FORTIFICATION OF IPO NORMS:
ANALYSING THE LEGALITY OF INFLATED VALUATIONS AND THE PROTECTION OF INVESTOR INTEREST
Ananya Soni & Vyshnavi Praveen
(Final Year students at Tamil Nadu National Law University)
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ABSTRACT
It is not hyperbolic to say that 2021 was the year of the IPOs, with the year witnessing about 110 offerings and Indian companies raising nearly 18 billion dollars. These IPOs included the trading debuts of technology driven unicorns like Zomato Ltd., FSN E-Commerce Ventures Nykaa Ltd. and One 97 Communications Paytm Ltd. During the stock market correction, the shares of such new-age technology firms crashed heavily and the investors who bought such IPOs underwent heavy losses. This phenomenon raised questions regarding the inflated valuations that were sought by these technology firms. This led to SEBI introducing a slew of changes, which aim at tightening the regulations that govern IPOs. This research paper will analyse the legality of the inflated valuations used to price the IPOs, with a special focus on investor interest. Further, this paper will also discuss the measures taken by the SEBI towards the protection of investor interest in the same regard.
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Keywords: Tech unicorns, Technology firms, Amendments, Capital Markets, Strict regulations
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I. INTRODUCTION AND BACKGROUND
Within a very short period of the COVID-19 outbreak, markets across the world faced huge losses. This was due to the fear of the spread of disease prevalent in the minds of investors. In India, Nifty 50 faced its second worst fall since inception, with the loss of 35% in March 2020 alone[1]. However, after the COVID-19 lockdown and the elevation of investor sentiment, the market eventually started gaining momentum. The IPO market was also positively affected by this momentum[2].
Post the pandemic, the average number of investors subscribing to IPOs has nearly tripled, with about 10 lakh new de-mat accounts being opened each month during the COVID-19 induced lockdown[3]. These are unprecedented numbers. Some of the biggest IPO stock listings in 2021 were of new age, technologically led companies. Interestingly, 2021 was when digital platforms and technology became an integral part of the Indian cultural tapestry. The Indian population was extremely intrigued and attracted to the opportunity of fulfilling their mundane needs and wants, and completing their chores by weaponizing the power of an application. Taking advantage of this trend and the growing appetite of retail investors, several technology companies filed for their IPO[4]. The wave of public listings in the Indian start-up ecosystem was a consistent undercurrent that was prevalent throughout 2021. There were about 110 offerings, and Indian IPOs raised about 18 billion dollars[5], which is a watershed phenomenon.
The most popular IPOs were of the companies called Zomato Ltd., One 97 Communications Paytm Ltd., and FSN E-Commerce Ventures Nykaa Ltd. The frenzy behind the IPOs for these companies can be explained by multiple factors. One reason that the frenzy can be attributed to is that these companies are common household names. The relatability of these companies was able to spark investor interest, and create a buzz in the market, which drove investors towards the purchase of the IPOs of the companies. However, a major reason behind the frenzy has been found to be that the average age of a new de-mat holder is only 29 years, and that young(er) people are more likely to invest in new age, technology led companies[6]. Further, the government has been pumping capital into the economy to combat the negative effects of the pandemic, which has flowed through India’s fiscal system to finally end up in the stock market. This has resulted in an increase in the liquidity in the market, and this has empowered investors with the ability to subscribe to the securities of new age companies[7]. From these phenomena, it appears that the Indian new age, technology led companies have entered and begun expanding in the capital markets.
Unfortunately, it was witnessed that these stock listings soon lost their edge and eroded in value. For instance, the One 97 Communications Paytm Ltd. IPO was listed at a price band of Rs. 2080 to Rs. 2150 per share, but its last traded price is Rs. 465.20 per share[8]. From this it is inferred that the value of the security has dropped by about 78 percent. The FSN E-Commerce Ventures Nykaa Ltd. IPO was listed at a price band of Rs. 1085 per share to Rs. 1125 per share, but its last traded price is Rs. 176.05 per share[9]. From this it is inferred that the value of the security has dropped by about 84%. The Zomato Ltd. IPO was listed at a price band of Rs. 72 per share to Rs. 76 per share, but its last traded price is Rs. 63.70 per share[10]. From this it is inferred that the value of the security has dropped by about 16%. Evidently, this has led to heavy and substantial losses for the investors who purchased the IPOs.
A common criticism that all of the offers made by such new age, technology led companies is that the companies listed their securities at inflated valuations. For instance, One 97 Communications Paytm Ltd. reported a net loss of Rs. 2942 in financial year 2019 to 2022[11], but still decided to issue an IPO at a valuation of about 26 times the estimated price to sales ratio calculated for the financial year 2023. Similarly, Zomato Ltd. has consistently reported losses, and is yet to turn profitable[12]. Even then, it decided to issue its IPO at a valuation which was about 25 times the enterprise value to sales in financial year 2021. These loss making new age, technology led companies did not disclose any concrete or tangible reason behind their excessive valuations. At this juncture, it is notable that although FSN E-Commerce Ventures Nykaa Ltd. did report a profit and projected growth for the financial year 2022 and financial year 2023[13], it did not disclose its roadmap to profitability or give data about any comparables. The company showed growth projections for the next 20 years in its prospectus, without any definite roadmap or plan, or reasons to substantiate their optimistic projections.
Black’s law dictionary defines misrepresentation as “the act of making a false or misleading assertion about something”. Presenting excessive valuations to investors, and projecting profits with no concreate reason or rationale, while riding on market frenzy, appears to be misrepresentation. Therefore, there is a need to analyse the legality of this misrepresentation under the SEBI’s regulatory regime.
II. SCOPE AND LIMITATION
The scope of this research paper is constrained to the Indian primary markets, and the steps taken towards addressing the ill effects of inflated valuations of IPOs by the Indian capital markets regulator, i.e., the SEBI. The limitation of this research paper is that the mitigation steps have been announced by the SEBI in a press release, and the amended document is not available for reference. Further, the developments are all very recent and the reforms taken are nascent in nature. Therefore, there is no empirical evidence available with regard to the impact of the reforms, and their efficacy.
III. AN ANALYSIS OF THE LEGALITY OF USING INFLATED VALUATIONS TO PRIE IPOs
The valuations utilised by such new age, technology led companies were not supported by sufficient disclosures, and the companies simply used the market frenzy and the bullish trend of the market to price their securities at extremely high price bands. Presenting excessive valuations to investors, and projecting profits with no concreate reason or rationale, while riding on market frenzy, appears to be misrepresentation, and it is surprising that an investor centric regulator like SEBI has allowed this misrepresentation, as it is clearly against investor interest.
It is evidenced that even before the entry of these technology companies, the “correct” valuation of IPOs had been a factor of concern from the regulatory perspective[14], especially in the case of new age companies which do not have comparables. Unfortunately, the IPOs of the new age, technology led companies flooded the markets with inflated and mystical valuations. For instance, at one point the valuation of the securities of PB Fintech Ltd (PolicyBazaar) were higher than the shares of some leading Indian insurance companies[15]. Since PB Fintech Ltd (PolicyBazaar) simply links the insurance companies to the target consumers, it is particularly absurd that the aggregator became larger than the actual seller of the products.
Despite the inherent absurdity and the blatant misrepresentation, there was no perceivable regulatory or statutory mechanism to deem inflated valuations to be illegal or even unacceptable[16]. It is an accepted phenomenon in the primary market that the investors always race with other investors to subscribe to IPOs, and are willing to pay premium prices even at the cost of due diligence. Further, at least on the outset, most companies attempt to price their IPOs at the “best valuation”, and they make a judgment call on the basis of various internal and external factors. The law and active regulatory mechanisms allow[17] the companies to make the said judgment call. The investors are free to operate in the primary markets, and as per the norm, they are required to operate after doing their personal due diligence, while bearing all sweet as well as bitter fruit of the result.
Therefore, it is evidenced that unless there is apparent instance of fraud as per the regulatory regime, inflated valuations are not against the letter of the law. This phenomenon does not invalidate the heavy losses faced by the investors due to the excessive valuations used by the new age, technology led companies. Considering the position of the SEBI, it is almost elementary that the Board would have taken cognisance of the same.
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IV. STEPS TAKEN BY SEBI TOWARDS PROTECTING INVESTOR INTEREST
The Preamble to the Securities and Exchange Board of India Act, 1992 categorically states that the Board has been established to protect the interests of investors. This implies that the Act is an investor-oriented statute, and the Board must endeavour to execute its responsibility towards investors to the fullest extent. As it has been established that the use of inflated valuations towards pricing IPOs is averse to investor interest, it is only elementary that the SEBI took cognisance of the same and introduced regulatory mechanisms to eliminate the fallacies.
Prima facie, it appears that the Board should have taken measures to directly regulate the prices of the offerings, and disallowed any listings at exorbitant prices. However, this approach is far too conservative, especially since the investors are free to purchase securities if they deem them to be worth the price. That being noted, it is important to focus on the importance of transparency between the issuing company and the investors, as transparency empowers the investors to foster trust, which furthers the development and growth of the business entity. This facet was confirmed by SEBI’s chairperson Madhabi Puri Buch at an event organised by the Federation of Indian Chambers of Commerce and Industry (FICCI)[18]. Since the abolition of the Controller of Capital Issue, regulatory bodies do not have the power to interfere with the pricing of securities, nor can they interfere with the investors’ decision to purchase securities at the price point of their choice. Chairperson Buch clarified the same, when she confirmed that companies will be allowed to decide the price and valuation of their securities at their own discretion, and the Board cannot interfere with the same[19].
Therefore, the Board has taken a measure to protect investor interests while also remaining within its scope of powers. It has enhanced disclosure norms for companies that are IPO bound, with the intention of addressing the concern that the traditional financial disclosures were inadequate for the firms that typically tend to remain loss making for prolonged periods of time. The Board has mandated that all entities issuing IPOs are required to disclose key numbers related to several key performance indicators in the Draft Red Herring Prospectus, which are not usually or traditionally a part of the traditional financial statements in the offer documents. The indicators that such issuers share with private equity investors are equally as relevant to the public in the primary market as well. With the new disclosure rules, the investors will be equipped with better information to make their investment decisions, and further reduce information asymmetry[20].
Further, these issuers will also be required to calculate the price per share on the basis of the past fund raising. In other words, the entities issuing IPOs will be required to disclose the price per share set based on the transactions made in the 18 months that were prior to the specific issue. It is important to note that if the issuer is in a relatively nascent stage and/or has not made any transactions in the past 18 months, then the issuer is required to disclose the details of the last five primary or secondary transactions made, which cannot be older than three years from the date of issue.[21]
The disclosure of Key Performance Indicators (KPIs) and the price per share of the issuer on the basis of past fundraising and previous transactions done by the issuing company have to be disclosed under “Basis for Issue Price” section present in the offer document, and in the Price Band Advertisement. To illustrate, if an issuing company has sold its equity to an investor at Rs. 100 six months prior to issuing the IPO, but wishes to issue the IPO at the price of Rs. 450, the SEBI will absolutely allow it, as long as the issuing company makes disclosures with regard to the disparity in price. This is in line with the issuing company’s freedom to price their securities at their will, and the investor’s freedom to make a business decision. With the reform measures, the Board is attempting to ensure that the investors are better equipped with the information needed to make the investment decision.
Additionally, it is required from the issuing companies that they disclose the Weighted Average Cost of Acquisition, on the basis of primary and/or secondary transactions. In furtherance of the same, it is required that they display the IPO floor price and cap price as a multiple of the Weighted Average Cost of Acquisition in the offer document and in the price band advertisement. In addition, the Board requires the issuer companies’ committee of independent directors to recommend/declare that the price band is justified on the basis of KPIs and other quantitative factors, in relation to the Weighted Average Cost of Acquisition of the primary issue and/or of secondary transactions.[22]
Therefore, it is evidenced that the SEBI has begun to embrace data, and has introduced a slew of reforms in an attempt to mitigate the infringement of investor interest caused by the use of inflated valuations towards the pricing of IPOs. The SEBI’s requirement of making full and detailed disclosures regarding the valuation of the IPOs is indicative of the Board’s desire to embrace data. While the Board is adamant that it cannot regulate the pricing of the IPOs or the investors’ choice to purchase such IPOs, it is confident that the disclosure mechanisms will equip the investors with the information that is required to make an informed and sound investment decision. As these are very nascent developments, there arises the need to estimate the efficacy of these reforms towards serving the purpose for which they have been promulgated.
V. CONCLUSION
The new age, technology led IPOs were extremely popular household names, which resulted in the investors, especially the younger investors, being caught in the market frenzy. The IPOs were oversubscribed, and resultantly their crash caused a very adverse effect on a large number investors, even when the mechanisms used by the companies were in compliance with the prevailing regulatory structures.
True to its nature, the SEBI did take cognizance of the matter, and issued a slew of reforms with the aim of tightening the regulations that govern IPOs.
However, the measures announced by the Board remain to neglect the prevailing fallacies of the Regulations, which have a large impact on the well-being of the Indian investors. The Regulations are available only in the English and Hindi language, and both versions host an extremely complicated and technical vocabulary and writing style, thereby hindering accessibility and utility. The SEBI is responsible for the welfare of every investor in the country, and therefore, presenting regulations in a manner that is not understandable to a large section of the investors is counter-productive. Therefore, it is evidenced that the accessibility issues in the Regulations must be addressed, in order to ensure the utility of further reformatory measures.
It is pertinent to note that the mitigation steps have been announced by the SEBI in a press release, and the amended document has not been released.[23] In the release, Chairperson Buch has simply said that the companies are required to disclose the rationale behind the valuation. She has not made any comment on the specifics of these disclosures. If the subsequent amendments to the Regulations fail to detail the requirement of the disclosures needed regarding the disparities in price, the issuing companies will be able to give vague and abstract reasoning behind the excessive valuations. This will remain to be against investor interest. Therefore, it is necessary the Board mandates the issuing companies to disclose information in a specific manner, as opposed to highly interpretable information.
There has been no information on the part of the SEBI regarding the release of the amended regulations, but it can be said with surety that the amendments are a step in the right direction and will further the interests of the investors, as long as the prevailing fallacies are addressed.
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[1] Dr Prateek Gupta et al, Corona Virus Impact on Indian Stock Market and Industry during Pandemic: A Case Study, 27(3) CIBG (2021).
[2] Madhu Maheshwari et al., Short-term IPO Performance Amidst Fearof COVID-19 Pandemic: Evidence from India, Vis. J. Bus. Perspect. (2022).
[3] Sundar Sethuraman, Explained: What is driving so many retail investors to the IPO market?, The Business Standard (Mar. 11, 2021), https://www.business-standard.com/article/markets/explained-what-is-driving-so-many-retail-investors-to-the-ipo-market-121031100029_1.html.
[4] Nisha Holla, India’s Unicorn Step-Function Growth Signals the Emergence of its Innovation Ecosystem, ORF (Apr. 28, 2022), https://www.orfonline.org/expert-speak/indias-unicorn-step-function-growth-signals/.
[5] Filipe Pacheco et al, The harsh reality of 5 famed Indian IPOs: $18 billion-wipeout!, The Economic Times (Nov. 17, 2022), https://economictimes.indiatimes.com/markets/ipos/fpos/an-18-billion-wipeout-is-harsh-reality-of-5-famed-indian-ipos/articleshow/95577078.cms.
[6] Aditya Kondawar, View: How tech IPOs differ from those of traditional firms, THE ECONOMIC TIMES (Nov. 09, 2021), https://economictimes.indiatimes.com/tech/catalysts/how-tech-ipos-differ-from-those-of-traditional-firms/articleshow/87610067.cms?from=mdr.
[7] The IPO Rush: Why are so many companies going public in 2021?, ANGEL ONE (Aug. 05, 2022), https://www.angelone.in/blog/the-ipo-rush-why-are-so-many-companies-going-public-in-2021.
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[8] One 97 Communications Paytm Ltd., MONEY CONTROL (Nov. 26, 2022), https://www.moneycontrol.com/india/stockpricequote/online-services/one97communicationspaytm/OC03.
[9] FSN E-Commerce Ventures Nykaa Ltd., MONEY CONTROL (Nov. 26, 2022), https://www.moneycontrol.com/india/stockpricequote/miscellaneous/fsne-commerceventuresnykaa/FEV.
[10] Zomato Ltd., MONEY CONTROL (Nov. 26, 2022), https://www.moneycontrol.com/india/stockpricequote/online-services/zomato/Z.
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[11] Chiranjivi Chakraborty, Loss making, but IPO bound! When can Paytm deliver profit?, THE ECONOMIC TIMES (May 29, 2021), https://economictimes.indiatimes.com/markets/ipos/fpos/so-when-is-ipo-bound-paytm-likely-to-turn-profitable/articleshow/83007553.cms?from=mdr.
[12] Nasrin Sultana, Analysts vary of Zomato IPO’s big valuation, LIVEMINT (Jul. 14, 2021), https://www.livemint.com/market/stock-market-news/analysts-wary-of-zomato-ipo-s-big-valuation-11626196516220.html.
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[13]Nykaa, Annual Audited Report (2022),
[14] Akshay Sakharkar et al., Pricing and Performance Evaluation of Initial Public Offerings (IPO’s): Evidence From Indian Stock Markets, 6(1) IJRAR (2019).
[15] Nikhil Rampal, Zomato, PayTM, Nykaa — how investors have lost big time after these big tech IPOs, THE PRINT (Jul. 27, 2022), https://theprint.in/economy/zomato-paytm-nykaa-how-investors-have-lost-big-time-after-these-big-tech-ipos/1056410/.
[16] Parimala Veluvali, Legal Framework and Governing Design for IPOs in India, RETAIL INVESTOR IN FOCUS (2019).
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[17] Ibid.
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[18] Priyanka Gawande et al, Price IPOs as you like but disclose fully: SEBI, LIVEMINT (Sept. 14, 2022), https://www.livemint.com/market/ipo/price-ipos-as-you-like-but-disclose-fully-sebi-11663088397719.html.
[19] IPO Pricing Is Company's Discretion, But Full Disclosure Mandatory: Sebi Chairman, BW DISRUPT (Sept. 13, 2022), https://bwdisrupt.businessworld.in/article/IPO-Pricing-Is-Company-s-Discretion-But-Full-Disclosure-Mandatory-Sebi-Chairman-/14-09-2022-446479/.
[20] Riya Singla et al., Analyst optimism, uncertainty and regulation: evidence from the Indian market, MANEGERIAL FINANCE (2023).
[21] SEBI tightens IPO rules; mandates issuer to disclose offer price based on past transactions, fund raising, THE HINDU (Sept. 30, 2022), https://www.thehindu.com/business/Industry/sebi-tightens-ipo-rules-mandates-issuer-to-disclose-offer-price-based-on-past-transactions-fund-raising/article65956121.ece.
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[22] Sebi tightens disclosure norms for IPOs, THE ECONOMIC TIMES (Sept. 30, 2022), https://economictimes.indiatimes.com/markets/ipos/fpos/sebi-tightens-disclosure-norms-for-ipos/articleshow/94565711.cms.
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[23] Ashish Rukhaiyar, Sebi has made crucial changes to how IPOs are approved. What are they? Business Today (Oct 30, 2022), https://www.businesstoday.in/magazine/markets/story/sebi-has-made-crucial-changes-to-how-ipos-are-approved-what-are-they-349736-2022-10-13.
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