Honasa Consumer Ltd’s IPO had lessons for investors

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On 7 November, Honasa Consumer Ltd listed on Indian stock exchanges after selling shares through an initial public offering (IPO). The company owns the popular Mamaearth brand and a few other brands along with it, and is in the business of selling personal care products. The issue price of the stock was 324.

On 10 November, the stock’s price fell during the day to a low of 256, which was more than a fifth lower than its issue price. Since then, the company’s stock price has recovered, and on Tuesday it closed at around 367, or a little over 13% higher than its issue price.

Nonetheless, several questions have been raised regarding the company’s listing. Should a startup which made a loss in the last financial year be allowed to sell shares to retail investors, especially when a large part of its IPO is an ‘offer for sale’? Further, should equity mutual funds, which primarily invest retail money in stocks, be allowed to invest in such stocks? As Honasa Consumer is not the first loss-making startup to be listed on the stock exchange, these questions hold true at a general level as well.

In fact, there were two parts to the money raised through its IPO. A bulk of it was an ‘offer for sale.’ So, the money raised through the sale of these shares was used to pay off existing investors who were selling their stake. Along with promoters and investment firms selling shares, other investors like Rishabh Harsh Mariwala, Kunal Bahl, Rohit Kumar Bansal and Shilpa Shetty Kundra also sold shares. At an issue price of 324, close to four-fifths of the IPO was an offer for sale.

Now, Honasa Consumer garnered a total of 765.2 crore through anchor investors. This refers to investment firms that act as anchors by buying shares in a company before its IPO opens. Of the 765.2 crore raised from anchor investors, seven mutual funds through 19 schemes bought shares worth 253 crore. Six insurance companies also bought shares. Both mutual funds and insurance companies mainly invest money raised from retail investors. Since these retail investors could also directly buy shares in the IPO, it raises the questions mentioned earlier.

This is not a forum to analyse the future prospects of Honasa Consumer. Nonetheless, it’s important to point out that the company made a loss of around 151 crore in 2022-23. A bulk of this loss was due to exceptional items. Even if we leave that out, the valuation at which the stock has been issued is extremely high. This strategy is in line with past IPOs of startups over the last few years.

Further, when a bulk of an IPO is an offer for sale, the money being invested by retail investors, both directly and indirectly, is being used to offer an exit path to existing investors at very high valuations. It has been argued that 253 crore invested by mutual funds is a very small amount in comparison with the total amount invested in mutual funds and hence it doesn’t matter. The amount invested in an individual IPO may be small, but this is not the first time something like this has happened. In the past, mutual funds have invested in IPOs of startups and burnt their fingers in doing so. So, individually it might be a small amount, but on the whole, it does add up. Moreover, just because something is small in scale does not mean it’s not a major problem.

More importantly, as Rahul Goel, a finance and publishing professional, asked in a recent column on livemint.com: “Does the mutual fund mandate allow the fund manager to invest the retail investors’ money in such stocks?” If one looks at mutual fund schemes which have bought into Honasa Consumer, there are several large cap schemes and all kinds of other schemes in the list. Large caps are stocks ranked in the top 100 as measured by market capitalization and Honasa Consumer is nowhere near that list.

Now, the fine-print perhaps allows mutual funds to do this, but then if things need to be justified using fine-print, what’s the point of a mandate anyway? This is a classic example of the principal-agent problem. A group, in this case retail investors in the role of the principal, have hired a mutual fund and a fund manager, who play the agent, to manage their money. The agent can engage in actions that could hurt the principal, which is what happens when mutual funds and insurance companies invest money in IPOs of expensively priced startups. Clearly, there is a need for the Securities and Exchange Board of India, which regulates stock markets and mutual funds in the country, to look into this matter in more detail.

The funny thing is that in the recent past, mutual funds have increased their stakes in startups that have listed over the past few years. But they did so only after the stock prices of these startups had fallen considerably. So, what is this rush to invest in such expensively priced IPOs?

The answer might perhaps lie in the fact that mutual funds and insurance companies do not work in isolation and are usually units of bigger financial organizations, which among other things also run investment banks that manage IPOs.

This factor needs to be kept in mind as well. Incentives are working at the financial firm level.

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