This system of pure auction will be more beneficial to investors and at the same time provide better clarity on the actual demand for an issue. In regular book-built issue the institutions always bought more shares as in the case of over-subscription of issue the company would allot the shares on a prorate basis. Consequently the investor will get much less than the shares he actually wanted to buy. For example, an institutional investor wanting to buy only five lakh shares would actually buy 5 or 10 times more number of shares. This way the investor can be assured of getting the actual number of shares he wanted when the issue is over-subscribed and the shares allotted on a prorate basis.
This New Year 2010 could probably see India Inc set a new fund raising record! Usually, companies raise funds for their new projects through several routes like the QIPs or the institutional placements, or through initial public offers more popularly called the IPOs and through right issues to existing shareholders. In 2010, funds raised through QIPs could skyrocket but the IPOs might also match this record or even exceed it as the public sector companies have not finalized the details yet. But what is this IPO? Why are we talking about it now? Let us find out.
What is IPO?
Before we get into the latest about IPOs let us see what an IPO is. As already said an IPO or initial public offer or ‘going public’ is the first sale of stock issued to the public by a company. An IPO is said to happen if the company has never issued equity to the public before.
Difference between normal book building and auction process
There are different processes while bidding in IPOs. In a normal book building or book-built issue the investors have no choice except bidding within the price band quoted for the issue by the merchant banker, which might not always reflect the fair value.
However, in the auction process there is a floor price mentioned by the company above which the investors can bid. Allocation of shares will begin on a top-down basis starting with the highest bidder.
The reason behind introducing this system
Following its earlier announcement of the system of pure auction method for public share offerings, the Securities and Exchange Board of India (SEBI) has now included follow-on public issues into the pure auction method for book-building. SEBI’s intention for introducing the system is to give more leverage to investors by allowing them to have a say in the price discovery process and pricing of the issue.
This experiment by SEBI however is not mandatory for companies but only optional and presently is restricted only for institutional investors.
Benefits to the investors
This system of pure auction will be more beneficial to investors and at the same time provide better clarity on the actual demand for an issue. In regular book-built issue the institutions always bought more shares as in the case of over-subscription of issue the company would allot the shares on a prorate basis. Consequently the investor will get much less than the shares he actually wanted to buy.
For example, an institutional investor wanting to buy only five lakh shares would actually buy 5 or 10 times more number of shares. This way the investor can be assured of getting the actual number of shares he wanted when the issue is over-subscribed and the shares allotted on a prorate basis.
However, this is set to change with the introduction of the pure auction method. Under this method, the investor would bid only for the quantity they want to buy and bid the highest amount. This way the investor might get the required number of shares as the allotment is done top-down starting from the highest bidder.
For the retail investors, the pure auction system by SEBI would ensure that they get the shares at a discount of the bid placed by institutional players that is at the floor price.
Drawbacks of this system
Despite the fact that the pure auction system will allow the company to know the price it deserves there is the fear of aggressive bidding by short-term investors like hedge funds which could upset the level-playing field for the usually conservatively bidders in long-term investors.
Further, the pure auction system is presently experimented with follow-on public offerings (FPOs), which carry only a small discount. Though the system could help a fund manager get what he wants at a single price it might not allow him to bid beyond a level as it could upset his portfolio earnings.
At this point in time the price auction method for FPOs is more beneficial to the institutional investors and considering the other drawbacks of this system SEBI has rightly left it to the companies to take a call on the number of shares it wants to allot a fund.