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Tutorials on IPOs

What is an IPO?

An Initial Public Offering is the formal name for a new issue of an unlisted company. It is often also loosely used to describe other types of issues. There will also be a prospectus or an offer document or prospectus that gives important details about the issue. All issues have an issue form, which has to be filled up and submitted by the wannabe subscriber.

How many other types of issues are there?

A rights issue/offer is an offer to existing equity holders to subscribe when the company needs further capital. In normal circumstances, the rights issue is offered at a discount to the existing share price. A non-shareholder can also subscribe to a rights issue if some existing equity holder renounces rights in his favour. A rights-cum-public offer allows both existing subscribers and new subscribers to apply. Other types of issues are of debentures and convertible debentures. Debentures are debt issues that pay interest and convertible debentures not only pay interest but also allow investors to convert them into equity shares at a later date.

Who are lead managers?

The Lead Managers and Bookrunning lead managers are the merchant bankers, who handle the details of pricing issues, determine issue size and perform a due diligence exercise on the company. We assume our reader has enough common sense to learn the name of the company making the issue, the business it is in, and the size of the offer. He can also easily learn the stock exchanges where the company will be listed. But when it comes to the issue price, he may be puzzled by bookbuilding.

What is book building?

Issues raising over Rs 100 crore are mandatorily required to go in for book building. Book building is an auction process where the lead manager invites bids from potential subscribers in a price range. They must mention the price at which they are willing to buy, and also what quantity they are willing to buy at a given price. The Bookrunning Managers will do complicated and opaque calculations to announce an acceptable price. The pricing is done at the price where the last share is sold and all subscribers pay that amount though they may have bid a higher price. Investors who don't want to miss the bus but can't predict the issue price can bid at cut-off price. There is also a part earmarked for small shareholders in the book built portion and also a public issue for the retail investors later.

What are face value and share premium?

This is the paid-up value at which the company issues shares. Most companies in India have a face value of Rs 10. The concept of face value is now changed and a company can have any face value, the minimum being Rs 1. Most companies charge an additional amount over the face value. This is the share premium.

What is minimum lot?

This is the minimum number of shares for which an application can be made. Applications can also be for higher amounts. Applicants may, or may not, get full allotment or partial allotment in the case of over-subscription. The payment may also be split into several stages. All these details plus tax benefits etc, and time-period before allotment and listing etc are described in a section of the OD or form called "The Terms of the Issue".

What is Stockinvest?

Since allotment of shares takes a few weeks, banks offer you the Stockinvest facility to earn interest on your application money. So investors lose less if allotment is denied, or only partial, and the subscription amount is returned.

Is there any other way to borrow money?

Yes. Many non banking finance companies and the lead managers offer investors a facility to borrow money and apply for shares in the book building category.

What is the object of the issue?

The company must raise the capital for some specific purpose and this must be mentioned in the offer document. An investor can use his judgement about the fundamental value of the issue and its objects.

What should you look for in management?

Management is by far the deciding factor in applying for an issue. You have to see if it is competent and will deliver its promises. Though past performance is not a sure-shot indicator of future success, it helps in the decision-making process. Look for the past financials, promoters' background and how well they have done in the past. The current top ten shareholders will also be listed and also the history of the business.

What are risk factors?

The prospectus has a list of risk factors and the management perception of how it will tackle them. This will provide insights to investors on whether to subscribe to the issue or not. Litigations against the company, payments that the company is yet to receive, any defaults of payments that the company has made etc will be mentioned in the risk factors.

What about financials?

The company must have a profit record for the last three years and it will give an abbreviated description of financial performance and indicators. There may be future projections by a financial institution or the company. The prospectus/offer document must also mention group companies and subsidiaries. Companies will also give business projections for the next few years. The more details the company releases, the more likely it is that the issue will receive a good response.

The profit record stipulation and projections may be relaxed for Internet and software start-ups but it hasn't happened yet. These financials can be compared to data for similar listed companies for growth and profitability ratios. The issue price can also be compared for earnings multiples and other valuation ratios. Quite often, the prospectus will also have a brief note on the industry prospects, which can be of help in making comparisons and a management strategy.

What is the grey market?

This is the illegal/semi-legal trading in shares that are yet to be listed. You can buy or sell shares before the allotment, but this is for hardened speculators.

What is the listing price?

The IPO process ends when the share starts trading on the stock exchanges. The listing price is the price at which the stock is first quoted on an exchange. This may differ substantially from the issue price.

Tutorials

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