IPO Valuation vs. Listing Performance: What Should Investors Examine?

Listing Day Is a Poor Scorecard

Every big Indian IPO is judged on one day. Did it list at a premium? How many times was it subscribed? What was the grey market premium? A big listing gain makes the IPO look like a success, and a listing below the issue price makes it look like a failure.

Listing day mostly measures one thing: how many people wanted shares compared with how many were available. That is demand, not value. A company can be overpriced and still list higher, and fairly priced and still list lower.

The Mechanics Behind a Listing Pop

Most Indian IPOs use book building. The company and its bankers set a price band, investors bid within it, and the final price is usually set at the top of the band.

The shares are split between investor groups. For a company with a record of profits, at least 35% goes to retail investors, at least 15% to non-institutional investors, and up to 50% to qualified institutional buyers (QIBs). Loss-making companies must give at least 75% to QIBs, and retail investors get at most 10%.

When an issue is heavily oversubscribed, most applicants get few or no shares. Those who missed out buy on listing day, and that scramble can push the price up regardless of value.

Two more factors add to the noise:

• Grey market premium (GMP). This is an unofficial price at which IPO shares trade before listing. It is not regulated by SEBI, and it reflects sentiment, not analysis.
• Anchor investors. Large institutions can buy up to 60% of the QIB portion a day before the issue opens. Their names give comfort, but half of their shares are locked in for only 30 days, and the rest for 90 days.

Since December 2023, listing must happen within three working days of the issue closing (T+3), so this whole process now takes less than a week.

Listing Gains and Value Are Different Things

Four well-known listings show how loosely listing day connects to anything else.

Paytm closed its first day 27% below its issue price. Its business in later years is a separate story from that first day, as are the stories of the other three. In each case, what happened over the following years depended on earnings and on how the market's view of the business changed, not on the opening trade.

The Offer Document Comes First

The red herring prospectus (RHP) filed with SEBI and the exchanges is long, but a few sections do most of the work.

Fresh issue vs offer for sale. A fresh issue brings new money into the company. An offer for sale (OFS) only moves existing shares from current owners, such as promoters or private equity funds, to new investors. The company gets nothing from an OFS. A large OFS is not bad in itself, but it tells you who wants to sell and at what price.

Objects of the offer. This section says how the fresh money will be used: repaying debt, building capacity, or "general corporate purposes." Specific uses are easier to track later than vague ones.

Basis for offer price. Here the company compares its valuation with listed peers and gives the key performance indicators it thinks matter. It also discloses the prices at which shares changed hands before the IPO. A sharp jump from a recent private deal price to the IPO price deserves a question.

Risk factors and restated financials. Risk factors are long and partly boilerplate, but the specific ones, such as dependence on one customer, pending litigation or regulatory approvals, matter. The restated financial statements show three years of results on a consistent basis.

A Worked Example: Pricing an IPO Against Peers

Illustrative example. A company prices its IPO at ₹500 per share. Its earnings per share for the last full year was ₹10, so the issue P/E is 50. Three listed peers trade at an average P/E of 35.

A 43% premium to peers can be justified, but only by something specific: faster growth, higher returns on capital, or a stronger market position. If the company's profit has grown at 15% a year while the peers grew at 20%, the premium is hard to explain. If it grew at 35% a year with a higher return on capital, the premium may be fair.

The useful test is the same as for any listed stock: work out what growth the price assumes, and judge whether the business can deliver it. Use the P/E ratio as a starting point, not the answer.

The Calendar After Listing

Lock-ins create predictable dates when more shares can be sold.

• 30 and 90 days after allotment: the two halves of the anchor lock-in end.
• Six months: pre-IPO shareholders other than the promoters' minimum contribution can usually sell.
• 18 months (or three years, if the money funds capital spending): the promoters' minimum contribution of 20% is released.

These dates do not mean prices must fall, but they do bring new supply. Check them in the RHP before buying.

A Checklist Before Applying

1. Split the issue into fresh issue and OFS, and note who is selling.
2. Read the objects of the offer and the planned use of funds.
3. Compare the issue P/E or EV/EBITDA with two or three listed peers.
4. Check the prices of recent pre-IPO share deals.
5. Read the specific risk factors, not just the headings.
6. Note the lock-in end dates.
7. Ignore the grey market premium.

The Reframe

An IPO is a listed company you have not yet had time to study. Listing day tells you how popular it was. The offer document tells you whether it was worth the price.