BOOK BUILDING PROCESS IN IPO
By
Vishnu Nair
vishnu1.618@gmail.com
A few days ago we heard about the Reliance Power Limited IPO. One of the largest IPO’s to occur in the world. This should have aroused our enthusiasm about the stock markets up to the brim. And I hope that the recent nosedive of the Sensex won’t hamper your interest in it. So let us now learn more about IPO’s.
IPO is one of the method by which a company can raise capital. Public issue of common shares are essentially carried out in two ways
- Fixed price method, and
- Book-building method
| Features | Fixed price method | Book-building method |
| Pricing |
Price at which the securities are offered/ allotted is known in advance to the investor.
|
Price at which securities will be offered/ allotted is not known in advance to the investor. Only an indicative price range is known.
|
| Demand |
Demand for the securities offered is known only after the closure of the issue
| Demand for the securities offered can be known everyday as the book is built |
| Payment |
Payment if made at the time of subscription wherein refund is given after allocation.
| Payment only after allocation. |
(Source: bseindia.com)
When a company decides to go for IPO its first task is to select an underwriter. Underwriters act as financial midwives to a new issue. They usually play a triple role.
They provide company with procedural and financial advice, then they buy the issue and finally they resell it to the public.
In India, for normal public issues underwriting is not compulsory. However, underwriting is necessary when issue price is determined by book building method.
Most of the IPO’s in India are made through book building method. Book building is a process of price and demand discovery used in initial public offer. In normal public offering, the demand for the share would not be known in advance. The likely demand for the shares can be estimated more realistically under book-building, and if there were to be no bids, the issue can even be deferred. The issuer sets a band within which the investor is allowed to bid for the share. The upper price (cap price) of the band can be a maximum of 1.2 times the floor price. Every public offer through the book-building process has a book running lead manager (BRLM), a merchant banker, who manages the issue.
In case the issuer chooses to issue securities through the book building route then as per SEBI guidelines the issuer company can issue securities in the following manner:
- 100% of the net offer to the public through the book building route,
- 75% of the net offer to the public through the book building process and 25% through the fixed price portion
Investors can bid for different quantities of shares at a price within the price band. An issue through book building process is kept open for at least 3 days and for a maximum of 10 days in case of price band revision.
Once the bidding period is over the BRLM along with the issuer arrives at an issue price on the basis of an evaluation criteria which may include price aggression, investor quality, earliness of bids, etc. Allocation of securities is made to successful bidders.
Book building process is in some ways similar to auction, since potential buyers state how many shares they are willing to buy at given prices. However, these bids are not binding and are used only as a guide to fix the price of the issue. Book building is a good concept and represents a capital market which is in the process of maturing.
There are three kinds of investors in a book building issue, viz Retail Individual Investors (RII), Non-Institutional Investors (NII) and Qualified Institutional Buyers (QIB). Individual Bidders who have Bid for Equity Shares for an amount not more than Rs. 100,000 are called RIIs. NIIs are All Bidders that are not QIBs or Retail Individual Bidders and who have Bid for Equity Shares for an amount more than Rs. 100,000. And QIBs includes Public financial institutions as specified in Section 4A of the Companies Act, FIIs, scheduled commercial banks, mutual funds registered with SEBI, venture capital funds registered with SEBI, state industrial development corporations, insurance companies registered with Insurance Regulatory and Development Authority, provident funds (subject to applicable law) with minimum corpus of Rs. 250 million and pension funds with minimum corpus of Rs. 250 million.
Each of these categories is allocated a fixed percentage of the total issue. Total allotment to RII and NII category should be at least 35% and 15% of the total issue respectively. And QIBs cannot be issued more than 50% of the total issue(in case the issue is through 100% book building)in case issue is through 75% book building process the balance 25% is priced at the price arrived at by the book building process.
Main alternatives to book building are fixed price offer or an auction. In the case of a fixed price offer, if the price is set too high investors will not apply for the entire share offered and underwriters will be obliged to buy them. If the price is set too low, the application will exceed the number of shares on offer and investors will receive a proportion of share they applied for. Most under priced offers are likely to be oversubscribed in which case even the ‘green shoe option’ for accepting oversubscription seems inadequate. Some of the recent IPO’s through book building route which attracted oversubscription poses a question over the efficacy of price discovery through book building processes. Such an oversubscription will create unnecessary hype about the share, and this will add to the uncertainties in our stock market. Thus SEBI has to discover new measures to end such bloated IPO’s.
(References: bseindia.com, Principles of Corporate Finance (TMH) )
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