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Why IPO stocks need close watching

Why IPO stocks need close watching

You may have hit the jackpot after bagging allotment in some of the recent initial public offers (IPOs), with the stock prices doubling or more on listing. But given the leverage and bidding frenzy that accompany IPOs in bull markets, such stocks can crash and burn after the initial excitement wears off. ICICI Securities, TCNS Clothing, Sterling & Wilson Solar are some stocks from the 2018-19 crop of offers that now trade 12-60 per cent below their offer prices. You need to run four key checks on your IPO companies after listing to satisfy yourself that they are worth holding on to.

Use of proceeds

Usually, a company going public raises new equity capital to invest in new projects, repay debt, build brands or otherwise expand the business so that profits can scale up. If you invested in an IPO because its mega expansion plans or store-opening targets excited you, be sure to keep track of whether the IPO proceeds are indeed being used to put the plans into action. This can be done by tracking the company’s filing with stock exchanges on its ‘Utilization of IPO proceeds.’

After observing many instances of rampant misuse of IPO money, SEBI has mandated a standard disclosure from IPO firms on any deviation in the use of their IPO proceeds against the promises made in their prospectus, from the December quarter of 2019. This statement is filed quarterly along with the results until the IPO money is fully utilised. The deviation statement must contain the comments of the company’s audit committee too. Be suspicious of companies that divert too much of the IPO proceeds to ‘general corporate purposes’ or working capital while leaving their expansion plans in the lurch. The use of IPO proceeds is more important for companies raising fresh equity than for those making offers for sale by promoters or private equity investors. But not sticking to promises can sometimes cause a fracas in the latter too. The share price of Sterling & Wilson Solar – a 2019 IPO – now trades at one-third of the IPO price, after it came to light that the company’s promoters did not use the offer-for-sale proceeds, within 90 days as promised, to repay loans taken from the company.

Shareholder shuffle

When bidding for IPOs, retail investors are often influenced by institutions queuing up to subscribe as anchor investors. But with anchor investors subject to just a 30-day lock-in, you can’t gauge at the allotment stage if these institutions are in the stock for a speculative punt or intend holding it long term. Large chunks of a company’s outstanding equity often change hands immediately following a new listing, like IRCTC which saw over 75 per cent of publicly held shares traded on Day 1.

To know if the anchor investors you emulated are long-term holders, it is important to track shareholding pattern disclosures of IPO firms. IPO companies are mandated by SEBI to file their shareholding patterns with the exchanges one day before the IPO as well as at the end of every quarter after listing, along with the quarterly results.

Shareholder shuffles between pre-IPO filings and subsequent updates can tell you whether the big fish who lapped up the IPO have added or pruned their holdings since.

Pay special attention to the lock-in periods for institutional shares and the identity of investors with large holdings. In the SBI Cards IPO in March 2020, mutual funds nearly doubled their holdings from 1.6 per cent just before the offer day to 3 per cent by end of March.

Drop-off in performance

Like newly weds decking up for the big day, companies preparing to go public are often not averse to dressing up their financials to make their growth rates, profit margins or return parameters look better than their peers or industry in their prospectus.

Once the listing is done, quarterly results turn tepid. So if the company you invested in showed a miraculous acceleration in its sales, operating profit margins or return on equity in the quarter or half-year immediately preceding its IPO, keep a close eye on its quarterly results for a few quarters after listing. If you spot a drop-off in business metrics, be prepared to bail out.

Corporate actions

Old habits die hard. Therefore, for some closely held companies that go public, promoters may disregard minority shareholder interest when initiating significant corporate actions even after listing. In many PSU stocks, disinvestment hasn’t made much of a difference to their promoter – the government – subjecting them to untimely takeovers, mergers and share buybacks by diktat, denting their investor perception and market valuations.

A study by Institutional Investor Advisory Services showed markedly lower governance scores for newly listed companies compared to the veterans.

In 2019, barely four years after its IPO in March 2015, the promoters of Prabhat Dairy decided to sell the company’s main revenue source, its dairy business to Groupe Lactalis, a French dairy major, without sharing any plans on how they proposed to compensate shareholders.

Soon after the sale, they came up with a proposal to delist the stock which ran into hot waters with SEBI, with the stock languishing 35 per cent below its offer price. Keep a close watch on the stock exchange filings of IPO firms to ensure that the investment thesis based on which you bought the IPO still holds good.

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