SMEs drive robust IPO activity in 2024 as 117 companies hit Dalal Street in H1; will the trend continue?

The Indian IPO market continues to thrive without any significant slowdown as a multitude of companies make their debuts on Dalal Street daily, buoyed by sustained participation across all investor segments.

Investors are notably enthusiastic about IPOs, particularly those from small and medium enterprises (SMEs), which have attracted considerable attention and interest. Many of these SMEs, which entered the public market in the past year, have received overwhelmingly positive responses from retail and non-institutional investors.

Following the record number of companies that went public in 2023, the momentum carries forward into 2024. According to Trendlyne data, 153 companies in H1FY24 have made their stock market debuts, with 117, accounting for 77%, originating from the SME segment.

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During the same period last year, 70 SME companies raised funds from the capital market, which shows a current-year growth of 67%. According to the Draft Red Herring Prospectuses (DRHPs) of several companies, the primary objectives for raising funds include meeting debt obligations, funding expansion initiatives, and fulfilling working capital needs.

Significantly, volumes from offer-for-sale (OFS) transactions have surpassed fresh capital issuances, as private equity (PE) and venture capital (VC) investors have exited through both primary (IPOs) and secondary (block deals) market routes. PE firms have taken advantage of bullish conditions in the secondary market to divest their stakes, either wholly or partially.

The record number of SME IPOs has caught the attention of both SEBI and the exchanges. Recently, the National Stock Exchange imposed a price control cap of 90% over the issue price for SME IPOs. This rule ensures that listing-day gains cannot exceed 90% of the issue price.

Several SMEs have experienced multibagger listing gains, sparking concerns about market froth. For instance, Shivalik Power recently debuted with a premium of 211% over its issue price. Investors are closely monitoring grey market premiums as indicators of listing-day performance, with some even basing their IPO participation decisions on these premiums.

Also Read: Will NSE's new rule for SME IPOs curb speculation or hinder growth?

Meanwhile, some industry experts believe this measure will discourage speculation, while others are concerned it could negatively impact valuations. Earlier this year, SEBI chairperson Madhabi Puri Buch highlighted “signs of manipulation in the SME segment.”

Amidst these developments, Kush Gupta, Director at SKG Investment & Advisory, offers insights into the key factors fueling interest in companies raising funds, along with his perspective on the current IPO boom.

Edited excerpts:

What factors are motivating companies to access the Indian primary market for capital raising?

SME IPOs have seen their most successful years in 2022 and 2023. Last year, SME IPOs accounted for 75% of the new listings. More and more companies are coming out to explore the capital markets. One of the main factors behind this IPO rush is the newfound financial prudence on the part of the promoters.

Traditionally, bank loans have been the only way for small companies to raise funds for their expansion and working capital requirements. Debt puts an undue burden on the business and also takes away the company's risk-taking appetite. With equity capital, promoters are able to grow without fear, and companies have become more profitable without the cost of interest.

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SEBI's efforts towards easing the process also have a big role to play. Due to widespread knowledge and reduced costs, companies now know that their interests are being looked after. They now have the confidence to explore unchartered territories and navigate the complexities of the stock market.

What do you attribute as the primary catalyst behind the robust subscription rates observed in the majority of SME IPOs?

The subscription rates that we have seen lately are off the charts and more than anyone ever expected. Last year, the average oversubscription of the top 10 IPOs was over 641 times. I think there are two major catalysts behind this phenomenon.

Firstly, the listing day's success has been tremendous. In May & June alone, there were 10 IPOs that gave more than 100% gain on the listing day, with 6 of them giving more than 200% gain. Investors are seeing this as a golden opportunity to gain quick returns. In spite of the fact that oversubscription leads to less allocation of shares, whatever shares are allocated are giving enough returns for investors to show interest.

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Secondly, SMEs have shown stability in the last 2-3 years, so investors who are not seeking listing day gains have come to truly believe in SMEs as an asset class that is risk-rewarding and provides diversification. Even wealth managers who are trying to provide alpha to their clients are finding it useful to suggest SME stocks and enhance returns.

In your assessment, how sustainable is the current IPO boom expected to be?

In my experience, anything that outperforms the broader market by a high margin is not sustainable. I think we will continue to see an increase in the number of listings, IPO market will remain busy because that’s a fundamental shift in India’s equity landscape.

SME promoters now believe in raising capital through IPOs instead of debt, and investors are ready to support them. What will be short-lived are the other tangibles around SME IPOs, such as listing day gains, oversubscriptions, and annualised returns that are crossing 100–150%.

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These are signs of an overheated market, and we could see this trend going down. SEBI is also stepping in to plug some loopholes; they believe there is a lot of froth that could hurt retail investors. IPOs will continue to hit the primary market, but investor returns should definitely taper down as they are not sustainable.

What suggestions would you recommend for retail investors before entering the IPO market?

I think retail investors have enjoyed a very good run for the past two years. Some of the companies that got listed are truly amazing and great businesses, and they were rightfully passing on the gains to the shareholders. Going forward, one should not get carried away and invest in every SME IPO that comes along their way. I always ask two major questions before deciding on an IPO.

First is the valuation. A high PE in an already overvalued market is a double whammy. Investors don’t need to be financially savvy to do simple math and divide the market cap of an upcoming IPO company by its profit after tax to judge if they are overpaying for the stock.

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The second and widely ignored factor is that a lot of IPOs are becoming a vehicle for existing promoters to sell their stakes to the public, and the capital raised isn’t actually going into the company for growth. A shareholder should invest in a company so their funds can help the company grow, not just to make the promoter rich. It is understandable that the existing promoters will cash out, but to what extent is the key question.

I feel that retail investors should pay more attention to the finer print and keep these factors in mind before investing.

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before taking any investment decisions.