Do MFs invest in IPO? How do they evaluate it?

Equity Fund Management-Process & Practice (FA)

B.B.A Sem-VI

SVKM’s NMIMS Anil Surendra Modi School of

Commerce

2022-23

TYBBA-B: AG 2

Adiraj Jain: B006

Adit Shah: B007
Aditya Patil: B008
Arnav Sharma: B009
Aryan Agarwal: B010

INTRODUCTION
Mutual Funds can participate in an IPO either as anchor investors or as institutional
investors in the general quota for qualified institutional buyers (QIBs).
Currently, mutual funds bid on shares at the fund house level, not at the scheme
level. There are no established criteria governing the allocation process. Therefore,
an AMC may assign shares to different schemes at its discretion following the
allocation of shares. The Securities and Exchange Board of India (SEBI) could
tighten requirements for mutual fund investments in initial public offerings (IPOs).
The rules may refer to the post-allotment allocation of shares to various schemes
and the process of due diligence for IPO investments. The regulator may order all
funds to allocate money according to a specific plan. Therefore, it will be important
to clearly identify which scheme is requesting how many shares when the bids are
placed. Consider a scenario where a large-cap scheme requests 2 million shares
and a flexi-cap scheme from the same fund company requests 1 million shares. It
will be necessary to disclose this upfront.
The regulator has also reached out to mutual funds regarding the process followed
for investing in initial public offerings (IPOs) and the type of analysis and research
conducted before picking one IPO over another. Before investing, the regulator may
require the trustees to confirm that the basis for IPO investment is sound and that
sufficient due diligence has been conducted. This comes as, throughout the past
year, a number of mutual funds schemes have invested in the initial public offerings
(IPOs) of new-age technology businesses, and have been criticized after the
companies' stock prices declined following listing.

EVALUATION OF IPOs

Case Study 1: Nykaa (FSN E-Commerce Ventures Limited)

About the company

Nykaa is an Indian-based e-commerce company in the fashion and beauty industry. It
was founded in 2012 by Falguni Nayar and is currently headquartered in Mumbai. It
sells beauty, wellness, and fashion products on its website, app, and over 100 retail
stores in the country. It became the first unicorn startup in India to be founded by a
woman in 2020.
Nykaa’s setup is all across India as well as internationally. In 2015, they moved out of
online-only shopping and started selling their products in their own stores. They
expanded their product portfolio majorly after moving past beauty products and
currently have over 2400 brands and more than 200,000 products in their stores.

Product/ Service Offering

As of March 2021, Nykaa had close to 200,000 SKUs and 2500 brands on its website
and stores. The products that these various brands were offering were primarily:
Makeup, haircare, skincare, body and bath products, grooming appliances,
fragrances, health and wellness categories, and personal care among many others.
These are the services provided by Nykaa:

Growth Drivers

1. Growth in BPC (beauty and personal care) Spend by Youth: Buyers of BPC
who are between the ages of 25 and 35 are the most active. Furthermore,
they are more inclined to buy expensive products. When they shop, these
customers don't behave like traditional Indian buyers. They are willing to try
out new product categories and enjoy basing their purchases on the most
recent fashions. They follow a rather sophisticated skincare and cosmetics
regimen. They also develop an emotional connection with the brand and
prefer those that employ organic materials.

2. Increase in fashion spending of the youth: The most frequent customers of

fashion are people between the ages of 20 and 35 who want to use it to
showcase their unique personalities. These consumers have a respectable
financial capacity, a high level of trend awareness, and excellent digital
maturity. These characteristics encourage them to choose specialized
product categories like streetwear, sleep, and loungewear, upgrade to their
favorite brands, strive to have a diverse range of products in their wardrobes,
and upgrade their interests in accordance with the most recent fashion
trends they have learned from their friends and coworkers.
 3. Increasing Spending on Fashion from Tier 2+ Cities: In recent years, demand
from Tier 2+ cities has increased significantly due to customers switching
from unbranded to value-branded items and the availability of value-focused
brands and retail outlets to meet this demand. Spending on clothing from Tier
2+ cities is anticipated to increase more quickly than the market. Growing
ticket sizes for fashion transactions have made it possible for Metro and Tier
1 markets to become more premiumized as a result of widespread
awareness, interest, accessibility, and affordability of high-end fashion
brands.

4. Rising Influence of Social Media: The newest fashions in clothing, accessories,

and footwear frequently impact consumers through their social media
networks. This not only informs them of the most recent market trends but
also encourages them to strive for newer goods and companies in order to
keep up with their social circle. This ultimately results in higher spending on
fashion-related items. Influence from social media has significantly changed
how consumers shop.

5. Growth of Men’s and Kids’ Segments: Despite being slightly smaller, the
men's market has expanded more quickly than the women's market. The
increase in aggressive male spenders with high disposable income who need
to look and feel well is partly responsible for the expansion. Additionally,
given the ongoing need for clothing and footwear by growing children, the
kids' segment also experienced rapid growth between 2016 and 2019. Future
predictions indicate that the men's and children's markets will expand more
quickly than the fashion market.

Future Prospects

Nykaa has a big Beauty & Personal Care market opportunity of 1,120 billion (US$16
billion), which will grow to 1,981 billion (US$28 billion) by 2025 at a rate of 12% per
year. The fashion market opportunity for Nykaa is currently worth 3,794 billion
(US$54 billion). This is expected to grow at an annual rate of 18% to 8,702 billion
(US$124 billion) in 2025. Nykaa can reach a market worth 10,683 billion (US$152
billion) in beauty and personal care, as well as in fashion.

Financial Analysis

1. Profit & Loss Statement

 Consolidated P&L
(Source: Red Herring Prospectus-FSN E-Commerce Ventures Limited)

● The company’s revenue has increased by 119.63 % in the last three

years and the Net Profit has turned positive in the latest year.
● The operating profit and net profit margins have consistently
increased.

2. Balance Sheet

Consolidated B/s (Assets)

(Source: Red Herring Prospectus-FSN E-Commerce Ventures Limited)

● As the business is inventory intensive, the business has a large size of

inventory. It forms 38.26% of the total asset size. The company does
not have any listed peers to compare the inventory size with, but the
company should have absolute efficiency in controlling and managing
 the inventory, as the fashion, beauty & personal care industry has
historically faced the challenge of high inventory cost.

Consolidated B/s (Liabilities)

(Source: Red Herring Prospectus-FSN E-Commerce Ventures Limited)

● The lease liabilities and borrowings which form roughly 37% of the
company’s liabilities have reduced in the latest year after a sharp rise
in the previous.

3. Cash Flow Statement

● The cash flow from operating activities has increased by 250.25% in three
years, signifying an increase in revenue from operations.

Valuation

The EPS of Nykaa is 1.39.

The price of the issue is ₹1085 to ₹1125 per share.
If we use the Earnings Multiple Valuation Model, the company has valued itself 780x
at the lower band and 809x at the higher band.
Such massively inflated valuation is the result of the massive bull run in the market
and inflated valuation demand by other newly listed new-age businesses. But such
factors still do not justify a valuation multiple higher than some of the world’s
biggest listed beauty brands and fashion clothing and accessories companies.

Competitor Analysis

Nykaa faces competition from organized multi-brand and exclusive stores,

unorganized vendors, horizontal online marketplaces like Amazon, Flipkart, and
Paytm Mall, as well as vertical marketplaces like Myntra, Purplle, and Myglamm in
India's beauty and personal care and fashion markets.

Nykaa faces some risks with regard to the competition and they are as follows:
1. Competition for Digital Traffic
Due to increased competition for digital traffic, there is a possibility of an
increase in the cost of acquiring new customers through marketing.
2. Competition from Competitive Channels
For the selling of all kinds of goods and services, the internet and mobile
networks offer brand-new, competitive channels that are continually evolving,
which the competitors can latch onto.
3. Competition for Talent
Due to the strong demand and fierce competition for talent, they may
struggle to quickly hire or keep the qualified or highly trained workers they
will need to realize their strategic goals.

Issue Details

The Nykaa IPO began on 28th October 2021 and the bid closed on 1st November
2021. The total issue size was ₹5,351.92 Cr. The Offer comprises of Fresh Issue and
an Offer for Sale
The proceeds from the Offer for Sale go towards selling shareholders. The proceed
from the fresh issue would be used for the following purpose:
The company fixed a price band of ₹1085 to ₹1125 per share for this IPO. The
minimum investment amount for 1 lot of 12 shares.

Conclusion

Strengths:

1. One of India’s leading lifestyle-focused consumer technology platforms

2. They are the preferred destination for luxury and prestige products in India
for consumers and brands
3. Resilient, capital-efficient business with a combination of strong growth and
profitability
4. Their proprietary technology stack
5. The capable founder-led company is supported by a professional
management team

6. The EPS has consistently grown for the organization in the last three years.
 7. The Return on Net Worth has increased consistently over the three years
signifying growing profitability over the equity capital of the company.

Weakness:

1. The company depends on the expansion of India's e-commerce market and

its capacity to adapt to shifting customer trends on digital platforms.
Consumers, sellers, and suppliers continuously adopt new and alternative
methods of transacting business, making purchases, and exchanging
information, such as through the internet and mobile devices. As a result,
Nykaa must effectively adapt to changing user behavior on such digital
platforms if they want to see its online revenue base grow.
2. Their top three categories account for a sizable amount of their GMV, thus
any underperformance of these products could have a negative impact on
their firm. 71.3% of total GMV in the Financial Year 2021 came from the top
three categories. The revenue from these items and consequently the
company may decrease in the future due to greater competition, pricing
pressures, changes in the demand or supply of products within these top
three categories, or other circumstances.

With all the mentioned strengths, weaknesses, and risks, Nykaa is overall an
investable IPO. The shortcoming and future challenges can be worked upon by
the capable management of the organization.

Case Study 2: Paytm (One97 Communications Ltd.)

About the company

The largest financial services company in India Paytm offers a wide variety of online
payment & financial solutions to consumers, online merchants, and service
partners. Through payments, trade, finance, employment, and financial services,
the company aspires to bring at least 500 million Indians into the global economy.
Vijay Shekhar Sharma launched One97 Communications Limited, which owns the
Paytm brand, in 2010. Its main office is located in Noida, Uttar Pradesh. Softbank,
Ant Financial, AGH Holdings, SAIF Partners, Berkshire Hathaway, T Rowe Price, and
Discovery Capital are some of its principal investors.
The nation's largest digital bank, Paytm Payments Bank, is owned by Vijay Shekhar
Sharma, founder and CEO of Paytm, and One97 Communications Limited. It has
over 58 million account users.

Product/Service Offering

Digital payments is Paytm's main line of business. Customers and businesses may
use Paytm as a payment gateway to make secure payments using credit cards,
bank accounts, and other e-wallets. Additional payment options offered by Paytm
include cell phone recharges, bill payments, cinema tickets, taxi, train, and aircraft
tickets, loan payments, insurance, foreign exchange, and more. Customers may
seamlessly make purchases on various retail and online e-commerce sites by
immediately linking their bank accounts and credit cards to their Paytm accounts.

It has since grown multi-fold and now has the following subsidiaries:

● Paytm Money
● Paytm Mall
● Paytm Labs
● Paytm Entertainment

Growth Drivers
The company has seen significant growth in recent years, driven by several key
factors:

1. Increase in digital payments adoption: India has seen a rapid increase in the
adoption of digital payments in recent years, driven by the government's
push for a cashless economy, as well as the convenience and accessibility of
digital payment services. This has created a large and growing market for
companies like Paytm.

2. Expansion of financial services: In addition to its digital payment services,

Paytm has also expanded into a range of financial services, including lending,
insurance, and wealth management. This has helped the company diversify
its revenue streams and increase its market share.

3. Strong brand reputation: Paytm has built a strong brand reputation in India,
known for its ease of use, reliability, and customer-centric approach. This has
helped the company establish a loyal customer base and differentiate itself
from competitors.

4. Strategic partnerships: Paytm has formed strategic partnerships with a range

of companies and organizations, including the government, banks, and
merchants. These partnerships have helped the company expand its reach
and access new customers.

5. Technological innovation: Paytm has invested heavily in technology and

innovation, developing new products and features to enhance the user
experience and stay ahead of the competition. This has helped the company
maintain its position as a leader in the Indian digital payments market.

These are some of the key growth drivers for Paytm, and the company is well-
positioned to continue its growth trajectory in the future as the adoption of digital
payments and financial services continues to rise in India.

Financial Parameters

1. Profit & Loss Statement

 Consolidated P&L
(Source: Red Herring Prospectus Paytm (One97 Communications Ltd.)

2. Balance Sheet

Consolidated B/s (Assets)

(Source: Red Herring Prospectus Paytm (One97 Communications Ltd.)
 Consolidated B/s (Equity and Liabilities)
(Source: Red Herring Prospectus Paytm (One97 Communications Ltd.)

3. Cash Flow Statement

Valuation

Valuation: $19 billion

IPO Price: Rs. 2,080 to Rs. 2,150
At the upper end of the IPO price band, One 97 Communications Ltd. is offered at a
price/book of 9.5x with a market capitalization of Rs 1.39 lakh crore.

Competitor Analysis

Paytm is a leading digital payment and financial services company in India. In terms
of competition, here are some of the key players that Paytm faces:

Google Pay: Google Pay is a popular digital payment app in India that offers similar
services to Paytm, including peer-to-peer (P2P) transfers, bill payments, and mobile
recharges.
PhonePe: PhonePe is another popular digital payment app in India that offers a wide
range of financial services, including P2P transfers, bill payments, mobile recharges,
and insurance.

Amazon Pay: Amazon Pay is a digital wallet service offered by Amazon in India that
allows users to make payments on the platform, as well as on other merchant sites.

BHIM UPI: BHIM UPI (Unified Payment Interface) is a government-backed digital

payment system in India that allows users to make payments and money transfers
directly from their bank accounts.

MobiKwik: MobiKwik is a leading digital payment and financial services company in

India that offers a wide range of services, including P2P transfers, bill payments,
mobile recharges, and loans.

Paytm faces intense competition from these players, and the company has
responded by expanding its offerings and partnerships to stay ahead in the market.
Additionally, Paytm has also invested heavily in technology, user experience, and
customer service to maintain its position as a leading player in the Indian digital
payments market.

Issue Details

As per Paytm’s draft red herring prospectus (DRHP) filed with SEBI, the issue size of
Paytm IPO will be Rs. 16,600 crores or $2.2 billion. Besides a fresh issue worth Rs.
8,300 crores, it will comprise an offer for sale of the same proportion.

Details of the Objectives of Issue

1. Growing and strengthening our Paytm ecosystem, including through the

acquisition of consumers and merchants and providing them with greater
access to technology and financial services
➔ Marketing and promotional expenses
➔ Expanding our merchant base and deepening our partnership with our
merchants
➔ Strengthening and expanding our technology-powered payments
platform

2. Investing in new business initiatives, acquisitions, and strategic partnerships

 ➔ Investments in new business initiatives: From a cashless digital
payments platform, we have been able to develop, introduce and scale
up a number of new business initiatives for our Paytm ecosystem, in
collaboration with financial institution partners, such as Paytm UPI,
Paytm Wallet, Paytm Postpaid, Paytm Food Wallet, Paytm FASTag,
Paytm Ads, travel and entertainment ticketing, online games, digital
banking services, digital lending, insurance broking, and wealth
management.
➔ Investments in acquisitions and strategic partnerships

3. General corporate purposes

Conclusion

The initial public offering of Indian fintech company Paytm could be a "very high-risk
bet," and the company's value may not go up much when it starts trading on stock
exchanges. In the case of Paytm, its network effects are strong— it is the biggest
digital payment from a merchant's point of view—the company has a long time to
take advantage of this and hopefully make some money along the way. I would
suggest avoiding investing in Paytm IPO as it is overvalued but their business is
promising so we need to wait for a better entry.

Edelweiss Recently Listed IPO fund

Fund Managers

1. Bhavesh Jain:
Bhavesh Jain started his career with Edelweiss Asset Management in January
2008 and has over 10 years of rich experience in the financial markets. He
joined the Low-Risk Trading team which is responsible for looking at arbitrage
between SGX Nifty and NSE Nifty along with normal cash-future and index
arbitrage Today, he’s the Fund Manager and Deputy Vice President with
Edelweiss managing several funds which are part of Risk Adjusted Returns
Strategies in addition to ETFs.

2. Bharat Lahoti:
Bharat Lahoti has 13 years of experience in areas of portfolio management,
macro, and sector research. He has earlier worked with marquee investment
banks and asset management companies. His last assignment before joining
 Edelweiss Asset Management Limited was with DE Shaw Group, a global
hedge fund, as a senior manager working on fundamental and quantitative
research ideas.

Strategy
The investment objective of the Scheme is to seek to provide capital appreciation
by investing in equity and equity-related securities of recently listed 100 companies
or upcoming Initial Public Offers (IPOs). However, there can be no assurance that
the investment objective of the Scheme will be realized. With an investment horizon
of 7 to 10 years, the Edelweiss Recently Listed IPO Fund, is for investors who are
interested in the “High-Risk High-Return” strategy. The strategy of the fund in
question is that it invests in 100 recent IPOs to capture listing and post-listing gains.
They also invest in new businesses that are emerging in the Indian Market. This
fund also invests in companies across different sectors with a bias towards small
and mid-cap companies that ensure growth. The fund is not really inclined towards
investments in a weak business that can easily be impacted by market shocks. They
also maintain the portfolio’s liquidity for any undue market fluctuations and
redemption pressures.

This product is suitable for investors who are seeking long-term capital growth and
investment in equity and equity-related securities of recently listed 100 companies
or upcoming Initial Public Offer (IPOs). The scheme benchmark is the India Recent
100 IPO TRI and has been performing really well against the benchmark.
As you can see, the riskometer for the scheme is very high and therefore the aspect
of investors toward risk should be very high.

Performance
As you can see in the charts below, the growth of this fund has been greater than
the benchmark and has been exceptional.

The chart above shows that the fund has grown from Rs 100,000 to Rs 168,142.37
in the past three years since the fund started for investors through the direct route.
The fund has been gaining through short-term IPO gains. When compared to the
growth of the benchmarks and the additional benchmarks as listed in the illustration
above, the Edelweiss Recently Listed IPO Fund has been performing exceptionally
well and has a higher CAGR than most of its set benchmarks.

The CAGR of the fund has been consistently higher than the two benchmarks since
the inception of the fund. With a CAGR (Direct) of 15.68% in the last 3 years with an
expense ratio of just 0.94% and no exit load, the Edelweiss Recently Listed IPO Fund
has been able to keep its investors satisfied.

Through the regular route, an investor of this IPO fund will be able to earn a CAGR
of 14.75% and an expense ratio of 2.24% which is higher than that of the direct
route, and an exit load of 2% if redeemed under 6 months.
A few quantitative indicators that the IPO fund has as on December 31,2022 are:

In conclusion to the performance of the fund, the Edelweiss Recently Listed IPO
Fund has been performing exceptionally well when compared to the two
benchmarks namely; India Recent 100 IPO Index TRI (primary benchmark) and the
NIFTY 50 TR Index (secondary benchmark). This proves that the strategies used by
the fund managers has been fruitful for the past three years yielding healthy
returns for the fund’s investors.

Portfolio
The market cap distribution of the fund is as follows:

The top holdings as of December 31, 2022, were:

Meanwhile, a sector-wise analysis of the portfolio has been shown in the illustration
below.
References
 https://www.financialexpress.com/market/ipo-news/sebi-mulls-norms-
for-mf-investment-in-ipos/2926059/
 https://investmentbank.kotak.com/downloads/fsn-e
%E2%80%93commerce-ventures-limited-RHP.pdf
 https://www1.nseindia.com/content/equities/IPO_RHP_PAYTM.pdf
 https://www.edelweissmf.com/types-of-mutual-funds/equity-fund/
edelweiss-recently-listed-ipo-fund