a safe government-owned behemoth that practically owns more than half the market.

But LIC’s weakness was its vintage. While its profitability metrics, such as value of new business (VNB) and VNB margin may shine and have indeed expanded, the insurer received only a limited bang for each of its buck in terms of embedded value. Embedded value is the fulcrum of valuation of life insurers and LIC fails to impress here when compared with its private peers.

Fiduciary business of banking too failed to impress investors. Tamilnad Mercantile Bank shares are down 6 percent from its listing price even though the banking sector as a whole flourished amid volatile markets.

What about IPOs this year?

A combination of weak market sentiment, luck or lack of it in terms of timing and unease in global markets weighed heavily on both IPO valuations and the conviction around listings. That said, when one removes the froth of external factors, there emerged the real reason for investor wariness.

A visible profitability path remained a key motivator for investors. In this regard, investors seem to look for companies that make tangible products which can be scaled with good margins or provide a service that can withstand external headwinds.

“Going by the outcome of IPOs of 2022, investors seem to prefer brick-and- mortar players who are either leaders in their space or are aspiring to be,” said Deepak Jasani, head of retail research at HDFC Securities.

Chawla of Emkay pointed out that Indian investors have changed their approach towards IPOs. “IPOs were mainly a process. You look at the grey market premium, you figure out how much allotment you can get and how much money you can make at listing. But now this is changing among investors. Institutional investors are becoming more demanding (about profitability),” he said.

Smart or smarting?

An IPO has several stakeholders, and, in a pinch, some stakeholders tend to gain at the cost of others. In 2022, most IPOs were essentially opportunities for early investors to exit at high returns or promoters to unlock value. Since the IPO proceeds do not get pumped into the business, there isn’t much value creation for every investor involved. This is perhaps one reason why investors have turned wary this year.

“Even if an IPO is priced at a sobering valuation, if the money is going into the pockets of an early investor, it isn’t of much use to the business. Fine, an early investor gets rewarded for his faith but what about the entrant now? This is where the business needs to be looked hard at,” said an equity fund manager requesting anonymity.

Incidentally, India’s fund houses have gone full throttle in their IPO investments during this year. Their IPO pickings exceed that of their secondary market shopping. Institutional investors, too, have grabbed IPO shares but they have been more careful this time. A look at the qualified institutional buyer (QIB) portion of IPOs suggests that institutional investors were discerning in picking firms that provided a clear path to profits.

Further, where the QIB portion saw phenomenal response, those IPO shares have also performed better than others in the secondary market. Campus Activewear, Electornics Mart, Harsha Engineering International and Kaynes Technology saw strong QIB interest as well as from high net worth individuals at their IPOs.

These companies also witnessed reasonably strong listing gains and their shares have since then continued to perform well.

Athleisure and footwear firm Campus Activewear’s operating profit and net profit doubled in FY22 despite the pandemic’s effects. The company reported a fall in its net profit for the September quarter but analysts point out the fast-growing sector of athleisure as a key support for valuations.

Further, the company is the leader in the market with 17 percent share. Electronics Mart and Harsha Engineering have reported resilient profitability for the first two quarters of FY23.

Kaynes Technology got investors’ vote as part of IPO proceeds will go towards expansion of its manufacturing. The company reported around 63 percent CAGR rise in the order book during FY19-22 and has reported a profit every year since its inception in 1988.

The notable feature of IPOs this year is the fact that listing gains have been few and sparse. But analysts are hopeful that good businesses will make a comeback next year and investors would keep the lesson of looking at profitability with them.