New Delhi: Consider the following situation. A small bike dealership in Delhi opts to go in for an Initial Public Offering (IPO) to raise resources. It goes in for a relatively modest issue, looking to raise Rs 12 crore. In its disclosures, it mentions several risks to its own business—including potential penal action by the government, related party transactions, high debt levels, and a negative cash flow. Yet, the IPO is oversubscribed nearly 400 times, receiving bids worth a staggering Rs 4,800 crore.
This is not just the story of Resourceful Automobile, issuer of the IPO and owner of two bike dealerships in Delhi, but also of the state of the Indian stock market, the irrational exuberance driving it, and risks faced by investors who are blindly riding the market surge.
The fact that the IPO is oversubscribed means that the number of applications for shares the bike dealership has received from investors is greater than the number of shares available for sale.
Resourceful Automobile, set up by Rahul Sawhney, Bindu Sawhney and Megha Chawla in 2018, offered 10.2 lakh shares at a fixed price of Rs 117 and was expecting to raise Rs 11.99 crore. The issue opened on 22 August and closed on 26 August.
According to data with the Bombay Stock Exchange (BSE), the subscription window closed with bids totalling nearly 40.8 crore shares, translating to a subscription that was 398 times the number of shares offered. The bids totalled nearly Rs 4,800 crore.
Data also shows that retail investors were the most active participants, with aggregate demand of 24.1 crore shares, which works out to a subscription of nearly 500 times the number of shares on offer for this category of investors.
Institutional investors, in comparison, subscribed to the offer to a level of just 12 times the shares on offer for them.
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Disclosures and ignorance
What is particularly notable about this exorbitant subscription level is that the company had made clear disclosures of several risks to its business—23 internal risks and 15 external risks—which included several factors that could significantly hurt the business.
Yet, according to stock market analysts, the enthusiasm with which retail investors flocked to this IPO is emblematic of the current problems with India’s retail investors—a recency bias that induces the belief that just because markets have risen recently, they will continue to do so, and the lack of knowledge among new investors who forego doing any research before investing.
“People are in danger of losing all their investments, and there is an insidious role played here by influencers and a section of the media,” Ajay Bodke, an independent market analyst, told ThePrint. “In a lot of TV shows on markets, the experts that are called don’t do any meaningful analysis of the risk factors. They only talk about the potential gains.”
Rising profits, but risks galore
If you just looked at the revenues and profits of Resourceful Automobile, you would be forgiven for thinking that the business was small but growing rapidly. The company’s revenues grew from Rs 11 crore in 2020-21 to Rs 18.8 crore in 2022-23. The latest data for 2023-24, which is as of 29 February 2024, shows its revenue at Rs 16.5 crore.
Profits grew from Rs 16,000 in 2020-21 to Rs 1.5 crore in 2023-24.
However, on the flip side, the company is also taking on rising amounts of debt. Its total borrowings grew from Rs 2.7 crore in 2020-21 to Rs 9.9 crore in 2023-24. Further, the company has reported a negative cash flow for the last two financial years, as of October 2023. This basically means the company had been spending more than it was earning during this period, on a rolling basis.
However, apart from this, the company also highlighted several risks that could negatively impact its business in a substantial manner. While some of these are generic, such as the Indian economic performance and the actions of competitors, others are much more specific to Resourceful Automobile.
Business concentration, possibility of penal action
The company, which operates two showrooms under the name ‘Sawhney Automobiles’, primarily deals in Yamaha bikes and only operates in Delhi.
“Our company’s growth is highly dependent on the growth of our OEMs [original equipment manufacturers] like Yamaha Motors (Commercial),” Resourceful Automobile’s pre-IPO Draft Red Herring Prospectus (DRHP) said. “We are subject to concentration risk in the event of any adverse events or financial distress, including bankruptcy, impacting Yamaha Motors (Commercial).”
A DRHP is a preliminary document filed by a company with regulatory bodies before launching an IPO.
The DRHP document also mentioned that the company has included inaccuracies in relation to regulatory filings made with the Registrar of Companies and that it “has made non-compliances of certain provisions under applicable law”.
“Although no show cause notice have been issued against the company till date in respect of above, in the event of any cognisance being taken by the concerned authorities in respect of above, penal actions may be taken against the company and its directors, in which event the financials of the Company and its directors may be affected,” the document said.
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Related party transactions & other risks
In largely the same vein, the company also disclosed that it has entered into “and will continue to enter into” related party transactions (transactions between two companies with a pre-existing business relationship) that “may potentially involve conflicts of interest”.
The company said that while it believed that all such related party transactions are legitimate business transactions conducted on an arms’ length basis, “we cannot assure you that we could not have achieved more favourable terms had such arrangements not been entered into with related parties”.
“Further, we cannot assure you that these or any future related party transactions that we may enter into, individually or in the aggregate, will not have an adverse effect on our business, financial condition, results of operations and prospects,” it added.
It also said that the related party transactions it has entered into already or will enter into in future “could potentially involve conflicts of interest which may be detrimental to our company”.
Other risks it mentioned included basic things like its insurance cover not being adequate to cover losses in the event of a business disruption. It also highlighted its high debt levels, saying its loans may be recalled by the relevant lenders at any time.
“We may not be able to generate sufficient funds at short notice to be able to repay such loans and may resort to refinancing such loans at a higher rate of interest and on terms not favourable to it,” the company said.
‘Greedy’, inexperienced investors
What all of these disclosures, and the retail investors’ enthusiasm nevertheless show is that India’s retail investors are blindly riding the current bull run in the market, oblivious of any risks.
“Out of the 16 crore demat accounts now, about 75 percent are newbies that entered the market post the Covid-19 crash,” V.K. Vijayakumar, chief investment strategist at Kochi-based investment services firm Geojit Financial Services, explained to ThePrint.
“They have only seen the market going up, and so the recency effect plays a factor here, making them believe the market will only go up.”
He further said that the vast majority of retail investors are not doing their due diligence which, he claimed, was “a growing problem”.
“They don’t have any idea of valuations. Far from doing due diligence, they are not even doing commonsensical monitoring,” he said.
According to Bodke, the stock market oscillates between greed and fear.
“It went from extreme fear in March 2020 at the onset of the Covid-19 pandemic and lockdowns to the current scenario of extreme greed where people believe they will double their money in the markets every few months,” he explained.
A bleak reality
However, the reality is that valuations of companies fall more often than they rise, especially at the small and mid-cap level, Bodke said, citing data from another long-time stock market analyst Devina Mehra, the founder, chairperson and managing director of First Global, a Mumbai-based portfolio management company.
Last week, Mehra had posted on X (formerly Twitter) stating that an analysis of companies on the National Stock Exchange between December 2017 and June 2024 found that while 45 companies went up a category (from mid cap/small to large or small to mid cap), 78 went down a category or more—5 large caps became small caps, 20 large caps became mid caps and 53 mid caps became small caps.
“A large number of companies have disappeared and many still do, especially in every small cap bubble burst, never to be seen (or traded) again,” Mehra wrote.
(Edited by Radifah Kabir)
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