Ipo and Book Building2

8/14/2019 Ipo and Book Building2

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INITIAL PUBLIC OFFER (IPO)INITIAL PUBLIC OFFER (IPO)

M EANING

An initial public offering (IPO) occurs when a company first sells common shares to investorsin the public. Generally, the company offers primary shares this way, although sometimessecondary shares are also sold as IPOs.

Broadly speaking, companies are either private or public. Going public means a company isswitching from private ownership to public ownership.

Going public raises cash and provides many benefits for a company.

DEFINITION

An IPO (initial public offering) is a first and one-time only sale of publicly tradable stockshares in a company that has previously been owned privately. An IPO is also sometimes knownas "going public." Technically, an IPO is the offering to sell but virtually all IPOs result in all the

stock offered being sold. IPOs are generally managed by companies that specialize in handlingIPOs and have experience in determining what the likely IPO offering price should be. If the IPOmanager determines that the stock will not sell at an offering price that is acceptable to thecompany, the application for an IPO is usually withdrawn until a better time. As soon as allshares of an IPO have been sold, the stock is now tradable through stock exchanges orspecialists that trade in the stock and the stock price may go up or down.

HISTORY

The term initial public offering (IPO) slipped into everyday speech during the tech bullmarket of the late 1990s. Back then, it seemed you couldn't go a day without hearing about adozen new dotcom millionaires in Silicon Valley who were cashing in on their latest IPO. The

phenomenon spawned the term silicon ire, which described the dotcom entrepreneurs in theirearly 20s and 30s who suddenly found themselves living large on the proceeds from theirinternet companies' IPOs.

INVESTORS are still wary of equities in the 1990s, to blame are the excesses in theprimary market in the 1990s. Of the thousands of IPOs (initial public offerings) and offers for salemade 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 toinvestors. The rest just frittered the money away.

The primary market of the mid-1990s was merely used as a channel to move publicfunds 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 theprerequisites 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 thecorporate sector has still not fully lived down the consequences of the excesses of the mid-1990s.)

CURRENT POSITION OF INDIAN IPO MARKET


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India is being lauded as the savior of the ailing global IPO market with $3.3 billion worthof proceeds from eight deals. This makes India the largest IPO market in the world so far thisyear.

1.According to Thomson Financial, the bulk of the volumes came from the biggest IPO deal

so far this year Reliance Power's $3 billion IPO on January 21, 2008.

2.On January 15, 2008, Reliance Power attracted $27.5 billion of bids on the first day of itsIPO, equivalent to 10.5 times the stock on offer, thereby, creating India's IPO record. Itsupper cut off price was Rs. 450. The proposed IPO was to fund the development of its sixpower projects across the country.

3.Emaar MGFs IPO, at $1.6 billion is estimated to be the second largest IPO in the worldso far this year, behind Reliance Power's $3 billion IPO.

4.Thomson Financial data reveals that India accounts for 49.1% of global IPO proceeds atthe moment, compared to just 3.7% same time last year. Significant, given that global IPOs

declined 36.1% over the last one year.

5. The Indian capital market has performed quite well in 2007. It raised US$8.3billion through 95 Initial Public Offers (IPOs). According to the Ernst & Young report,"Globalization - Global IPO Trend Report 2007" India was the fifth largest market in theworld in terms of the number of IPOs and the seventh largest in terms of the proceeds forthe year.

6. It was the real estate sector which took the maximum advantage of the bullishstock market trends in 2007. According to the industry body Assocham, real estate playersraised the maximum amount of funds from the capital market through IPOs last year. Realtyfirms picked up around 42.7% of the total funds generated through IPOs. Of the Rs.34,119

crore raised in the primary market in the period starting from January 1, 2007 to mid-December, about Rs.14,591 crore was raised by the realty firms.

7. An initial public offering (IPO) is the first sale of stock by a company to the public.

PRIMARY MARKET AND SECONDARY MARKET

When shares are bought in an IPO it is termed primary market. The primary market doesnot involve the stock exchanges. A company that plans an IPO contacts an investment bankerwho will in turn called on securities dealers to help sell the new stock issue.

FINANCIAL YEAR AMOUNT RAISED THROUHG IPO

2002-03 Rs 1039 crore

2003-04 Rs 17807 crore

2004-05 Rs 21432 crore

2005-06 Rs 23,676 crore

2006-07 Rs 24,994 crore

2007-08 Rs 52,253 crore


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This process of selling the new stock issues to prospective investors in the primarymarket is called underwriting.

When an investor buys shares from another investor at an agreed prevailing marketprice, it is called as buying from the secondary market.

The secondary market involves the stock exchanges and it is regulated by a regulatoryauthority. In India, the secondary and primary markets are governed by the Security andExchange Board of India (SEBI).

KINDS OF PUBLIC OFFERINGS

1. Primary offering :- New shares are sold to raise cash for the company.

2. Secondary offering :- Existing shares (owned by VCs or firm founders) are sold, no newcash goes to company. A single offering may include both of these initial public offering.

SOME MOTIVATIONS

Additional source of capital. Increase debt capacity (give breathing room for debt). Stock prices give measure of performance. Allows managers to be compensated with options, or have incentives otherwise directly tied

to shareholder value. Potentially more information about firm (analyst following), makes borrowing cheaper.

ADVANTAGES AND DISADVANTAGES OF AN IPO

Making a public offering of stock ("going public") is a financing option for well-establishedsmall firms. In addition to its potential of generating large amounts of growth capital, publicofferings also provide a way for owners to profit more immediately from their success and helpovercome some of the tax issues faced when passing the business to the next generation. Whenbusiness owners speak of going public, they are usually talking about an initial public offering(IPO), in which stock is registered with the Singapore Stock Exchange (SGX) and offered to thepublic through an investment banker or brokerage firm. Shares of the company are then tradedpublicly on the stock market. Due to its expense, extensive filing requirements, and equityconsiderations, relatively few small companies ever undertake an IPO. The decision to take acompany public in the form of an Initial Public Offering (IPO) should not be considered lightly.There are several advantages and disadvantages to being a public company, which shouldthoroughly be considered. This memorandum will discuss the advantages and disadvantages ofconducting an IPO and will briefly discuss the steps to be taken to register an offering for sale tothe public. The purpose of this memorandum is to provide a thumbnail sketch of the process.

The reader should understand that the process is very time consuming and complicated andcompanies should undertake this process only after serious consideration of the advantages anddisadvantages and discussions with qualified advisors.

Advantages:1. Increased Capital:-


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A public offering will allow a company to raise capital to use for various corporatepurposes such as working capital, acquisitions, research and development, marketing, andexpanding plant and equipment.

2. Liquidity :-Once shares of a company are traded on a public exchange, those shares have a

market value and can be resold. This allows a company to attract and retain employees byoffering stock incentive packages to those employees. Moreover, it also provides investorsin the company the option to trade their shares thus enhancing investor confidence.

3. Increased Prestige:-Public companies often are better known and more visible than private companies,

this enables them to obtain a larger market for their goods or services. Public companiesare able to have access to larger pools of capital as well as different types of capital.

4. Valuation:-Public trading of a company's shares sets a value for the company that is set by the

public market and not through more subjective standards set by a private valuator. This is

helpful for a company that is looking for a merger or acquisition. It also allows theshareholders to know the value of the shares.

5. Increased wealth:-The founders of the company often have the sense of increased wealth as a result of

the IPO. Prior to the IPO these shares were illiquid and had a more subjective price. Theseshares now have an ascertainable price and after any lockup period these shares may besold to the public, subject to limitations of federal and state securities laws.

Disadvantages:1. Time and Expense:-

Conducting an IPO is time consuming and expensive. A successful IPO can take up

to a year or more to complete and a company can expect to spend several hundreds ofthousands of dollars on attorneys, accountants, and printers. In addition, the underwriter'sfees can range from 3% to 10% of the value of the offering. Due to the time and expense ofpreparation of the IPO, many companies simply cannot afford the time or spare the expenseof preparing the IPO.

2. Disclosure:-The Securities and Exchange Commission (SEC) disclosure rules are very

extensive. Once a company is a reporting company it must provide information regardingcompensation of senior management, transactions with parties related to the company,conflicts of interest, competitive positions, how the company intends to develop futureproducts, material contracts, and lawsuits. In addition, once the offering statement is

effective, a company will be required to make financial disclosures, public companiesrequired to file quarterly statements containing unaudited financial statements and auditedfinancial statements annually. These statements must also contain updated informationregarding nonfinancial matters similar to information provided in the initial registrationstatement. This usually entails retaining lawyers and auditors to prepare these quarterly andannual statements. In addition, a company must report certain material events as they arise.This information is available to investors, employees, and competitors.

3. Decisions based upon Stock Price:-


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Management's decisions may be effected by the market price of the shares and thefeeling that they must get market recognition for the company's stock.

4. Regulatory Review:-The Company will be open to review by the Securities and Exchange Commission

(SEC) to ensure that the company is making the appropriate filings with all relevant

disclosures.

5. Falling Stock Price:-If the shares of the company's stock fall, the company may lose market confidence,

decreased valuation of the company may effect lines of credits, secondary offering pricing,the company's ability to maintain employees, and the personal wealth of insiders andinvestors.

6. Vulnerablility:-If a large portion of the company's shares are sold to the public, the company may

become a target for a takeover, causing insiders to lose control. A takeover bid may be theresult of shareholders being upset with management or corporate raiders looking for an

opportunity. Defending a hostile bid can be both expensive and time consuming. Once acompany has weighed the advantages and disadvantages of being a public company, if itdecides that it would like to conduct an IPO it will have to retain a lead underwriter to sell thesecurities, an attorney to assist in the preparation of a registration statement, and auditors toprepare financial statements.

UNDERSTANDING ISSUES

This portion tries to cover the basic concepts and questions related to issues (issues inthemeaning of issuance of securities). The aim is towards understanding the various types ofissues, eligibility norms, exemptions from the same. The disclosure requirements regarding theissuance of securities are covered in detail in the SEBI (Disclosure and Investor Protection)

Guidelines, 2000.

KINDS OF ISSUES

Primarily, issues can be classified as a Public, Rights or preferential issues (also knownas private placements). While public and rights issues involve a detailed procedure, privateplacements or preferential issues are relatively simpler. The classification of issues is illustratedbelow:

Public issues can be further classified into Initial Public offerings and further publicofferings. In a public offering, the issuer makes an offer for new investors to enter itsshareholding family. The issuer company makes detailed disclosures as per the DIP guidelines

in its offer document and offers it for subscription. The significant features are illustrated below:

1. Initial Public Offering (IPO) :-It is when an unlisted company makes either a fresh issue of securities or an offer for

sale of its existing securities or both for the first time to the public. This paves way for listingand trading of the issuers securities.

2. Further public offering (FPO) :-


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It is when an already listed company makes either a fresh issue of securities to thepublic or an offer for sale to the public, through an offer document. An offer for sale in suchscenario is allowed only if it is made to satisfy listing or continuous listing obligations.

3. Rights Issue (RI) :-It is when a listed company which proposes to issue fresh securities to its existing

shareholders as on a record date. The rights are normally offered in a particular ratio to thenumber of securities held prior to the issue. This route is best suited for companies whowould like to raise capital without diluting stake of its existing shareholders unless they donot intend to subscribe to their entitlements.

4. Private placement :-It is an issue of shares or of convertible securities by a company to a select group of

persons under Section 81 of the Companies Act, 1956 which is neither a rights issue nor apublic issue. This is a faster way for a company to raise equity capital. A private placement ofshares or of convertible securities by a listed company is generally known by name ofpreferential allotment. A listed company going for preferential allotment has to comply withthe requirements contained in Chapter XIII of SEBI (DIP) Guidelines pertaining to preferentialallotment in SEBI (DIP) guidelines include pricing, disclosures in notice etc, in addition to therequirements specified in the Companies Act.

5. Free-pricing abused :-As controls over pricing of equity were abolished in 1992, prudence took a backseatas companies set about raising funds at fancy prices; the pricing was justified with helpfulprojections of profitability dished out even by ICICI, IDBI, IFCI, Kotak Mahindra and EnamSecurities, leave alone the plethora of lesser-known investment banking outfits. The earningsprojections were vastly out of tune with reality. There was no element of the risk of businesscycle built into them; in many cases, it appeared as if the price had been fixed, and therevenue and earnings numbers generated to justify it.


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That the IDBI's stock traded at the offer price for just a couple of days over aneight-year period and, subsequently, well below that price, tells the tale of abuse of free-pricing. Not surprisingly, this put investors off; they had patronised such IPOs in a big way asthe first few offers in the free-pricing mode of IFCI, Bank of Baroda, Infosys and SatyamComputer delivered value. Corporate greed was penalised, as investor apathy ensuredthat between 1998 and 2001, the number of IPOs/offers for sale could be counted on the

fingers of one hand..

6. A colossal misconception :-This period was also witness to a popular notion that equity was the cheapest source

of the funding, as the premium element was perceived as carrying no cost. What companiesfailed to recognize in this process they were also encouraged by investment banksseeking more IPO opportunities was that their capital cost could only be the same as theinvestor's expected rate return.

By assuming and assigning a zero-cost to the premium element, companiesconverted what is, inarguably, the most expensive source of finance to the cheapest one.This led to an overhang on equity across Corporate India, with funds being mobilised in the

domestic and global markets through the issuance of global depository receipts. As thisunderstanding of the cost was not clued to reality, it soon fell apart.

7. Capacity overhang :-The primary market boom of the mid-1990s also ensured excess of a different kind: A

fad for capacity creation across a range of commodities, with the possible exception ofaluminum and copper. Cement and steel were good examples. Buoyed by high cement andsteel prices, and expectations of consistent double-digit growth in demand that wasattributed to liberalization of the economy, several firms set up cement and steel capacities.

Binani Zinc, Sanghi Polesyter and the Rajan Raheja group and the DLF group(both cited backward integration to construction as the reason for their cement foray) set up

large-sized cement units. Jindal Vijayanagar, Essar Steel, Bhushan Steel, Ispat Industriesand Lloyds Steel completed the steel story. The effect of the overcapacity still exertspressure on profitability. For instance, in cement, a better balance between demand andsupply is expected only two years from now.

This binge effectively ensured that even in the small number of companies whereprojects were implemented without exception marked by time and cost-overrun investors have had nothing to show by way of wealth accretion. Only the IPOs of the pasttwo-and-half years have changed that. If the ongoing bullish phase is used to perpetrateexcesses, the consequences would not be any different. Corporate India needs to walk adifferent path now, both for its sake as well as in the interest of investors.

8. Qualified Institutions Placement :-It is a private placement of equity shares or securities convertible in to equity shares

by a listed company to Qualified Institutions Buyers only in terms of provisions of ChapterXIIIA of SEBI (DIP) guidelines. The Chapter contains provisions relating to pricing,disclosures, currency of instruments etc.

IPO GRADING


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IPO grading is the grade assigned by a Credit Rating Agency registered with SEBI, to theinitial public offering (IPO) of equity shares or any other security which may be converted into orexchanged with equity shares at a later date. The grade represents a relative assessment of thefundamentals of that issue in relation to the other listed equity securities in India. Such grading isgenerally assigned on a five-point point scale with a higher score indicating strongerfundamentals and vice versa as below.

IPO grade 1: Poor fundamentalsIPO grade 2: Below-average fundamentalsIPO grade 3: Average fundamentalsIPO grade 4: Above-average fundamentalsIPO grade 5: Strong fundamentals

IPO grading has been introduced as an endeavor to make additional informationavailable for the investors in order to facilitate their assessment of equity issues offered throughan IPO.

1. IPO grading can be done either before filing the draft offer documents with SEBI orthereafter. However, the Prospectus/Red Herring Prospectus, as the case may be, must

contain the grade/s given to the IPO by all CRAs approached by the company for gradingsuch IPO.

2. Further information regarding the grading process may be obtained from the CreditRating Agencies.

3. The company desirous of making the IPO is required to bear the expenses incurred forgrading such IPO.

4. A company which has filed the draft offer document for its IPO with SEBI, on or after 1 st

May, 2007, is required to obtain a grade for the IPO from at least one CRA.

5. IPO grade/s cannot be rejected. Irrespective of whether the issuer finds the grade givenby the rating agency acceptable or not, the grade has to be disclosed as required under theDIP Guidelines.

6. However the issuer has the option of opting for another grading by a different agency. Insuch an event all grades obtained for the IPO will have to be disclosed in the offerdocuments, advertisements etc.

7. IPO grading is intended to run parallel to the filing of offer document with SEBI and theconsequent issuance of observations. Since issuance of observation by SEBI and thegrading process, function independently, IPO grading is not expected to delay the issueprocess.

8. The IPO grading process is expected to take into account the prospects of the industry inwhich the company operates, the competitive strengths of the company that would allow it toaddress the risks inherent in the business(es) and capitalise on the opportunities available,as well as the companys financial position.

9. While the actual factors considered for grading may not be identical or limited to thefollowing, the areas listed below are generally looked into by the rating agencies, whilearriving at an IPO grad Business Prospects and Competitive Position.


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i. Industry Prospects

ii. Company Prospects

Financial Position.Management Quality.

Corporate Governance Practices.Compliance and Litigation History.New ProjectsRisks and Prospects.

It may be noted that the above is only indicative of some of the factors considered in theIPO grading process and may vary on a case to case basis.

10. IPO grading is done without taking into account the price at which the security isoffered in the IPO. Since IPO grading does not consider the issue price, the investor needsto make an independent judgment regarding the price at which to bid for/subscribe to theshares offered through the IPO.

11. All grades obtained for the IPO along with a description of the grades can befound in the Prospectus. Abridged Prospectus, issue advertisement or any other placewhere the issuer company is making advertisement for its issue. Further the Grading letterof the Credit Rating Agency which contains the detailed rationale for assigning the particulargrade will be included among the Material Documents available for Inspection.

12. An IPO grade is NOT a suggestion or recommendation as to whether one shouldsubscribe to the IPO or not. IPO grade needs to be read together with the disclosures madein the prospectus including the risk factors as well as the price at which the shares areoffered in the issue.

13. The grades are allocated on a 5-point scale, the lowest being Grade 1 and

highest Grade.

14. IPO Grading is intended to provide the investor with an informed and objectiveopinion expressed by a professional rating agency after analyzing factors like business andfinancial prospects, management quality and corporate governance practices etc. However,irrespective of the grade obtained by the issuer, the investor needs to make his/her ownindependent decision regarding investing in any issue after studying the contents of theprospectus including risk factors carefully.

15. SEBI does not play any role in the assessment made by the grading agency. Thegrading is intended to be an independent and unbiased opinion of that agency.

16. The grading is intended to be an independent and unbiased opinion of a ratingagency. SEBI does not pass any judgment on the quality of the issuer company. SEBIsobservations on the IPO document are entirely independent of the IPO grading process orthe grades received by the company.

RATING IPO - POWERFUL GUIDANCE TOOL

SEBI's proposal to make the IPO assessment available to investors is a step in the rightdirection.


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Though the move to make IPO assessment mandatory has drawn some criticalcomments, the need for a tool to help investors make better-informed decisions and judge thequality of issues hitting the market is undisputed.

An IPO assessment brings four major pluses.

Firstly, it improves information content through a professional and independent assessment. Secondly, it is relief for individual investors from information overload. Thirdly, it provides disincentives for weak companies to come to the market in the hope of

raising easy capital. And fourthly, it brings about greater level of investor sophistication.

ARRANGING AN IPO

1. Select Underwriter :-

Provides procedural, financial advice. Ultimately buys issue from company (at issue price).

Ultimately sells it to public (at offer price).

2. Prepare Registration Statement :-For approval of SEC (in accord with Securities Act of 1933). Formal summary that

provides information on an issue of securities.

3. Prepare Prospectus :-Streamlined version of registration statement, for consideration by potential investors.

4. Set price :-

Road show:-Talks organized to introduce company to potential investors, before the IPO.

Bookbuilding:-Book Building means a process undertaken by which a demand for the securities

proposed to be issued by a body corporate is elicited and built up and the price for suchsecurities is assessed for the determination of the quantum of such securities to be issuedby means of a notice, circular, advertisement, document or information memoranda oroffer document.

5. Selling the shares :-

Best efforts offering:-IPO method in which underwriter promises to sell as much as possible, give best

effort, not commit to selling all of issue.

Firm commitment offering:-Method in which underwriter buys the whole issue, bears all risk.

Syndicate:-Group of underwriters formed to sell a particular issue.

Spread:-


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Difference between public offer price and price paid by underwriter (issueprice). Biggest part of underwriter compensation.

PROCEDURE OF SALE OF IPOS

IPOs generally involve one or more investment banks as "underwriters." The company

offering its shares, called the "issuer," enters a contract with a lead underwriter to sell its sharesto the public. The underwriter then approaches investors with offers to sell these shares.

The sale (that is, the allocation and pricing) of shares in an IPO may take several forms.Common methods include: Dutch auction Firm commitment Best efforts Bought deal Self Distribution of Stock

A large IPO is usually underwritten by a "syndicate" of investment banks led by one ormore major investment banks (lead underwriter). Upon selling the shares, the underwriters keepa commission based on a percentage of the value of the shares sold. Usually, the leadunderwriters, i.e. the underwriters selling the largest proportions of the IPO, take the highestcommissionsup to 8% in some cases.

Multinational IPOs may have as many as three syndicates to deal with differing legalrequirements in both the issuer's domestic market and other regions. For example, an issuerbased in the E.U. may be represented by the main selling syndicate in its domestic market,Europe, in addition to separate syndicates or selling groups for US/Canada and for Asia.Usually, the lead underwriter in the main selling group is also the lead bank in the other sellinggroups.

Because of the wide array of legal requirements, IPOs typically involve one or more lawfirms with major practices in securities law, such as the Magic Circle firms of London and thewhite shoe firms of New York City.

Usually, the offering will include the issuance of new shares, intended to raise newcapital, as well the secondary sale of existing shares. However, certain regulatory restrictionsand restrictions imposed by the lead underwriter are often placed on the sale of existing shares.Public offerings are primarily sold to institutional investors, but some shares are also allocated tothe underwriters' retail investors. A broker selling shares of a public offering to his clients is paidthrough a sales credit instead of a commission. The client pays no commission to purchase theshares of a public offering; the purchase price simply includes the built-in sales credit.

The issuer usually allows the underwriters an option to increase the size of the offeringby up to 15% under certain circumstance known as the greenshoe or overallotment option.

FACTORS REQUIRED TO APPLY FOR AN IPO

Track record of the promoters Financials position of that company Read Prospectus very carefully


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Issue price

IPO RISKY FOR PUBLIC

IPOs can be a risky investment. For the individual investor, it is tough to predict what thestock 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 goingthrough a transitory growth period, and they are therefore subject to additional uncertaintyregarding their future value.

DRAWBACKS OF IPO

It is true that IPO raises huge capital for the issuing company. But, in order to launch an IPO,it is also necessary to make certain investments.

Setting up an IPO does not always lead to an improvement in the economic performance ofthe company. A continuing expenditure has to be incurred after the setting up of an IPO bythe parent company.

A lot of expenses have to be incurred in the form of legal fees, printing costs and accountingfees, which are connected to the registering of an IPO.

The rules and regulations involved to set up public offerings and this entire process on theother hand involve a number of complexities which sometime require the services of expertsin relevant fields.

ELIGIBILITY CRITERIA

Net Tangible assets of Rs. 3.00 Crore in each of the preceding 3 years. And Trackrecord of Distributable profits at least 3 out of 5 preceding years and The Company has a

Networth of Rs. 1.00 Crore in preceding 3 years and the proposed issue should not exceed 5times of its Pre-issue networth. Book building process and 50% of the offer to QIBs or 15%participation in project by F/Is or Schedule Banks;10% of the Project cost from appraiser;10% ofthe Issue to QIBs and Minimum post issue face capital of Rs.10 Crores or Market making for 2years and Minimum number of allottees atleast 1000 Minimum number of allottees atleast 1000.

SEBI GUIDELINES

1. Filing of prospectus :-Prospectus to be filed with SEBI Through Merchant Banker At least 30 days