While the buzz around initial public offers (IPOs) may seem exciting, investing solely on market sentiment can be risky, cautioned a RBI study.
“During bullish phases in the market, enthusiasm and investors’ appetite may cause investors overlook due diligence.
“In this phase, demand for surge, and expectations of substantial listing gains can lead to inflated valuations. However, market reversals can quickly dampen this optimism,” said officials in the study “Fundraising by Indian Small and Medium Enterprises through IPO: Recent Trends and Developments,” published in the latest monthly bulletin.
The officials — Bhagyashree Chattopadhyay and Shromona Ganguly, emphasised that SME IPOs may offer impressive gains in favourable conditions but carry higher volatility and risk during downturns, making due diligence indispensable.
“Investors should carefully evaluate the company’s fundamentals, growth prospects, and risk factors before committing capital. Overall, SME exchanges offer a unique challenge from the regulatory perspective, where there is a need to balance the objective of market development with that of investors’ protection,” they said
The authors underscored that the saying, “Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria”, serves as a crucial reminder for investors in the SME IPO segment.
Merchant bankers & IPO subscription rates
Subscription rates of IPOs managed by the top merchant banks/Lead Managers are on an average twice as those managed by others (non-top lead managers), per the RBI study.
“This demonstrates the importance of the reputation of the merchant bank for attracting potential investors. Their extensive networks, strategic distribution, and strong ties with institutional investors help generate demand even before the IPO launches, significantly increasing the likelihood of oversubscription,” it said.
Chattopadhyay and Ganguly observed that merchant banks are crucial intermediaries in the SME IPO process, as they also play the role of mandatory market maker during the initial years after IPO. Reputed merchant banks are typically more trusted by investors due to their strong track record, global presence, and market expertise.
To analyse the effect of merchant banks’ reputation on subscription rates, the lead merchant banks were divided into two groups – top and non-top. The top category included seven banks managing over 50 per cent of total IPO issue (value) in FY 2023-24 and FY 2024-25, while the remaining banks were classified as non-top.
Oversubscription & Listing Premiums
The study noted that SME IPOs in India have been witnessing massive oversubscription, with listing at significant premiums. Some SME IPOs have surged by 100 per cent post-listing, attracting retail investors primarily seeking listing gains.
During FY 2023-24 and FY 2024- 25 (till October 15, 2024), 224 out of 255 SME IPOs on NSE listed at a premium, while 31 debuted at a discount. Similarly, on BSE, 91 out of 100 SME IPOs saw listing gains, with only 9 listing below issue price.
The authors assessed that SME IPOs’ listing premiums (measured as percentage gain of closing price on listing date over the issue price) in India tend to range from 0 to 400 per cent on the listing day, depending on factors like demand, merchant banker reputation, and the market sentiment.
In contrast, mainboard IPOs, involving larger, established companies, undergo stricter regulatory scrutiny and attract a broader investor base, including institutional investors, high net worth individuals and mutual funds. As a result, their listing premiums tend to be more stable, typically averaging between 10 to 40 per cent.
The Officials said there is a positive correlation between SME IPOs’ subscription levels and listing day returns, underscoring the crucial role of retail and institutional demand in influencing IPO performance. Higher oversubscription levels often indicate strong market sentiment, leading to substantial listing gains.