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Program - PGPM (Session – 2009-11)
Financial Markets & Services
ASSIGNMENT - 1
(Topic – Bookbuilding Process: will it
help to build the Indin market)
Instructor: - Prof. Rajee Jabbal
Submitted By: GROUP – 1
ANUPAM MOHANTY PGPM/09-11/10
NIHAR RANJAN MOHANTY PGPM/09-11/25
RITA AGARWAL PGPM/09-11/33
SIRASA VENKATESH PGPM/09-11/44
SOUMYA PRAKASH RATH PGPM/09-11/49
SWADESH KUMAR PGPM/09-11/56
TRIPATHY
ARNAB ROY PGPM/09-11/76
NEELAM CHOWHAN PGPM/09-11/86
POOJA JAJODIA PGPM/09-11/94
RAMCHANDRA MULIA PGPM/09-11/108
Introduction:
Maruti Udyog Ltd., India’s largest passenger car manufacturer, has been in the
news recently. The government, which had a majority stake in the company,
divested a part of its stake in the company. But instead of taking the traditional
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IPO issue route, it opted for the ‘book-building’ route. However, it is not the first
company to do so. Some companies, which adopted the book-building route in
the recent past, include Hughes Software, Mukta Arts, Creative Eye, HCL
Technologies, Bharti Televentures and i-flex.
Book building is a comparatively new concept for the Indian investors as
compared to their peers in the US or the UK, where it is a very common practice.
It is a process wherein various bids are collected from investors and the entries
made in a book. It must be noted here that book building is just another form of
an IPO wherein investors, retail and institutional, can participate in the process
and acquire shares of the company up for divestment or whose equity is at sale.
This assignment is mainly focused on the different IPO pricing and allocating
mechanisms, their advantages and disadvantages for issuers, underwriters, and
investors. We have emphasized particularly on the book-building system and
whether the new system would be able to play a role in strengthening the capital
market of India. We have tried to shed some lights on the IPOs scenarios, the
institutional settings, allotment / placement procedure, and offer price
determination under the existing IPO pricing and allocating mechanism.
Price at which securities will be allotted is not known in case of offer of shares
through book building while in case of offer of shares through normal public
issue, price is known in advance to investor. In case of Book Building, the
demand can be known everyday as the book is built. But in case of the public
issue the demand is known at the close of the issue.
The rise of book building in India:-
The introduction of book-building in India in 1995 was on account of the
recommendations of an expert committee appointed by SEBI under
Chairmanship of YH Malegam “to review the (then) existing disclosure
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requirements in offer documents.” Two of the terms of reference being “the basis
of pricing the issue” and “whether substantial reduction was possible in the time
taken for processing applications by SEBI.” The committee has submitted its
report with several recommendations and the SEBI accepted the same in
November 1995. The bookbuilding route should be open to issuer companies,
subject to certain terms and conditions.
Some of them are presented below:
• The option should be available only to issues exceeding Rs. 100 crore;
• The book-building issuer companies could either reserve the securities for
firm allotment or avail themselves of the bookbuilding process;
• Draft prospectus to be submitted to SEBI could exclude information about
the offer price;
• A book runner to be nominated from among the lead merchant bankers,
charged with specific responsibilities and the name is to be submitted to
the SEBI’s approval;
• The requirement of 25 percent of the securities to be offered to the public
will be continued.
There have been several amendments/revisions to the above guidelines: the first
one in December 1996 made available the option of book-building to all
corporate bodies which were otherwise eligible to make an issue of capital to the
public, and in case of under subscription, the spill-over from the public portion
could be permitted to the placement area and vice-versa.
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In 1997, the restriction of the facility to 75 percent of the issue was thought to
severely constrain the benefits arising out of price and demand discovery, and
the facility was extended to 100 percent of the issue, available only if the issue
amount was Rs. 100 crore and above, compulsorily offering an additional 10
percent of the issue sise to the public through prospectus, and reserving at least
15 percent of the issue size to individual investors applying up to ten tradable
lots.
However, there were no takers for the 100 percent book-building facility. Based
on suggestions made by leading merchant bankers, the following amendments
were made to the guidelines in
1999:
1. The issuer may be allowed to disclose either the issue size or the number of
securities to be offered to the public;
2. Allotment should be in demat mode only; and
3. Reservation of 15 percent of issue amount for individual investors need to the
public at a fixed price.
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SEBI Guidelines:-
1 After the price has been determined on the basis of bidding, statutory public
advertisements for a continuous three days containing, inter alia, the price as
well as a table showing the number of securities and the amount payable by an
investor, based on the price determined, shall be issued and the interval
between the advertisement and issue opening date should be a minimum of five
days.
2 The draft prospectus to be circulated has to indicate the price band within
which the securities are being offered for subscription. The bids have to be within
the price bands. Bidding is permissible only if an electronically- linked
transparent facility is used. An issuing company can also fix a minimum bid size.
An initial bid can be changed before the final rate is determined. The mega
issues such as Petronet LNG and Biocon were successfully launched through
the 100 percent book-building route.
3. The Prospective bidders were advised to read the “Red herring prospectus”
carefully. According to the Act, a “Red herring prospectus” means a prospectus
that does not have complete particulars on the price and the quantum of
securities offered.
4 The year 2000, Amendment to the Act gave legal cloak to the book-building
route by allowing circulation of the information memorandum and the red herring
prospectus. According to the Act, a process is to be undertaken prior to the filing
of a prospectus by which a demand for the securities proposed to be issued by a
company is elicited, the price and the terms of the issue of such securities are
assessed by means of a notice, circular, advertisement or document.
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Book Building Process:
Book-building is a process by which an underwriter attempts to determine at
what price an IPO should be offered based on demand from institutional
investors. An underwriter builds a book by accepting orders from fund managers
indicating the number of shares they desire and the price they are willing to pay.
The book normally includes each bid submitted, the identity of the bidder, the
number of shares (or dollar amount) requested, and any limit price. The book
also shows the date when the bid was entered and any subsequent revision (or
cancellation) of the bid. Underwriter retains sole discretion over allocation of the
shares to investors.
• The Issuer who is planning an offer nominates lead merchant banker(s)
as 'book runners' or also known as book runners lead merchant (BRLM)
• Initially, the issuer company draws up a draft prospectus (i.e. offer
document) with BRLM, including details regarding the size of the issue,
past history of the company, and a price band. The securities available to
the public are separately identified as “net offer to the public”.
• A definite period is fixed as the bid period and BRLM conducts awareness
campaigns like advertisement, road shows etc.
• The Issuer also appoints syndicate members with whom orders are to be
placed by the investors. BRLM should circulate the copy of draft
prospectus to the institutional investors and syndicate members.
• The BRLM is entitled to remuneration for conducting the Book Building
process.
• The syndicate members input the orders into an 'electronic book'. This
process is called 'bidding' and is similar to open auction.
• The BRLM receives the feedback about the investor’s bids (demand of
company’s shares at various prices), through syndicate members. The
prospective investors may revise their bids at any time during the bid
period which is generally 5 days.
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• On receipts of the above information, the BRLM and the issuer company
determine the issue price. This is known as the market-clearing price.
• Allocation of securities is made to the successful bidders. The rest get
refund orders.
• Once the final price is determined, the allocation of securities should be
made by the BRLM based on prior commitment, investor’s quality, price
aggression, earliness of bids etc. as the Book Building portion of
institutional investors is left entirely at the discretion of the issuer company
and the BRLM.
• The Final prospectus is filed with the registrar of companies within 2 days
of determination of issue price and receipts of acknowledgement card
from SEBI.
• Two different accounts for collection of application money, one for the
private placement portion and the other for the public subscription should
be opened by the issuer company.
• The placement portion is closed a day before the opening of the public
issue through fixed price method. The BRLM is required to have the
application forms along with the application money from the institutional
buyers and the underwriters to the private placement portion.
• Finally, the SEBI has the right to inspect such records and books which
are maintained by the BRLM and other intermediaries involved in the
Book Building process.
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BOOK-BUILDING vs. OTHER MECHANISMS: THE DEBATE:
The two methods for marketing and pricing IPOs are book-building and fixed
price that differ mainly in whether or not a price-discovery effort is undertaken
prior to setting the offer price. However, book-building and auctions are
distinguished by different sets of rules, with each set presumably designed to be
optimal for the company and set of circumstances at hand. Fixed price offerings
are priced without first soliciting investor demand, with price discovery taking
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place mainly in the aftermarket. In contrast, book-building involves road shows
and one-to-one meetings with potential investors that allow the underwriter to
discover investor valuations prior to setting the offer price. Moreover, if there is
an oversubscription in fixed price method and underwriter does not have any
control over allocation like bookbuilding. However, fixed price method has some
similarities to book-building. For example, in both the methods, underwriter
judges market conditions and underwriter/issuer set offering price.
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Both book-building and auction appear to be equivalent in terms of their
expected proceeds, but the apparent similarities mask two key differences.
First the issuer/underwriter has substantial control over information acquisition
through book-building, but little or no control in an auction.
Second, the expected number of shares sold is higher for book-building,
because there is a greater chance of under subscription in an auction. With
book-building, the underwriter co-ordinates the number of investors that will
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participate, guaranteeing that a sufficient number (but not too many) are
involved. With an auction, an issuer simply sets the reservation price and waits
to see what happens. Because auctions sell fewer shares on average, expected
IPO proceeds are strictly higher for book-building, holding constant the amount
spent on information acquisition. Regarding rules, book-building has its own too.
But the difference is that the auction rules are explicit, whereas the book-building
rules are implicit and provide considerable latitude for exercising human
judgment
Book-building methods have resulted in a major change in the types of investors.
The auction system requires a wide distribution of new IPO shares among
general investors, whereas under the book-building regime, the underwriter
exclusively selects all investors without restriction as to their relationship to the
firm or a limit as to the amount of new shares purchased. Thus, the auction
method’s objective of a wide distribution of shares among investors was dropped
in favor of a more exclusive and underwriter-selected group of investors following
book-building. This may be more efficient from an underwriter perspective, but
the public policy objectives of a wide distribution of new shareholders and lower
levels of initial return levels have not been achieved by the adoption of book-
building methods in Japan.
The riskiness of auctions, relative to book-building, is a major factor in their lack
of popularity. Book-building allows the underwriter to co-ordinate the number of
both informed and uninformed investors, ensuring that enough investors have an
incentive to participate in and scrutinize the issue, and preventing random free
riders from overwhelming the process. The reduced risk of book-building may be
attractive even if it comes at the cost of greater underpricing (and it’s not clear,
based on the empirical evidence so far, that auctions automatically lead to less
underpricing). Underpricing is an almost universal feature of the IPO market.
Several studies have confirmed that there is a difference in underpricing between
auction and book-building. Bookbuilding may allow issuers to reveal their quality
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credibly to investors. Thus bookbuilding allows them to obtain a higher price for
their shares, but also entails a revelation cost that might take the form of higher
underpricing. However, with respect to total issue cost, for large issues (by large,
well-established firms), book-building is less costly than auctioning. For small
issues (by small and young firms), auctioning is less costly.
Green shoe option (GSO):
In most of the cases, it is experienced that IPO through Book Building method in
India turns out to be overpriced or underpriced after their listing of them and
ultimately the small investors become a net looser. If the IPO is overpriced it
creates a bad feeling in investor’s mind as initial returns to them may be negative
at that point of time. On the other side, if the prices in the open market fall below
the issue price, small investors may start selling their securities to minimize
losses. Therefore, there was a vital need of a market stabilizer to smoothen the
swings in the open market price of a newly listed share, after an initial public
offering. Market stabilization is the mechanism by which stabilizing agent acts on
behalf of the issuer company, buys a newly issued security for the limited
purpose of preventing a declining in the new security’s open market price in
order to facilitate its distribution to the public. It can prevent the IPO from huge
price fluctuations and save investors from potential loss. Such mechanism is
known as Green Shoe Option (GSO) which is an internationally recognized for
market stabilization. So, GSO can rectify the demand and supply imbalances
and can stabilize the price of the stock. It owes its origin to the Green Shoe
Company which used this option for the first time throughout the World.
Recently, ICICI Bank has, used Green Shoe Option first time in case of its public
issue through the book building mechanism in India. GSO in the system of initial
public offerings (IPOs) using book building method was recognized by SEBI in
India through its new guidelines on 14.08.2003(vide SEBI/CFD/DIL/DIP/Circular
No.11). According to SEBI guidelines, “a company desirous of availing the GSO
shall in the resolution of the general meeting authorizing the public issue, seek
authorization also for the possibility of allotment of further shares to the
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‘stabilizing agent’ (SA). The company shall appoint one of the lead book runners,
amongst the issue management team, as the “stabilizing agent” (SA), who will be
responsible for the price stabilization process, if required. The SA shall enter into
an agreement with the issuer company, prior to filing of offer document with
SEBI, clearly stating all the
Recent trends in India:-
• The year 2004 was a significant and bumper because companies have
raised Rs. 30,511 crore through public issue and 99 per cent of this being
good quality securities from established companies and almost all issues
were through book-building.
• The practice of bookbuilding is new to the Indian capital market and the
procedure is still evolving. ICICI was the first company to use Book-
building method for its Rs. 1000 crorebond issue in April 1996 followed by
Rs. 4,323 crore Larsen & Toubro issue and Rs. 5,878 crore TISCO bond
issue for the placement portion
• The recent issue of Hughes Software made history in more than one way.
It was the first Indian IPO in IT industries to adopt the “Book- Building”
process and the issue was highly over subscribed.
• The book-building process in India is very transparent. All investors
(including small investors) can see on an hourly basis where the book is
being built before applying.
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• In November 1999 the HCL technologies has raised capital through IPO
Book-building method, investors gave an enthusiastic response. The
issue got over subscribed by 27 times. This was despite the fact that the
company revised its original price band of Rs. 450-540 to Rs. 500- 580.
The final price offered was Rs. 580 for the shares
• Other companies which have accepted the bookbuilding mechanism were
Shree Rama Multi Tech Ltd., Sydus Cadila Healthcare Ltd., Mascot
Systems Ltd., Creative Eye Ltd., MosChip Semiconductor Technology
Ltd., SIP Technologies and Exports Ltd., Hughes Tele. Com India Ltd.,
MRO TEK Ltd., Pritish Nandy CommunicationsLtd., Balaji Telefilms Ltd.,
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ASTEC Software & Technology Services Ltd., Mid- Day Multimedia Ltd.,
D-Link (India) Ltd., Jet Airways (India) Ltd., UTV Software
Communications Ltd., Punjab National Bank, Gateway Distriparks Ltd.,
IVRCL Infrastructure & Projects Ltd.
Conclusion:-
Book Building process aims at fair pricing of the issue which is supposed to
emerge out of offers made by various investors. One question may arise whether
book building is the right mechanism for fair pricing discovery in IPOs? The
answer may be in the negative because a floor price is fixed for the Book
Building below which no bid can be accepted. Since investors participate through
Book Building process in making fair pricing of IPOs where there is no ceiling
price, there should not be any floor price. In addition to this, unlike international
market, India has not reached the stage of development of the institutional
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framework to experiment with the book building process because retail investors
(i.e. individual investors) are still now an integral part of Indian capital market. If
the interests of the small investors are not safeguarded appropriately, this may
be very dangerous to the primary capital market. Although only two book built
issues — Hughes software and HCL Technologies have given proper returns to
the shareholders in 1999 and Maruti Udyog in 2003 but the other four book built
issues of Shree Rama Multitech, Cadila, Cinevista and Mascot system were
trading at huge discounts to their issue price ranging between 35-50%.
The spirit beyond the introduction of book-building mechanism in India is to
discover the right price for a public issue, which in turn would eliminate
unreasonable issue pricing by greedy promoters. The success of the book-
building system depends on co-operation among the Book Runner Lead
Manager, Issuing Company, Securities and Exchange Board of India
(Regulator), and Investors.
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