Emerging Giants or Investors’ Trap?

Is the hype around SME IPOs justified?

Anyone who is into the Indian stock market will recall Jaspal Bhatti's iconic PP Waterballs sketch. In it, Bhatti glorifies the launch of an absurd IPO for a street vendor selling golgappas, portraying how investors can get swept up in the hype. As the IPO balloons, Bhatti books gains for himself while leaving unsuspecting investors trapped in a financial mirage. It’s all comedy, right? But what if that fictional world is no longer so far from reality? As scrutiny mounts on many recent Small and Medium Enterprise Initial Public Offerings (SME IPOs), the line between satire and the actual market starts to blur. Today, many of these IPOs have raised red flags due to opaque financials, questionable valuations, and rampant speculation. What was once a humorous tale of market manipulation has evolved into a cautionary warning for modern investors. 

Understanding SME IPOs

While the contribution of SMEs to total GDP was around 30-40% they were not able to flourish their enterprises since they relied majorly on bank loans for the expansion as the banks charged them high rates of interest and a larger portion of the money went into repayment of loan and interest. It was then, the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) got together to launch this initiative in 2012 where Small and Medium Enterprises could raise funds via Initial Public Offerings. They have less stringent listing requirements compared to mainboard IPOs, making it easier for smaller companies to go public. This move aimed to provide SMEs with a much-needed avenue to raise capital, while it also spurs economic growth and creates job opportunities.

Unmasking the Dark Side

However, as good as it may seem from the outside, SME IPOs have suddenly come into the eyes of investors because of their shady workings and the unjustifiable hype. Take Resourceful Automobile Pvt Ltd, for instance—a company whose recent SME IPO raised more than a few eyebrows. With an issue price of ₹117 per share and a minimum investment of ₹140,400 for retail investors, the offering appeared relatively standard on the surface. But look a little deeper, and the narrative takes a curious turn. The IPO, offering just over a million shares, was oversubscribed by 418 times, with bids worth a whopping ₹4,800 crores. For context, that’s hundreds of times more than what the company itself reported in revenues—a modest ₹17 crores over the last 11 months. And its profit after tax? Just ₹1.5 crores! Suddenly, the numbers don’t seem to add up, do they?

The massive demand for shares of a company with just 2 showrooms and 8 employees which sells and services YAMAHA Motorcycles and Scooters, under the banner Sawhney Automobile begs the question: are investors really seeing value, or are they being swept up in a speculative frenzy? Resourceful Automobile might be driving its way to the stock market, but what’s under the hood seems suspiciously underwhelming.

Cases of such SME IPOs do not just stop here, another such case was the Broach Lifecare Hospital operating under the name Maple Hospitals. It floated an IPO to raise ₹ 4 crores, but received bids worth ₹ 604 crore. The hospital operates just 2 branches in Gujarat with 40 beds.

Not to forget, the case of Boss Packing Solutions, a company which supplies packaging machines, labeling, capping, and filling equipment and operates from a 500 square yard facility in Ahmedabad. According to its Red Herring Prospectus (RHP), Boss Packing's profits remained flat over 2022-23 and 2023-24, and its net debt increased by 82% in 2023. But running by the trend, its issue size of ₹ 8 crores was oversubscribed by a staggering 135 times.

As with Bhatti’s PP Waterballs, what’s glorified at first glance might not survive deeper scrutiny. The stark contrast between the companies’ financial health and their IPO success just smells like cases of an overhyped IPO built on shaky fundamentals.

Addressing Concerns and Shaping Regulations 

The surge in SME IPOs in India has not only raised concerns about investor protection but also revealed a shadowy practice involving some unscrupulous investment bankers. These bankers have been inflating valuations of SMEs in exchange for a share of the excess funds raised, creating significant risks for investors. Typically, these bankers charge a legal fee of 1% to 3%, but behind the scenes, they negotiate deals with promoters for as much as 50% of the inflated value. These inflated valuations are often backed by falsified financials, with the help of unscrupulous chartered accountants, misleading investors about the true worth of these companies.

Such practices have raised cautions about market manipulation, pushing regulators like the National Stock Exchange (NSE) to tighten rules around SME listings. To combat this, the NSE has introduced measures like requiring companies to show positive Free Cash Flow to Equity (FCFE) for at least two out of the last three years and placing a 90% cap on the price of the securities on the first day of trading after getting listed. These steps aim to enhance transparency and curb excessive speculation, while SEBI continues to monitor the role of investment bankers in such dubious practices. As these regulatory reforms take shape, investors must be cautious, conduct thorough research, and not get swept up in the hype, as the SME IPO market becomes more scrutinised and tightly regulated. The NSE's crackdown is just the beginning, and more regulations are expected to follow. The capital raised through Initial Public Offering has witnessed a significant increase. As of June 13, 2024, SMEs stood up with 1000 Crores more compared to the last year which is around 2064 Crores, 53% of SMEs have given more than 300% returns in the past 2 years. This itself is a testament to the fact why retail investors have a keen interest in these SMEs as they can provide them with both short and long-term gains.

What’s Next for SME IPOs?

As the SME IPO market continues to grow and becomes more regulated, it’s clear that both opportunities and risks exist. For investors, the key takeaway is to stay vigilant and informed. Instead of relying on flashy pitches or questionable brokers like “Prasad” from Bhatti’s skit, take time to study the fundamentals of the companies you're investing in. Understand their financial health, dig into their valuations, and ask tough questions before putting your money at risk. In this rapidly evolving landscape, being cautious and proactive will help you make smarter decisions. Stay informed, stay skeptical, and most importantly, stay in control of your investments—because not everything that shines is gold.

Authors: Brahmjot Singh and Palak Kalra

Illustration: Japneet Singh Sethi