The Basics Of Stock Market

Lesson -> The Initial Public Offer (IPO)- Part 02

5.1 - The Overview

We have seen how a company evolves from its idea generation stage through to the moment it files for an IPO. This chapter is a fictional account of how a company grows over time. The focus was clearly on the various stages of business as well as funding options at different stages. This chapter provides a glimpse into the process a company must go through before it is open to the public for shares.

This information is vital because the IPO market (also known as the primary market sometimes companies offer their shares to the public by appealing to investors without ever having received funding. A few rounds of funding from credible VC or PE firms will validate the quality and credibility of the business and its promoters. This is a good indicator of well-run companies.

5.2 -The Reason Why the company goes Public.

The previous chapter was closed with some critical questions. One was: Why did the company file for an IPO? And, in general, why do companies go public.

IPOs are filed by companies for the primary reason of raising funds to finance their CAPEX requirements. The public listing of a company gives the promoter three advantages:

  1. He is raising funds for the CAPEX requirement
  2. He has avoided the need to take on debt, which means he doesn't have to pay finance fees. This translates into better profitability.
  3. You are taking the same risk when you purchase shares in a company as the promoter. The number of shares you have will determine the impact of the risk. However, you must remember that you are also buying risk when you purchase shares. The promoter spreads his risk to a large audience when the company goes public.

An IPO can also offer other benefits...

  1. Offer an exit option for early investors shares of the company go public once the company is listed. This is open to any existing shareholder, including promoters, venture capitalists, and PE funds. They can also sell their shares on the open market. They can sell their shares and get an exit from their initial investment in the company. If they want, they can choose to sell smaller shares.
  2. Reward employees As an incentive, employees who work for the company will be given shares. This arrangement is known as the "Employee stock option". Employees receive a discount on the shares. Employees have the opportunity to benefit from capital appreciation when the company goes public. Google, Infosys and Twitter are just a few examples of employees who have benefited from ESOP.
  3. Increase visibilityPublication increases visibility, as the company is publicly traded and held. This increases the chance that people will be interested in the company and this can have a positive effect on its growth.

Let's continue our fictional business story and find out the details for this company's IPO.

The company needs 200 Crs to finance their CAPEX. Management had previously decided to fund it partly through internal accrual and partially by filing for an IPO.

Remember that the company has 16% of its authorized capital, which translates to 800,000. Shares that are not yet allotted. These shares were valued at 64Crs when Series B was invested by the PE firm. Since the PE firm invested in Series B, the company has made great progress and the value of these shares would have gone up.

Let's assume that the company values the 16% shares at 125 Crs or 150 Crs. This translates to a per-share value, anywhere between Rs.1562 to Rs.1875/-...(125Crs/8lakh).

If the company offers 16% to the public, they will likely raise between 125 and 150 Crs. The rest must be generated internally. Naturally, the more money that they raise the company is better.

5.3 - Merchant Bankers

Once the company has decided to go public, it must do several things to ensure a successful initial public offer. First, appoint an administrator. merchant banker. Merchant bankers are also known as book Running Lead Managers/Lead Managers (BRLM)Merchant bankers are responsible for assisting the company in various aspects of the IPO process, including:

  • Do your due diligence on any company that is filing for an IPO. Also, make sure they comply with the law.
  • You should work closely with the company to prepare their listing documents, Draft Red Herring Prospectus (DRHP). These issues will be addressed in more detail at a later stage.
  • Underwrite shares- Merchant bankers agree to underwrite shares. They will buy all or part IPO shares and resell them to the public.
  • Assist the company in determining the price range for an IPO. A price bandThe price band is the lowest and highest limit of the share prices within which the company will become public. The price band for our example is Rs.1562/- and R.1875/.
  • Help the company with the roadshows - This is like a promotional/marketing activity for the company's IPO
  • Other intermediaries, such as registrars and bankers, are also appointed, including advertising agencies, registrars, and bankers. The issue's Lead Manager also develops marketing strategies.

The merchant banker and the company will partner together to make the company public.

5.4 - IPO sequence

It is obvious that each step in the IPO process must be done according to the SEBI guidelines. Here is the general sequence.

  • Designate a merchant banker. If the company is involved in a large public offering, it can appoint more merchant bankers
  • Register with SEBI to apply- The registration statement includes details about the company, its plans for public disclosure, and financial health.
  • SEBI gives you a nod- After SEBI has received the registration statement, SEBI makes a decision on whether or not to issue a go-ahead or a 'no-go' to the IPO
  • DRHP- Once the company has been granted the SEBI approval, it will need to prepare the DRHP. A DRHP (Document for Distribution to the Public) is a document. DRHPs should include the following information:
    • The estimated size of the IPO
    • The estimated number offered to the public
    • What is the company's motivation for going public? How does it plan to use the funds, and what are the timeline projections of fund utilization
    • Description of the business, including details about revenue model and expenditures
    • Complete financial statements
    • Management Discussion and Analysis – How the company sees future business operations.
    • Running a business comes with its own risks
    • Manager details and background
  • Market the IPO- This would include TV and print ads to raise awareness about the company's IPO offering. This is known as the IPO roadshow.
  • Fix the price band- Determine the price range within which the company wants to be public. This can't be different from the general perception. If this is the case, the public won't subscribe to the IPO
  • Book BuildingAfter the roadshow has ended and the price band is set, the company must now open the window for the public to subscribe for shares. If the price range is between Rs.100 to Rs.120, the public can choose a price that they feel is reasonable for the IPO issue. Book Building is the process of gathering all the price points and quantities. Book building can be described as a powerful price discovery tool.
  • Closure- The price at which the issue is listed is determined after the book building window has closed. This is the price at which maximum bids have already been received.
  • Listing Day- This day is when the company becomes listed on the stock exchange. The price at which the stock is listed is determined based on the market demand and supply that day. Stocks are listed at a premium or par price, or a discount of the cut off price

5.5 - What happens next to an IPO?

Investors can place bids for shares at a specific price within a specified price range during the bidding process (also known as the date of issue). The whole system surrounding the date of issue, where investors can bid for shares is known as the primary Market. The stock trades publicly once it is listed on the stock exchange. This is known as "The Beginning of Trading".Secondary market.

The stock is traded daily on the stock market once it has moved from primary to secondary markets. Stocks are bought and sold regularly by people.

Why do people trade? Why does stock market volatility occur? We will be answering all of these questions in the next chapters.

5.6 - Few key IPO jargons

Let's review some important jargon about IPOs before we close the chapter.

  • Subscription - Let's suppose that the company wishes to sell 100,000 shares to the public. The book-building process uncovers that only 90,000.0 bids were received. This makes the issue undersubscribed. This is a bad situation as it indicates negative public sentiment.
  • Oversubscription - If there is 200,000 bids to purchase 100,000 shares, then the issue will be considered oversubscribed. times (2x)
  • Green Shoe Option – This is a part of the underwriting agreement that allows the issuer (typically 15%) to authorize additional shares to be distributed in case of oversubscription. This option is also known as the overallotment.
  • Fixed Price IPO - Sometimes companies set the price for the IPO, and they do not choose a price range. These issues are known as fixed price IPO
  • Price Band and Cutoff price -Price range is the price range at which the stock can be listed. If the price range is between Rs.100 to Rs.130, the issue may list within that range. Let's say it is listed at 125. The cutoff price is 125.

5.6 - Most recent IPO's in India

Here's a look at some recent IPOs in India. This table should be simple to read, given all the background information.

Sl No
Name of IssueIssue Price (INR)BRLM
Date of Issue
Issue Size (Lakh Shares)Price Band (INR)
01Wonderla Holidays Limited125
Edelweiss Financial Services and ICICI Securities Limited
21/04/2014 to 23/04/201414,500,000115 to 125
02Power Grid Corporation of India Ltd90
SBI, Citi, ICICI, Kotak, UBS
03/12/2013 to 06/12/2013787,053,30985 to 90
03Just Dial Ltd530Citi, Morgan Stanley
20/05/2013 to 22/05/2013
17,493,458470 to 543
04Repco Homes Finance Limited172SBI, IDFC, JM Financials13/03/2013 to 15/03/20131,57,20,262
165 to 172
05V-Mart Retail Ltd210Anand Rathi01/02/2013 to 05/02/20134,496,000195 to 215

To Summerize

    1. Public companies are public for the following reasons: to raise funds, offer exit options for early investors, reward employees, and increase visibility
    2. During the IPO process, the merchant banker is a key partner for the company
    3. SEBI is the regulator of the IPO market. It has the final say on whether a company may go public or not.
    4. To learn everything you can about the company as an investor in the IPO, it is important to read the DRHP
    5. The majority of Indian IPOs follow a book-building process