Harsh Reality of IPO Investing

In the context of some of the recent and upcoming IPOs, the valuation game has come into play. So in this entire game, who is the real winner? the founders?the early investors? or the retail investors?

Let's take Mama Earth IPO example, Indian actress Shilpa Shetty was one of the early investors in the firm, she has invested about ₹6 crores in the brand.Shilpa Shetty might sell her shares in the company and her ₹6 crore investment in the company could yield almost ₹80 crore. So now who's the real winner?

Why do companies have overpriced IPOs?

Raises more capital, for the equity sold to the public. It benefits investment bankers, by increasing their commission proportionate to the company's valuation.

Now comes the psychological factor: the fear of missing out on listing gains.

People assume an IPO is an opportunity to “get in at lower prices”. In reality, by the time you buy shares of a company in its IPO, other parties have almost always invested earlier at lower prices – often, much lower prices.

Before you even learned about the company, there were probably three or four rounds of private investment, and each round sees an increase in the ownership price per share.

One of the main reasons for an IPO is really to allow prior investors—founders, venture capital firms, and significant individual investors—to "cash out" at least a percentage of their initial capital.

Because of this, the majority of IPOs have high asking prices.

They are not priced so that you can buy a piece of the company at a low or acceptable cost, but rather so that "larger fools" can enter when the "privileged few" are leaving.

When investment bankers claim that initial public offerings are "cheap and attractive," don't trust them. Their goal is to determine the IPO price up front (whatever the promoter desires) and then justify it from the ground up.

Recent IPOs failure

Paytm had a market value of $19.5 billion to $20 billion when it went public. The company at the time described the valuation as "appropriate and fair," despite maintaining that it might have set its own price higher in response to demand from outside investors. FSN E-Commerce Ventures Ltd, the parent company of the cosmetics online retailer, announced the price range for its initial public offering at Rs. 1085–1125 per share as it sought a valuation of around $7.4 billion, or Rs. 52,574 crores.

The market value was Rs. 44,041 crore after the stock was listed at the higher price range of Rs. 980, which analysts thought extravagant. Zomato, a food delivery firm, was valued at $12 billion after its IPO was 35 times oversubscribed. All four of these equities have experienced a precipitous decline since being listed. Paytm shares have dropped by over 65%, Zomato shares by roughly 55%, PB Fintech shares by 66%, and Nykaa shares by over 65% when compared to the IPO issue price.

Let's talk about Mama Earth!!!

Folks are concerned about the proposed Rs 2,900 crore IPO of Mamaearth parent firm Honasa Consumer.

With a fresh issue of Rs 400 crore and an offer-for-sale (OFS) of 46.8 million shares, Honasa has submitted a DRHP to SEBI for an IPO that could raise up to Rs 2,900 crore.

When the company raised $52 million in a capital round led by Sequoia in January 2022, it was valued at $1.2 billion.

A year later, Honasa is aiming for a $3 billion valuation through its IPO.

The company has set a valuation goal of more than 1,000 times earnings for its company Mamaearth.

According to different reports, more than 80% of this IPO will go to OFS, which is bad news for market participants. It will be challenging to see a rise in the stock price given the numerous concerns surrounding the super-premium valuation that would mostly grant exits to current owners. By refining both its distribution and product strategy, Mamaearth has been successful in developing a strong D2C brand. However, it's important to keep in mind that it took significant FMCG businesses took decades to get to where they are today, indicating that Mama Earth still has a long way to go.