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An initial public offering (IPO), referred to simply as an "offering" or "flotation", is when a company (called the issuer) issues common stock or shares to the public for the first time. They are often issued by smaller, wenger companies seeking capital to expand, but can also be done by large privately-owned companies looking to become publicly traded. In an IPO the issuer may obtain the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), best offering price and time to bring it to market. An IPO can be a risky investment. For the individual investor it is tough to predict what the stock or shares will do on its initial day of trading and in the near future since there is often little historical data with which to analyze the company. Also, most IPOs are of companies going through a transitory growth period, and they are therefore subject to additional uncertainty regarding their future value
The term initial public offering (IPO) slipped into everyday speech during the tech bull market of the late 1990s. Back then, it seemed you couldn't go a day without hearing about a dozen new dotcom millionaires in Silicon Valley who were cashing in on their latest IPO. The phenomenon spawned the term siliconaire, which described the dotcom entrepreneurs in their early 20s and 30s who suddenly found themselves living large on the proceeds from their internet companies' IPOs. INVESTORS are still wary of equities in the 1990s, to blame are the excesses in the primary market in the 1990s. Of the thousands of IPOs (initial public offerings) and offers for sale made between 1994 and 1996, less than a hundred were from companies with track record. Even in this shortlist, only a few managed to complete planned projects and deliver value to investors. The rest just frittered the money away. The primary market of the mid-1990s was merely used as a channel to move public funds into private hands. The Securities and Exchange Board of India (SEBI) was late to wake up to the excesses, but when it did, it improved the disclosure framework, tightened the prerequisites for an IPO, and towards the end of the decade, introduced book-building.
( This route brought to market quality, wealth-creating IPOs such as Hughes Software, i-flex solutions, Maruti, Bharti Tele-Ventures, TV Today and Divi's Labs, to name a few. Yet the corporate sector has still not fully lived down the consequences of the excesses of the mid- 1990s.)
Primary and Secondary market
When shares are bought in an IPO it is termed primary market. The primary market does not involve the stock exchanges. A company that plans an IPO contacts an investment banker who will in turn called on securities dealers to help sell the new stock issue. This process of selling the new stock issues to prospective investors in the primary market is called underwriting. When an investor buys shares from another investor at an agreed prevailing market price, it is called as buying from the secondary market. The secondary market involves the stock exchanges and it is regulated by a regulatory authority. In India, the secondary and primary markets are governed by the Security and Exchange Board of India (SEBI)
Primary market is a place where a corporate may raise capital by way of a : 1. Public Issue : Sale of securities to member of the Public. 2. Rights basis. 3. Private placement: As its name suggests it; involves selling securities privately to a group of investors. All issues by a new company has to be made at par and for existing companies the issue price should be justified as per Malegam Committee recommendations by issue : Method of raising further capital from the existing
shareholders/debenture holders by offering additional shares to them on a pre-emptive
• • •
The earnings per share (EPS) for the last three years and comparison of preissue price to earnings (P/E) ratio to the P/E ratio of the Industry. Latest Net Asset Value. Minimum return on increased networth to maintain pre-issues EPS. Accompany may also raise finance from the international markets by issuing GDR’s and ADR’s.
. For this commitment they are entitled to a maximum commission of 2. terms of the issue. The Banks provide temporary loans for the period between the issue date and the date the issue proceeds becomes available after allotment . promoters background. which is referred to as a ‘bridge loan’. (e) Filing of prospectus with the Registrar of Companies: The draft prospectus along with the copies of the agreements entered into with the Lead Manager. registrars and Brokers to the issue is filed with the Registrar of Companies of the state where the registered office of the company is located. projected profitability and others.5 % on the amount underwritten. ‘ (a) Appointment of underwriters: The underwriters are appointed who commit to shoulder the liability and subscribe to the shortfall in case the issue is undersubscribed. Management. Vetting of prospectus by SEBI A draft prospectus is prepared giving out details of the Company. Additionally a Venture Capital Firm has to file the details of the terms subject to which funds are to be raised in the proposed issue in a document called the ‘placement memorandum. past financial performance. Bankers. (c) Appointment of Registrars : Registrars process the application forms. (d) Appointment of the brokers to the issue: Recognized members of the Stock exchanges are appointed as brokers to the issue for marketing the issue. Underwriters. modes of financing. tabulate the amounts collected during the issue and initiate the allotment procedures.CHAP-2 PRINCIPAL STEPS OF A PUBLIC ISSUE 1.the public issue . They are eligible for a maximum brokerage of 1.5%. project details. (b) Appointment of Bankers: Bankers along with their branch network act as the collecting agencies and process the funds procured during .
500/-. (g) Filing of the initial listing application: A letter is sent to the Stock exchanges where the issue is proposed to be listed giving the details and stating the intent . the allotment procedure as prescribed by SEBI is initiated. 7. tabulated and then shares are allotted against these application. then the liability for the subscription falls on the underwriters who have to subscribe to the shortfall. For Equity & Convertible • For Non Convertible debentures • When the issue size is upto n5 crores =Mandatory costs + 5% When the issue size is upto 5 crores = Mandatory costs + 2% • When the issue size is greater than 5 crores : Mandatory costs + 2% • When the Issue size is greater than 5 crores : Mandatory costs + 1% .dailies and vernacular newspapers. brokers to the issue. 2.the Issue start and close dates are published in major English . underwriters.of getting the shares listed on the Exchange. (i) Processing of applications: After the close of the Public Issue all the application forms are scrutinized. incase they have not procured the amount committed by them as per the Underwriting agreement. (l) Listing of the Issue : The shares after having been allotted have to be listed compulsorily in the regional stock exchange and optionally at the other stock exchanges. The initial listing application has to be sent with a fee of Rs. (k) Allotment of shares: after the issue is subscribed to the minimum level. Cost of a Public issue The cost of a public issue works out between 8% to 12% depending of the issue size but the maximum has been specified by SEBI as under.(f) Printing and dispatch of Application forms: The prospectus and application forms are printed and dispatched to all the merchant bankers. (j) Establishing the liability of the underwriter: In case the Issue is not fully subscribed to. (h) Statutory announcement: An abridged version of the prospectus and .
Typically a new company has to compulsorily issue shares at par. while for companies with a track record the shares can be issued at a premium. Rights Issue The rights issue involves selling of securities to the existing shareholders in proportion to their current holding. When a company issues additional equity capital it has to be offered in the first instance to the existing shareholders on a pro-rata basis as per Section 81 of the Companies Act. listing fees and stamp duty. 3. The company has a track record of dividend paying capability for 3 out of the immediately preceding 5 years. partially or fully by a special resolution to enable the .**Mandatory costs includes underwriting commission. expenses on statutory announcements. The shareholders may by a special resolution forfeit this right. A public financial institution or scheduled commercial banks has appraised the project to be financed through the proposed offer and the appraising agency participates in the financing of the project to the extent of at least 10% of the Project cost. fees of the lead managers of the issue . 1956. Eligibility for an IPO An Indian Company is allowed to make an IPO if: 1. Before the advent of SEBI the prices of shares were valued as per the Controller of Capital Issues (CCI). brokerage. 2. 4.
. The securities are placed normally with the Institutional investors. Private Placement A private placement results from the sale of securities by the company to one or few investors. Mutual funds or other Financial Institutional. 5. The distinctive features of private placement is that: • • There is no need for a formal prospectus as well as underwriting arrangement The terms of the issue are negotiated between the company and the investors The issuers are normally the listed public limited companies or closely held public or private limited companies which cannot access the primary market.company to issue additional capital to the public or alternatively by passing a simple resolution and taking the permission of the Central Government.
Quoting of permanent Account number or GIR No. All the listing formalities for a public Issue has to be completed within 70 days from the date of closure of the subscription list. 4. 8.50. firstly. in application for allotment of securities is compulsory where monetary value of Investment is Rs. A Venture Capital Fund shall not be entitled to get its securities listed on any stock exchange till the expiry of 3 years from the date of issuance of securities. Firm Allotment to permanent and regular employees of the issuer is subject to a ceiling of 10% of the issue amount. Paid up capital should be Rs. 9. Minimum of 50% of the Net offer to the Public has to be reserved for Investors applying for less than 1000 shares. 5. 3. 5 Crores. secondly the issuer or the promoting company should have a track record of profitability and thirdly the project should be appraised by a financial Institution. For knowledge based companies like IT the paid up capital should be Rs. 12. For listing an IPO on the NSE firstly. Indian development financial institutions ad Mutual Fund can be allotted securities upto 75% of the Issue Amount. banks or Category I merchant bank. 7. In an issue of more than Rs. . 100 crores the issuer is allowed to place the whole issue by book building. 50 Crores.000/.supported by a resolution passed in the General Meeting. Allotment has to be made within 30 days of the closure of the Public Issue and 42 days in case of a Rights issue. Allotment to categories of FIP's and NRI's/OCB's is upto ? Maximum of 24% which can be further extended to 30% by an application to the RBI . 6. 2. 10% individual ceiling for each category a) Permanent employees' b) Shareholding of the promoting companies. Net Offer to the General Public has to be at least 25% of the Total Issue Size for listing on a Stock exchange.Chap-3 SEBI Guidelines for IPO's 1. but the market capitalization should be at least Rs. There should be at-least 5 investors for every 1 lakh of equity offered.or above. 11. It is mandatory for a company to get its shares listed at the regional stock exchange where the registered office of the issuer is located. 20 Crores. 10.
Refund orders have to be dispatched within 30 days of the closure of the Public Issue. A rights issue has to procure 90% subscription in 60 days of the opening of the issue: 17. Refunds of excess application money i. for un-allotted shares have to be made within 30 days of the closure of the Public Issue. 15.subscription the company may have the right to retain the excess application money and allot shares more than the proposed issue which is referred to as the 'green-shoe' option. The minimum period for a rights issue is 15 working days and the maximum 60 working days.e. 14. 19.13. . Securities issued to the promoter. However shares allotted to FII's and certain Indian and multilateral development financial institutions and Indian Mutual Funds are not subject to Lock-in periods. 16. In case of over . if the company is an unlisted one with a three year track record of consistent profitability Else in all cases the following slab rate apply: Size of Capital issued (Including Premium) Contribution % 18. 20% of the total issued capital. The minimum period for which a public issue has to be kept open is 10 working days. A public issue is effected if the issue is able to procure 90% of the Total issue size within 60 days from the date of earliest closure of the Public Issue. his group companies by way of firm allotment and reservation have a lock-in period of 3 years.
once a company is listed. The existing shareholders will see their shareholdings diluted as a proportion of the company's shares. The money paid by investors for the newly-issued shares goes directly to the company (in contrast to a later trade of shares on the exchange. rather than having to seek and negotiate with individual investors. namely: • • • • • • • Bolstering and diversifying equity base Enabling cheaper access to capital Exposure and prestige Attracting and retaining the best management and employees Facilitating acquisitions Creating multiple financing opportunities: equity. but instead the new shareholders have a right to future profits distributed by the company and the right to a capital distribution in case of a dissolution. convertible debt. it will be able to issue further shares via a rights issue. is a key incentive for many companies seeking to list. etc. This regular ability to raise large amounts of capital from the general market. thereby again providing itself with capital for expansion without incurring any debt.Reasons for Listing When a company lists its shares on a public exchange. allows a company to tap a wide pool of stock market investors to provide it with large volumes of capital for future growth. Increased liquidity for equity holder . An IPO. where the money passes between investors). they hope that the capital investment will make their shareholdings more valuable in absolute terms. therefore. However. In addition. There are several benefits to being a public company. cheaper bank loans. The company is never required to repay the capital. it will almost invariably look to issue additional new shares in order at the same time.
given that global IPOs declined 36.3 billion through 95 Initial Public Offers (IPOs).591 crore was raised by the realty firms. the bulk of the volumes came from the biggest IPO deal so far this year — Reliance Power's $3 billion IPO on January 21. This makes India the largest IPO market in the world so far this year.6 billion is estimated to be the second largest IPO in the world so far this year. equivalent to 10.5 times the stock on offer. Realty firms picked up around 42. at $1. • According to Thomson Financial.Global IPO Trend Report 2007" India was the fifth largest market in the world in terms of the number of IPOs and the seventh largest in terms of the proceeds for the year • It was the real estate sector which took the maximum advantage of the bullish stock market trends in 2007.34. thereby.7% of the total funds generated through IPOs. • Emaar MGF’s IPO. • On January 15. 2008. behind Reliance Power's $3 billion IPO. Reliance Power attracted $27.1% of global IPO proceeds at the moment. • Thomson Financial data reveals that India accounts for 49.Chap-4 Current position of Indian IPO Market India is being lauded as the savior of the ailing global IPO market with $3. It raised US$8.1% over the last one year.7% same time last year. about Rs.3 billion worth of proceeds from eight deals. creating India's IPO record. • The Indian capital market has performed quite well in 2007. 2008. Significant. 450.119 crore raised in the primary market in the period starting from January 2007 to mid-December. The proposed IPO was to fund the development of its six power projects across the country.5 billion of bids on the first day of its IPO.14. According to the Ernst & Young report. real estate players raised the maximum amount of funds from the capital market through IPOs last year. Of the Rs. Its upper cut off price was Rs. . According to the industry body Assocham. compared to just 3. "Globalisation .
which will divest its 10 per cent stake through the offering. which raised Rs 11. which include FIIs.500 crore through its mega IPO in January 2008. is India's biggest public issue till date. For qualified institutional buyers. The Centre. . is also bullish on the issue that will help the government to fulfill Rs 40.211. Anil Ambani Group company Reliance Power . At the upper end of price range. the IPO will close on October 20.81 crore. Coal India public issue is valued worth Rs 15.Largest IPO in India CIL's initial public offering. The CIL IPO has seen a broad endorsement from almost all the big as well as small investment banking firms.000 crore divestment target this fiscal.475 crore and at the lower end it would fetch about Rs 14. priced in the range of Rs 225 to Rs 245 per share. is the biggest issue in the Corporate India's history so far. insurance firms and mutual funds. The offering opens on 18 th October and closes on October 21.
. at least in the short term. However. Arriving at the decision was with a belief that the IPO grade represented a relative assessment of the fundamentals of that ise in relation to the other listed equity securities in India. We further find that the IPO grade fails to explain with any t market performance of the issues in terms of capital gains Introduction As a first of its kind among securities market regulators in the world. the subscription rate of the IPOs improves across all class of investors. with higher IPO grades. Through this study. The parties that are in op position want the grading to be an optional exercise. We note that while SEBI and the rating agencies advocate the benefit of the IPO grade. fund managers. not everyone in the industry and academia is convinced of the grade’s merits. we conducted regression analysis study of a total of 63 IPOs that have been graded. we find that securities with higher IPO grades tend to exhibit underpricing to a lesser extent. To analyze the efficacy of IPO grading. in India.e. Hence. i. 2007 that a firm planning to be listed in the stock exchange obtain a grading of its ipo through is registered with SEBI. the Securities & Exchan ge Board of India (SEBI) after much deliberation introduced a new requirement effective May 1. higher graded IPOs don’t exhibit high turnover ratio. SEBI (India’s capital market regulator) introduced the IPO grading as a mandatory requirement for all IPOs. Given that the grading expenses have been as high as one percent of the the total issue size. which SE BI was attempting to make faster and shorter with the help of grading. Further more. market experts and even the SEBI board members2. in arriving a t an investment decision. IPO grading c an be seen as an endeavor to make additional information available to the investors in order to facilitate their asessment of equity issues offered through an IPO The decision to introduce the requirement recognized the specific needs of the Indian capital market and was the result of preure from certain investor groups. quality signal represented by an IPO grade yields discernible benefits to the market. based on independent and objective analysis. SEBI believed that an IPO grade provided an additional input to investors. with opposition from companies. We also find that IPO grades are inversely related to the shortterm liquidity of the IPOs. We also find that. investment bankers. and the requirement seems to have been borne by the fact that. where institutions are less developed and retail participation in IPOs is significant. including retail investors. the path to manda tory grading of IPOs has been rocky. They argue that the mandatory grading has increased the cost of raising funds and also has led to delay in the IPO process.Chap-5 IPO Grading IPO grading assesses the fundamentals of the Initial Public Offerings (IPOs) and is reflected on a fivepoint point scale (15) with a higher score indicating stronger fundamentals of the IPO issuing firm.
The grading is assigned on a five point basis:IPO grade 1 : Poor fundamentals IPO grade 2: Below Avg fundamentals IPO grade 3 : Average fundamentals IPO grade 4 : Aboveaverage fundamentals IPO grade 5: Strong fundamentals The grading exercise emphasizes on evaluating the prospects of the industry in which the company operates. and the company’s competitive strengths that would allow it to address the risks inherent in the business(es). In case the IPO proceeds are planned to be used to set up projects. and the likely benefits a ccruing from the successful completion of the project in terms of profitability and return to shareholders. ES. P/E. The Grade assigned to any individual IPO is an assessment of the “fundamentals” of the issuer concerned on a relative grading scale. either Greenfield or Brownfield. • Management Quality. the grading evaluates the risks inherent in such proj ects. IPO Grading methodology examines the following key fundam entals: • • Business and Competitive Position ‐The alignment between industry opportunities the company’s strategy and objectives. Accordingly. relevant or a eq uity investor .An evaluation of ability of management to handle uncertainity In terms of capitializing on future business opportunity and mitigating the impact of Contingencies. Corporate Governance practices :An evaluation of the company’s go vernance architecture to determine if it is structured such that the risks and r ewards of • . in relation to the other listed securities in India. growth in profit. Financial Position and Prospects ‐ Forward looking assessment of ke y financial indicators such as RoE. the capacity of the company’s management to execute the same.IPO Grading and Criteria for Evaluation SEBI’s guidelines suggest that the grading of IPOs is a service aimed at facilitating asessment of equity issues offered to thepublic.
To that effect. . Similarly. While growt h prospects of the industry and financial strength are some of the quantitati ve parameters qualitative parameters such as management capability also provide critica l input in determining a grade. helps in both widening and deepening the market. it is not an investment recommendation. In this context. in arriving at an investment decision. sell or hold the securities. objective indicators of the relative fundamental positions of the issuers concerned. The primary stakeholders in this context are SEBI. SEBI’s View An investor may find it challenging to appropriately assess. grading is done looking at roughly a three year time horizon and would involve an in‐depth assessme nt of the various quantitative and qualitative parameters of the issuer. a firm’s business prospects and risks. the rating agencies. being simple. SEBI has further said that as the IPO grading does not take into consideration the pricing of the security. it is prudent to first look at the views of the various stakeholders. SEBI’s belief is that an IPO grade provides an additional input to investors. with the stock market participation of new and foreign investors increasing in India. SEBI contends that there is need for greater value‐added information on companies tapping the capital market and their intrinsic quality.the firms aspiring to issue an IPO and the investors. It is worth noting that IPO grading is NOT a recommendation to buy. Normally. SEBI’s view is that all other things remaining equal. on the basis of the information available on the prospectus. what is unique about India’s capital market that calls for IPO grading? To assess the necessity. Is IPO grading Necessary? Given that no other capital market in the world practices such a grading scheme. In recent times. Rather it is only one of the inputs for the investor to aid in the decision making process.busess are equally available to all shareholders. IPO grading is a one time assessment done prior to the IPO issue and relie s significant on the draft prospectus filed with SE. a security with stronger fundamentals would command a higher market price. it is NOT a comment on the valuation or pricing of the IPO nor is it an indication of the likely listing price of the securitis. IPO grades.
SEBI believes that it has taken a pioneering role in safeguarding investors’ interest by increas ing disclosure levels by entits seeking to access equity markets for funding. will prevent vanishing companies in future. Rating Agencies View Until now. its issue might suffer despite stro ng fundamentals. One of our concerns is whether we are going to have another round of ‘vanishing companies’ which will raise money and never spend it for the intended purpose. Rating agencies co ntend that an IPO grade . A tricky situation prevailed where in a good company would not go for the rating fearing that if it gets a bad rating. However. helping investors separate good floats from risky ones. but in the event that they obtain a grading. they were required to disclose it in the prospectus. only four companies approached the agencies for their rating. Looking at these uncertainties. they may not fully disseminate or comprehend the implications of the disclosures made. Grading Exercise optional to Mandatory When first introduced in April 2006. This meant that issuers were not required to get their IPO gra ded. if made mandatory. SEBI chairman M. a bad company too would not go for the ratin g fearing that its cover ups might get exposed with a poor rating. Similarly. It is not that only the best and the brightest continue to come to the market. SEBI kept the IPO grading as an option al exercise. research has been available to equity investors only in the form of investmentadvice (buy/sell/hold recommendations). I firmly believe that [IPO] grading. despite more than 40 IPOs expected to hit the market in the first half of 2006‐07. This has caused India to be amongst one of the more transparent and efficient markets in the world. Therefore SEBI’s belief is that there is a vital need to rate equity offerings. A majorit of retail investors do not read the offer document (prospectus) and even when they do. there was no incentive for the companies to rate their IPOs. they did not accept the ratings awarded to them as the ratings did not m atch up to their expectations Additionally. there are a lot of other people [companies] who started entering the market. Incidentally . Damodaran explains t he decision to make IPO grading a mandatory exercise: “When the market started going up suddenly a lot of people [companies] started coming to the market. SEBI decided to make IPO grading a mandatory exe rcise effective as of May 1. 2007.
brings an independent.The fundamentals. the credit rating ag encies point out that the investors should not misconstrue an IPO grading to be an investment decision. operating efficiency and p rofile of promoters. Rather. Rating agencies further substantiate that the IPO grade summarizes the v oluminous data in the prospectus and its implications. it is only one of the inputs to the investor decision making process. Although there are some reservations regarding the de gree of unbiased nature of the IPO grade. believes t hat grading helps if investors know where exactly it belongs in their investment decision process process. Investment decision making is three step process:- . which we shall look at later in the paper. In response to the fact that there isn’t a lot of clari ty in the market as far as what an IPO grade indicates. can be looked at in ter ms of factors such as competence of management. It needs to be read to gether with thedisclosures made in the prospectus as well as the price at which the shares are offered. which a lay investor may not b e able to comprehend. One of the rating agencies. the rating agencie s believe that the assessment is in no way influenced by the issuer and therefore brings fresh perspectives to the market. unbiased assessment of the fundamentals of the IP O issuing firm. as stated earlier. competitive edge. CRISIL.
while others oppose it. Rating will certainly facilitate which are not very well known . the onus of bearing the cost of obtaining the grade has since been . or by Investor Education Protection Funds (IPF) administered by the Ministries of Companies Affairs. Additional benefi t of the IPO grade.The rating agencies compare the fundamentals of the IPO firm to those of other listed firms in the primary and the secondaryarket. the relative comparison set of potential IPO companies must include all companies that are potential investment equity options for the investor. Initially. SEBI sources had disclosed that t he cost of the grading would be borne by the Investor Protection Funds ad ministered by the stk exchanges. However. in the eyes of the rating agencies. Doing so benefits the issuer company by benchmarking itself with peers. some of whom believe in the merits of the IP O grade. there are other stakeholders. While the large and well‐known companies would not find it difficult to raise funds. is particularly significant for the smaller firms. th e middle rung companies would like their equity to be graded such that they could access fun ds without much track record about their performance. This is done with an understanding that if IPO grading is to meet investors’ needs. to tap markets. Doing so benefits the issuer company by benchmarking itself with its peers. Other stake holders View Along with SEBI and the rating agencies who are advocates of the IPO gra ding system.
since payment would now be made by companies to rating agencies . some argue that vulnerable are the mall and medium enterprises (SMEs) as most rating agencies are known to treat SMEs with little respect. already available in the prospectus. would some level of biasness be involved in the equation? Would their be a conflict of i nterest in the hands of the rating agencies in that they would want to assign a high grade to company In order to increase the likelihood of getting paid. a good company with an issue that is priced high can be a bad investment. Price to Earning (P/E) ratio. if a good company is given poor rating. the company’s IPO plans might get shelved. argues that at certain times.transferred to the companies themselves. Contrary to the rating agencies’ view that small companies benefit from the IPO grade. and a gradin g by an independent rating agency would be useful. There does not seem to be any justification for having shifted the cost responsibilities from IPF to the companies. he suggests. because if it were a true grading exercise. Kotak Securities says: “Pricing of shares is the most critical factor in evaluating IPOs and by not taking the pricing into consideration. it would take into account the price at which the shares are offered. Siddhartha Sankar Saha. which is subject to SEBI’s approval. Xavier’s College.” From an investment standpoint. lecturer of Accounting & Fin ance at St. Even tho ugh the IPO grading process is to be carried out in parallel along with other pre‐issue a ctivities. Mridul Sagar. not all in the indu stry are pessimistic. the filing of the final offer document to the registrar of companies (RoC) remains pending. Due to lack of justification on this. He suggests that IPO grading is particularly useful for companies with no track record of prior m arket performance. To that effect. chief economist. Moreover. regardless of the fundamentals. However.The IPO grading is required to be completed and disclosed in the fi nal prospectutherefore until the grading is complete. the usefulness of grading is diminished. Some have argued that the term “IPO grade” is misleading. The other argument is that given the details of the company’s projections in terms of target growth. the need for an IPO grade is not justified. a high grade could allow issuing companies to demand a better premium on their offer also argues that the IPO grade allows invest ors to . there is belief that one more layer of deliverable has led to the delay in th e overall IPO process. a company may not know the extent of its own performance. He suggests that IPO grading serves as an investment assistance device to enable more realistic pricing of shares. some in the finance industry have suggested that the IPO grading has increased the cost of raising funds in the capital market Also. and thus could assign them poor grades. in his article on ‐‐The Chartered Accountant‐‐.
Saha also suggests that the grading can be an impediment for weak comp anies. The steps involved in the grading process are as follows: Step I: The issuer shares the required information with the grading team of the ra ting agency Step II: Rating agency follows up with detailed management meetings with the CE O. the company first contac ts one of the Grading agencies. The process of obtaining a grade:The grading agencies that are approved by SEBI to carry out the grading are As follows:• • • • Credit Analysis and Research Ltd(CARE) Credit rating Information services of India ltd. CFO. rather then page through the voluminous prospects. Therefore IPO grading behaves as a deterrent for weak companies pla nning to come to the market to raise easy capital.understand the fundamentals of the company via a std set of disclosures. and further follows up with subsequent site visits Step III The grading team prepares a detailed note and grading committee assign s the grade .(CRISIL) FITCH Ratings ICRA Ltd To initiate the process of obtaining an IPO grade. and thoard of directors. These companies will find it difficult to create speculative demand among investo rs.
Step IV: Grading gency publishes a rationale outlining the reasons for the assinged grade Step V: Grading agency sends the grading report to SEBI.Stock Exchanges and the company. The IPO grading Process:- Rationale for Assigned Grades In an effort to gauge what sort of firm characteristics the rating agencies look for before .
arrivng at a particular grade..” “The company management lacks depth since the key management personnel have a limited understanding of the business. .” “The company is currently enjoying a debt free status CRISIL justification in assigning a grade 4 to a firm in telecom sector.” “Total income in FY06 has depicted a quantum jump..” “The grading also reflects the firm’s ability to leverage on the unique voice recognition capability….” “Consolidation coupled with low operational expenditure contributed to healthy PBILDT margins…. We note again that the grades are assigned on a 5 point scale (1‐5). “The grading reflects the firm’s position as the largest player in the mobile valueadded services (VAS) market in India…. well entrenched position in the construction industry. Out of the 63 graded IPOs that we have studied.” “The firm plans to reduce its dependence on the Indian market by expanding into international markets. as reflected in the company’s consistent track record in product innovation.and its ability to offer customer contact products to companies by virtue of having a voice channel relationship with almost al telecom operators. we look at the rating agencies’ justification for some of the grade s assigned. Rationale for Grade 1 (out of 5) CRISIL’s justification in assigning a grade of 1 to a firm in the mining sector: The grading reflects weak management capability of the firm and its present uncertain business model…. Rationale for Grade 4 (out of 5) CARE’s justification in assigning a grade of 4 to a firm in the infrastructure sector: “The grading factors in the long experience.” “The company is leveraging strategic relationships with global infrastructure companies to enhance their project bidding and devlopment capabilities. the highest and the lowest grades assigned have been a 4 a nd 1 respectively.” “The company's financial returns are also vulnerable to spot price movements of the raw material.” “The grading also factors in the management's strong understanding of market dynamics. as indicated by the appointment of independent directors..” “The rating takes into account the improvement in the financial position of the company. and proactiveness in setting up a corporate governance system…. In the last one year the company has made two acquisitions.
”. “The grading also reflects the firm’s belowaverage corporate governance structure.. • While credit rating is assigned based on past responsibilities of debt payment along with future capabilities. it is worthwhile to note a f ew underlying differences between IPO grading and credit rating. IPO grade is assigned based solely on fundamentals and on assessment of the future performanc e. • Companies that are likely to raise far more equity than they need in an IPO and hence suffer a depressed return on equity (RoE) are likel y to be assessed unfavorably in the IPO grading exercise.“The limited management capability is also reflected in its significant dependence on thirdparty consultants. However. The concept of IPO grading being a unique one. they are likely to be assessed more favorably in a credit rating exercise. as more equity lowers the deb t to equity (D/E) ratio and provides cushion to assume more debt. .
The actual price is then discovered based on these bids. 2. Retail Individual Investor (RII): In the retail individual investor category. Each investor states how many shares s/he wants and what s/he is willing to pay for those shares (depending on the price band). it indicates a price band that mentions the lowest (referred to as the floor) and the highest (the cap) prices at which a share can be sold. NRI’s who apply with less than Rs 100000/ are also considered as RII category. Bids are then invited for the shares. etc. who bid for more than Rs 1 lakh are known as Non Institutional bidders. NRI’s. There is no upper limit for bidding amount in ‘NON institutional Investors Category. The actual price is then discovered based on these bids. they are considered as HNI. As we continue with the series. . Retail Individual investors have an allocation of 35% of shares of the total issue size in Book build IPOs.Chap-6 Book building Process This is the process of price discovery. According to the book building process. Each investor states how many shares s/he wants and what s/he is willing to pay for those shares (depending on the price band).High Networth Individual (HNI): If Retail Investor applies for more than Rs 100000 of shares in an IPO . Retail Individual investor can bid for more than Rs 100000 in an IPO by applying in NON institutional Investors Category. Bids are then invited or the shares.investors cannot apply more than Rs one lakh (Rs 1. instead. 1. 3. The company does not come out with a fixed price for its shares. four classes of investors can bid for the shares.000) in an IPO. we will explain the process in detail. Non. trusts. Companies . 00.Institutional bidders have an allocation of 15% of shares of the total issue size in Book build IPOs. Non Institutional bidders : Individual investors .
A stock is usually only underpriced temporarily because the laws of supply and demand will eventually drive it toward its intrinsic value. Say. banks . as per the conventional notion of IPO pricing. The investors are then selected by lottery and the issue allotted on a proportional basis. For instance. the stock is considered to be underpriced. Allotment & Evaluation of IPO This is the process whereby those who apply are given (allotted) shares. That is why there is no way we can be sure of getting an allotment. The bids are first allotted to the different categories and the over-subscription (more shares applied for than shares available) in each category is determined. QIBs are mostly representatives of small investors who invest through mutual funds.4. the over-subscription is huge or the issue is priced so high that retail investors cannot really bid for too many shares before the Rs 50. They usually apply in very high quantities. Since that isn't possible.Qualified Institutional Bidders (QIBs): Financial institutions . Retail investors and high net worth individuals get allotments on a proportional basis. ULIP schemes of insurance companies and pension schemes .000 limit is reached. and the issue is over-subscribed five times in the retail category. When the offer price is lower than the price of the first trade. The less liquid and less predictable the shares are. a retail investor has applied for five shares in an issue. then the retail investor gets to get 40 shares (200 shares/5). if a retail investor has applied for 200 shares in the issue. Underpricing Often the pricing of an initial public offering (IPO) is below its market value. In such cases. The investor is entitled to half a share. and the retail category has been oversubscribed 10 times. It is believed that IPOs are often underpriced because of concerns relating to liquidity and uncertainty about the level at which the stock will trade. The conventional argument given for ‘underpricing’ is that an IPO's issuer tends to know . it may then be decided that every 1 in 2 retail investors will get allotment. FII’s and Mutual funds who are registered with SEBI are called QIB’s. QIB have an allocation of 50% of shares of the total issue size in book build IPOs. the more underpriced they will have to be in order to compensate investors for the risk they are taking. Sometimes. allotments are made on the basis of a lottery.
There are other factors that occur behind the scenes that can be important to the value of an IPO. we can be certain that the company is at least stable to a degree at the current moment. If we can find sufficient evidence supporting the fact that the business releasing the IPO is worth wer money.more about the value of the shares than the investor. they are a profitable investment. We should look into who is releasing the IPO to the public. One of the easiest ways to evaluate whether we should purchase an IPO is by analyzing the type of company the IPO represents. and many other facts that may affect the overall value of the investment in the long-run. the initial evaluation process we must perform when we are purchasing an IPO is definitely the most important action we can take when we are first investing into this realm the stock market. . As we probably already know. One of the easiest ways to understand the type of company that is being represented by an IPO is by analyzing the products and services the company is offering to the public. If the company is making more than their current expenses are charging their bank accounts. we should also investigate a variety of other factors that can be highly relevant to the value of an IPO investment. the company is in an unstable financial situation. If we can find a company that is selling to the open market with assets that are worth more than its debt. If we invest into a company that has me more expenses than income. One of the most important aspects of an IPO investment is the amount of income the company is bringing in relative to the value of any expenses it maintains. The first aspect we should look into as we are investing into an IPO is the amount of assets the company has within its balance sheet compared to the amount of debt the company owes. for what reasons they selling the initial public offering to the public. How to evaluate IPO As we can see. consider it as an investment option. The best situation we can find a company in is a situation where they have more assets than debt. and therefore. which is certainly an investment we should stay away from. the company must underprice its stock to encourage investors to participate in the IPO.
They give a commitment to underwrite the issue. If. it doesn't mean it recommends the issue or guarantees its contents. we will certainly be able to discern whether or not the investment we are considering is worth wer current capital. that means lead managers have to ensure the company is following the rules laid down for an IPO. who are supposed to do due diligence on the issue. which are a risky investment with no guarantees. If underwriters don't pay up. They are also called merchant bankers and are in charge of the issue process. It is then left to the underwriters to pick up the balance Rs 20 crore (Rs 200 million). phone numbers and e-mail addresses. This responsibility rests with the lead managers to the issue. broker. and growing company. Suppose there is an issue is for Rs 100 crore (Rs 1 billion) and subscriptions are received only for Rs 80 crore (Rs 800 million). that it has made available all the information a potential investor needs to know and that the facts in the prospectus are correct. They act as intermediaries between the company and the investors. SEBI will cancel their licenses. This is a financial institution appointed to keep a record of the issue and ownership of company shares. in such cases. they are also called Book Running Lead Managers. are therefore. Post issue activities. stable. like intimation of allotments and refunds. is done by the Registrar to the Issue. nothing but stocks. crediting the shares to their demat accounts and ensuring refunds. In the case of complaints like non-receipts of shares or refunds. we discover that the company being represented by the IPO is a solid. In plain language. IPOs are. after we perform IPO valuation. . if not allotted the shares. The names of all the lead managers and the registrar to the issue. If it is a book building process. the lead manager also helps determine the price band.If we put all of these different factors into the forefront of wer thinking process as we analyze IPO investments. consider it as a possible investment for expanding portfolio. merchant banker or a financial institution. with their addresses. are their responsibility as well. Underwriting means they will subscribe to the balance shares if all the shares offered at the IPO are not picked up. are displayed prominently on the cover of every prospectus. we should consider placing wer money elsewhere. investors must complain to the lead managers. who take up the matter with the registrars. They are also responsible for drawing up the prospectus and marketing the issue. The actual work of drawing up the list of allotees. An Underwriter to the issue could be a banker. The Syndicate Just because the prospectus has been filed with SEBI. If we discover that any of these factors do not provide sufficient evidence that the IPO is a valuable investment.
The issue may even end up being oversubscribed. Prominent financial institutions may agree to underwrite the issue. which are subject to additional uncertainty regarding their future values. . growth rates and even investor confidence. the best offering price and the time to bring it to market. The issuer obtains the assistance of an underwriting firm. most IPOs are of companies going through a transitory growth period. When underwriters determine the public offering price. This price is known as the ‘Issue Price’ or ‘Public Offering Price’ (PoP). Also. public trends.The lead manager may have certified that the facts. IPOs can be a risky investment. All this still does not mean that IPOs are being offered and being priced by the IPO market at the right or ‘True Price’. In an IPO is also referred to as a "public offering". are correct. as disclosed in the prospectus. Some of these include the company's financial statements (how profitable it is). which helps it determine what type of security to issue (common or preferred). For the individual investor. they look at a number of factors. it is tough to predict what the stock will do on its initial day of trading and in the near future because there is often little historical data with which to analyze the company.
in such a case will notify the floor price or a price band by way of an advertisement one day prior to the opening of the issue.Draft Offer Document Means the offer document in draft stage. it is a process of price discovery and the price cannot be determined until the bidding process is completed. An offer document covers all the relevant information to help an investor to make his/her investment decision. SEBI may specifies changes.Offer Document Means Prospectus in case of a public issue or offer for sale and Letter of Offer in case of a rights issue which is filed Registrar of Companies (ROC) and Stock Exchanges. atleast 21 days prior to the filing of the Offer Document with ROC/ SEs. 2. if any.Chap-7 Some Terms in IPO Industry 1. An RHP for and FPO can be filed with the ROC without the price band and the issuer. an issuer can state the issue size and the number of shares are determined later.Red Herring Prospectus It is a prospectus which does not have details of either price or number of shares being offered or the amount of issue. such details are not shown in the Red Herring prospectus filed with ROC in terms of the provisions of the Companies Act. Hence. . This means that in case price is not disclosed. The Draft Offer document is available on the SEBI website for public comments for a period of 21 days from the filing of the Draft Offer Document with SEBI. The draft offer documents are filed with SEBI. in the draft Offer Document and the issuer or the Lead Merchant banker shall carry out such changes in the draft offer document before filing the Offer Document with ROC/SEs. 3. On the other hand. the number of shares and the upper and lower price bands are disclosed. In the case of book-built issues.
Lock. shall continue to hold some minimum percentage in the company after the public issue. The letter of offer contains all the disclosures as required in term of SEBI(DIP) guidelines and enable shareholder in making an informed decision.Abridged Prospectus Means the memorandum as prescribed in Form 2A under sub-section (3) of section 56 of the Companies Act.Only on completion of the bidding process. 7. Listed company is required to send the abridged letter of offer to each and every shareholder who is eligible for participating in the rights issue along with the application form. the details of the final price are included in the offer document. A company is also required to send detailed letter of offer upon request by any Shareholder. Chapter XIII and Chapter XIIIA of DIP guidelines. 1956. Placement Document Means document prepared by Merchant Banker for the purpose of Qualified Institutions placement and contains all the relevant and material disclosures to enable QIBs to make an informed decision. There is lock-in on the shares held before IPO and also on shares acquired through preferential allotment route.In “Lock-in” indicates a freeze on the shares. 8. It accompanies the application form of public issues 5. The requirements are detailed in Chapter IV of DIP guidelines. SEBI (DIP) Guidelines have stipulated lock-in requirements on shares of promoters mainly to ensure that the promoters or main persons who are controlling the company. The requirements are detailed in Chapter IV. .Letter of Offer Means the offer document prepared by company for its rights issue and which is filed with the Stock Exchanges. It contains all the salient features of a prospectus. However there is no lock. 6. Abridged Offer of Letter Means the abridged version of the letter of offer. The offer document filed thereafter with ROC is called a prospectus 4.in on shares/ securities allotted through QIP route.
any company in which 10% or more of the share capital is held by the promoter or an immediate relative of the promoter' or a firm or HUF in which the 'Promoter' or any one or more of his immediate relative is a member. E-IPO A company proposing to issue capital to public through the on-line system of the stock exchange for offer of securities can do so if it complies with the requirements under Chapter11A of DIP Guidelines. From an investor’s perspective.Promoter The promoter has been defined as a person or persons who are in over-all control of the company. It may be noted that a director / officer of the issuer company or person. 11. The appointment of various intermediaries by . brother. who are instrumental in the formulation of a plan or programme pursuant to which the securities are offered to the public and those named in the prospectus as promoters(s). any company in which a group of individuals or companies or combinations thereof who holds 20% or more of the equity capital in that company also holds 20% or more of the equity capital of the issuer company. In case the promoter is an individual. or any parent. of the share capital. an issue with green shoe option provides more probability of getting shares and also that post listing price may show relatively more stability as compared to market. sister or child of the person or of the spouse). if they are acting as such merely in their professional capacity are not be included in the definition of a promoter 'Promoter Group' includes the promoter. holds 10% or more. and all persons whose shareholding is aggregated for the purpose of disclosing in the prospectus "shareholding of the promoter group" 10. any HUF or firm in which the aggregate share of the promoter and his immediate relatives is equal to or more than 10% of the total. a subsidiary or holding company of that company. any spouse of that person. This is an arrangement wherein the issue would be over allotted to the extent of a maximum of 15% of the issue size.9.Green Shoe Option A Green Shoe option means an option of allocating shares in excess of the shares included in the public issue and operating a post-listing price stabilizing mechanism for a period not exceeding 30 days in accordance with the provisions of Chapter VIIIA of DIP Guidelines. an immediate relative of the promoter (i. any company in whicha company specified in. In case promoter is a company.e. any company in which the promoter holds 10% or more of the equity capital or which holds 10% or more of the equity capital of the Promoter. which is granted to a company to be exercised through a Stabilizing Agent.
There are no laws that prevent flipping. Safety Net Any safety net scheme or buy-back arrangements of the shares proposed in any public issue shall be finalized by an issuer company with the lead merchant banker in advance and disclosed in the prospectus. The double standard exists and there is nothing we can do about it because they have the buying power. The syndicate members are mainly appointed to collect and entre the bid forms in a book built issue. Open /Close Book Presently. Syndicate Member The Book Runner(s) may appoint those intermediaries who are registered with the Board and who are permitted to carry on activity as an ‘Underwriter’ as syndicate members. not traders. Such buy back or safety net arrangements shall be made available only to all original resident individual allottees limited up to a maximum of 1000 shares per allottee and the offer is kept open for a period of 6 months from the last date of dispatch of securities. the book is not made public and the bidders will have to take a call on the price at which they intend to make a bid without having any information on the bids submitted by other bidders 16. Under closed book building.Many IPOs that have big gains on the first day will come back to earth as the institutions take their profits. Here. 12. the investor can be guided by the movements of the bids during the period in which the bid is kept open. The details regarding Safety Net are covered under Clause 8. This isn't easy to do. Issuers and merchant bankers are required to ensure online display of the demand and bids during the bidding period. Because of flipping. it's a good rule not to buy shares of an IPO if you don't get in on the initial offering.18 of DIP Guidelines 13. The reason behind this is that companies want long-term investors who hold their stock. Hard Underwrting . and you'll be strongly discouraged by your brokerage. in issues made through book building. 15. This is the Open book system of book building.the issuer includes a prerequisite that such members/registrars have the required facilities to accommodate such an online issue process. but your broker may blacklist you from future offerings Institutional investors flip stocks all the time and make big money. 14 Flipping Flipping is reselling a hot IPO stock in the first few days to earn a quick profit.
The underwriter guarantees a fixed amount to the issuer from the issue.Minority IPO An initial public offering in which a parent company spins off one of its subsidiaries or divisions. This type of IPO allows the company to raise funds. Also. Cut Off Price In Book building issue. the parent company will still have a controlling stake of the new public company. the issue is devolved on underwriters and they have to bring in the amount by subscribing to the shares. 20. to fund its own operation or return value to shareholders. This issue price is called “Cut off price”. Thus.the soft underwriter has the option to invoke a force Majeure (acts of God) clause in case there are certain factors beyond the control that can affect the underwriter’s ability to place the shares with the buyers 18. In DIP Guidelines differential pricing is allowed only if the securities to applicants in the firm allotment category is at a price higher than the price at which the net offer to the public is made. Soft Underwriting Soft underwriting is when an underwriter agrees to buy the shares at later stages as soon as the pricing process is complete. 19. The underwriter bears a risk which is much higher in soft underwriting. This is decided by the issuer and LM after considering the book and investors’ appetite for the stock SEBI (DIP) guidelines permit only retail individual investors to have an option of applying at cut off price. . This means that after the public offering. He then.Hard underwriting is when an underwriter agrees to buy his commitment at its earliest stage. immediately places those shares with institutional players. accessing the value of the subsidiary. but retains a majority stake in the company after issuance. in case the shares are not subscribed by investors. The parent company may retain this majority stake forever or may slowly dissolve their ownership over time.Differential Pricing Pricing of an issue where one category is offered shares at a price different from the other category is called differential pricing. 17. the issuer is required to indicate either the price band or a floor price in the red herring prospectus. The net offer to the public means the offer made to the Indian public and does not include firm allotments or reservations or promoters’ contributions. The risk faced by the underwriter as such is reduced to a small window of time. The actual discovered issue price can be any price in the price band or any price above the floor price.
suppliers. a DPO will typically raise much less than a traditional offering. Public Offering Price The price at which new issues are offered to the public by an underwriter. When the offer price is lower than the price of the first trade. distributors and friends in the community. In other words. 24. On the other hand. UnderPricing The pricing of an initial public offering (IPO) below its market value. The quiet period usually lasts either 40 or 90 days from the IPO. It is believed that IPOs are often underpriced because of concerns relating to liquidity and uncertainty about the level at which the stock will trade. a company must underprice its stock to encourage investors to participate in the IPO. they don't have the restrictions that are usually associated with bank and venture capital financing. There are two time windows commonly referred to as "quiet periods" . they look at a number of factors. The less liquid and less predictable the shares are.21. the more underpriced they will have to be in order to compensate investors for the risk they are taking.Some of these include the company's financial statements (how profitable it is). Direct Public offering When a company raises capital by marketing its shares directly to its own customers. you can't talk about your stock to anybody for 3 months.growth rates and even investor confidence. A stock is usually only underpriced temporarily because the laws of supply and demand will eventually drive it toward its intrinsic value. the period where an issuer is subject to a SEC ban on promotional publicity.Quiet Period In terms of an IPO. 23. If you take your company public. employees. Because an IPO's issuer tends to know more about the value of the shares than the investor. When underwriters determine the public offering price.Direct public offerings are considerably less expensive than traditional underwritten offerings. Additionally. the stock is considered to be underpriced. public trends. DPOs are an alternative to underwritten public offerings by securities broker-dealer firms where a company's shares are sold to the broker's customers and prospects. 22.
take many factors into consideration when pricing an IPO. the NASD and NYSE have approved a rule mandating a 10-day quiet period after a secondary offering and a 15-day quiet period both before and after expiration of a "lock-up agreement" for a securities offering. 2002. are restricted from issuing any earnings forecasts or research reports for the company. Further to this. Pricing Historically. The effect of initialunderpricing an IPO is to generate additional interest in the stock when it first becomes publicly traded. issuers. generally the lead underwriters will initiate research coverage on the firm. IPOs both globally and in the US have been underpriced. company insiders. insiders and any underwriters involved in the IPO. During this time. Even if they sell all of the issued shares.during an IPO's history. it may lose its marketability and hence even more of its value Investment banks. During this time. The first and the one linked above is the period of time following the filing of the company's registration statement. 26. This can lead to significant gains for investors who have been allocated shares of the IPO at the offering price. therefore. However. and other parties are legally restricted in their ability to discuss or promote the upcoming IPO. Regulatory changes enacted by the SEC as part of the Global Settlement. When the quiet period is over. There are two ways in which the price of an IPO can be determined: . The danger of overpricing is also an important consideration. if the stock falls in value on the first day of trading. Issue Price A company that is planning an IPO appoints lead managers to help it decide on an appropriate price at which the shares should be issued. but high enough to raise an adequate amount of capital for the company. If a stock is offered to the public at a higher price than the market will pay. and attempt to reach an offering price that is low enough to stimulate interest in the stock. enlarged the "quiet period" from 25 days to 40 days on July 9. underpricing an IPO results in "money left on the table"—lost capital that could have been raised for the company had the stock been offered at a higher price. The process of determining an optimal price usually involves the underwriters ("syndicate") arranging share purchase commitments from lead institutional investors. The other "quiet period" refers to a period of 40 calendar days following an IPO's first day of public trading. but before SEC staff declare the registration statement effective. 25. analysts. the underwriters may have trouble meeting their commitments to sell shares.
· Either the company. with the help of its lead managers. List of TOP ten IPO performers :- . This information is not sufficient. Note: Not all IPOs are eligible for delivery settlement through the DTC system. which would then either require the physical delivery of the stock certificates to the clearing agent bank's custodian. or a delivery versus payment ("DVP") arrangement with the selling group brokerage firm. fixes a price or · The price is arrived at through the process of book building.
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