Paytm/Zomato IPO Saga: SEBI Proposes Tougher Norms for Pricing of IPOs

Table of Contents:
1. Introduction
2. Current regulatory framework w.r.t “Basis of Issue Price.”
3. Problem in the existing regulatory framework
4. Recommendation as envisaged in the Consultation paper
5. Concluding Remarks

By Editorial Team

1. Introduction

The term ‘IPO’ remained a household word in the year 2021. It would not be hyperbolic to say that year 2021 was ‘the year of IPOs’ as it was packed with 65 IPOs. Most of the IPOs were successful, few of them were record-breaking successful whereas IPOs of tech companies like Paytm and Zomato left investors baffled and saddened by eroding half of their investments.

Learning from this incident, the market watchdog, the Securities and Exchange Board of India (SEBI) has proposed a stringent disclosure framework for companies coming out with Initial Public Offering (IPO). In this regard, SEBI on Friday, Feb 18, 2022, floated the consultation paper for public comments proposing detailed disclosure to be made. This proposal aims to cover only those companies which don’t fulfill the three-year profitability track record, while the rules remain unchanged for others.

The objective of the discussion paper is to seek public comments on SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations), regarding provisions relating to disclosures for the ‘Basis of Issue Price’ section in the offer document.

SEBI observed that the existing parameters for deciding the IPO price cannot be applied to the new-age tech companies as new-age start-ups listing shares is not like traditional businesses. Therefore SEBI has proposed stricter norms for IPO pricing and sought public comments thereupon to be submitted latest by 05th March 2022.

2. Current regulatory framework w.r.t “Basis of Issue Price.”

Currently, whenever a company comes out with Initial Public Offering (IPO) an issuer is required to make certain disclosure of critical accounting ratios viz. Earnings per share (EPS), price to earnings (P/E), return on net worth (RoNW), and net asset value (NAV) of the Company. Further comparison of such accounting ratios with its peers i.e. companies of comparable size in the same industry is also required. Apart from this, there are no additional requirements.

3. Problem in the existing regulatory framework

SEBI observed that the pricing parameters are typically descriptive of companies/issuers which are profit-making and do not relate to a company/issuer that is loss-making.

According to SEBI, the existing parameters to judge a company’s IPO offer price “may not help investors much in taking investment decisions with respect to a loss-making issuer”.

Further, it was noticed that many new companies are coming out with IPOs. The majority of Companies are new-age technology companies (NATCs). NATCs generally remain loss-making for a longer period before achieving break-even as these companies in their growth phase opt for gaining scale over profits.

Present traditional methods of IPO pricing particularly for a loss-making company, are required to be supplemented with non-traditional parameters like key performance indicators (KPIs) and disclosure of certain additional parameters such as valuation based on past transactions/fundraising by the issuer company.

The current consultation papers focus on adding these requirements as well while deciding the IPO price for a loss-making company. It will help the investors to make a well-informed decision.

4. Recommendation as envisaged in the Consultation paper

Considering the issues and additional disclosures for the “Basis of Issue Price” section were examined by a sub-group of the Primary Market Advisory Committee (PMAC) of SEBI. The PMAC proposed that the following recommendations can be considered by SEBI.

4.1 Disclosure on – Key Performance Indicators (KPIs)

PMAC recommended that every issuer coming out with IPO need to disclose its audited Key Performance Indicators (KPIs) apart from disclosing the financial ratios as required under the SEBI (ICDR) regulations. Relevant and material KPIs during the 3 years prior to IPO is to be disclosed.

Further, the justification should be given how the stated KPIs contribute to form the basis for issue price. KPIs should not be misleading and should be defined clearly, consistently, and precisely.

4.2 Valuation of Issuer Company

The consultation paper also proposes that the Issuer Companies also make some disclosure on valuations. The SEBI proposed the following valuations to be done:

(a) Valuation of Issuer Company based on secondary sale/acquisition of shares (equity/convertible securities) excluding gifts: The issuer should provide the valuation of the company based upon the transactions executed during the 18 months prior to the date of filing of the Draft Red Herring Prospectus (DRHP)/ Red Herring Prospectus (RHP).

The disclosure is to be made only when where either acquisition or sale is equal to or more than 5% of the fully diluted paid-up share capital of the Issuer whether in a single transaction or a group of transactions.

(b) Valuation of Issuer Company based on primary/new issue of shares (equity/convertible securities) excluding gifts: The issuer should provide the valuation of the company based upon the transactions executed during the 18 month, prior to the date of filing of the Draft Red Herring Prospectus (DRHP)/ Red Herring Prospectus (RHP).

The disclosure is to be made only when the issue is equal to or more than 5% of the fully diluted paid-up share capital of the Issuer Company whether in a single transaction or a group of transactions.

Further the SEBI proposed that disclosure of the floor price and Cap price is to be made with respect to the weighted average cost of acquisition (WACA) of primary issue or secondary issue as the case may be. SEBI also specified the disclosure format in this regard.

Further also in order to enable the investors to have a comparative view of the KPIs and other financial ratios for the same period, the comparison of the Issuer’s KPIs and financials ratios viz. EPS, P/E Ratio, Return on net worth, Net asset value, etc. for the last two full financial years and interim period (if any) is also proposed to be included in the offer document.

5. Concluding Remarks

Indian markets witnessed a flood of IPOs by technology companies since mid-2021. Zomato was the first to float a public offering followed by others like Policy Bazaar, Paytm, and Nykaa.

The share prices of all these companies have corrected post their IPOs, prompting criticism amongst market participants saying the issuances were priced steep, leaving little money on the table for the IPO and post-IPO investors.

The current disclosure requirement in the draft offer documents was put in with traditional companies in mind. With more and more new-age, tech-driven companies which are loss-making eyeing to list.

Therefore, considering the current scenario there is a need to strengthen the existing IPO pricing norms for the loss-making companies. As the traditional method of the IPO, pricing does not provide clear insight to prospective investors.

The last date of submitting the comments is Mar 5, 2022. Once comments from the public are received SEBI will issue the modified norms depending upon the public comments.