The world of finance can be exciting, and Initial Public Offerings (IPOs) offer a unique opportunity for investors. These are moments when a promising private company decides to go public, selling shares to the public for the first time. But before you jump in, a crucial question arises: how do you know if the price of these shares is fair?
Figuring out the IPO price is a complex process, a dance between the company, investment banks, and the overall market. Investment banks play a key role, acting as financial experts who assess the company’s value and determine the price per share. While there’s a science to it, there’s also a bit of art involved, requiring informed judgment.
Investors like you need knowledge to navigate this terrain. So, join us as we unveil the mysteries behind IPO pricing. Let’s navigate this landscape together and discover how companies set their price tags when entering the public spotlight!
What Is IPO Pricing?
IPO pricing is the meticulous process of establishing the initial offer price of a company’s shares when it transitions to a public entity. This critical step involves a comprehensive assessment of the company’s valuation to set a price that is both appealing to investors and effective in maximising capital raised. Typically, this process involves a collaboration between the company and investment banks, employing various sophisticated methods to determine the optimal price. A thorough understanding of IPO pricing is imperative for investors who wish to engage in a company’s initial public offering, as it significantly impacts the potential returns on their investments.
IPO Pricing Methods
IPO prices are determined using either the book-building or fixed-price methods. The issuing company chooses the method based on its preferences unless the mainboard-eligible business does not meet the SEBI-mandated profitability standards. A corporation would then have to choose the QIB method, which requires the issue to go through the book-building process.
Book Building Method
In the book-building method, the IPO price isn’t set in advance. The issuing company announces a price range (e.g., ₹75 to ₹80 per share). The final price is determined based on demand at various price levels during the bidding period.
Advantages
- Efficient price discovery.
- Assesses company credibility based on demand.
- Realistic pricing is based on market demand, not management’s decision.
Disadvantages
- More costly than fixed-price IPOs.
- Lengthier process due to the need to calculate the final price at the end of bidding.
- More suitable for larger issuances.
Features
- IPO is launched without a final price.
- A price range is announced at least two business days before the issue opens for subscription.
- The price range can be revised during the offering period.
- The issue remains open for 3-7 business days, extendable by three days if the price range is revised.
- BSE and NSE offer fully automated online bidding systems.
IPO Price Band Rules
The IPO price band is the offer price range within which investors can place their bids.
Key Facts and Features
- The price band includes a lower (Floor Price) and upper price (Cap Price).
- The difference between the lower and upper prices shouldn’t exceed 20%.
- Retail investors can apply at any price within the range or at the Cut-off price.
- The Cut-off price is the final price at which shares are allocated and is determined at the end of bidding.
- The basis for price determination is stated in the prospectus.
Book Building Process
The book-building process is managed by Lead Managers and Underwriters. Here’s an overview of the process:
- Determine Issue Size and Price Range: The lead manager, in consultation with the issuing company, sets the issue size and price range.
- Appoint Syndicate Members: The lead manager and issuing company appoint syndicate members for IPO duties.
- Bidding: Investors bid for shares at different prices within the range once the IPO is launched.
- Final Price Determination: The lead manager collects all bids and determines the final issue price using the weighted average method.
- Transparency and Allotment: The lead manager publishes bid details to ensure transparency. Investors who bid at or above the cut-off price receive an allotment, while bids below the cut-off price are rejected, and the subscription money is returned.
Types of Book Building Offers
- 100% Book Built Offer: The entire issue is offered through the book-building process.
- 75% Book Building: 75% of the issue is offered through the book-building process, and 25% is offered at the threshold determined by this process.
Example
In a book-building issue, the issuer might announce a price range of ₹601 – ₹650 for 1 million shares. Investors can bid at any price within this range or at the cut-off price. Based on demand, the final price might be set at ₹640 using the weighted average method.
Case 1: Bidding Above the Cut-Off Price
Full Allotment Example:
- Bid Price: ₹645
- Shares Applied: 10
- Application Amount: ₹6450
- Shares Allotted: 10
- Refund: ₹ 50 (₹ 5 per share for 10 shares)
Partial Allotment Example:
- Bid Price: ₹645
- Shares Applied: 10
- Application Amount: ₹6450
- Shares Allotted: 5
- Refund: ₹3250
- ₹645 per share for 5 unallotted shares (₹3225)
- ₹5 per share for 5 allotted shares (₹25)
Case 2: Bidding Below the Cut-Off Price
All bids below ₹640 are rejected, and the full amount is refunded.
Case 3: Bidding at the Cut-Off Price
- Full Allotment: No refund.
- Partial Allotment: Pro-rata refund for unallotted shares.
Note: If demand is very high, the highest price in the range (₹650) often becomes the cut-off price.
Fixed Price Issue Method
In a fixed price issue, the offer price (e.g., ₹75 per share) is decided in advance before the IPO opens for subscription. SME companies often prefer this method due to the smaller issue size.
Features of Fixed Price Issue
- The prospectus contains all details about the IPO price and the basis for setting it.
- The prospectus must be registered with the Registrar of Companies before the subscription opens.
- At least 50% of the net offering should be available to retail investors.
- The offering should be open for 3-10 business days.
Fixed Price IPO Process
The fixed-price IPO method is simpler than the book-building method due to the absence of price discovery. Deciding the right price is crucial for the issuing company. Steps include:
- Appointment of Lead Manager: The issuer appoints a lead manager to evaluate the company’s financial position, growth prospects, assets, and liabilities. Together, they decide on the issue size and IPO price.
- Bidding Process: The IPO opens for subscription, and investors submit bids at the set price.
- Demand Assessment: The lead manager assesses demand at the close of the bidding period and works with the Registrar of Companies (RoC) for allotment.
- Allotment and Refund: The Registrar completes the allotment, credits shares to Demat accounts, and initiates refunds if necessary.
Example of Fixed Price Issue
The price of an IPO under the fixed-price method is determined in advance.
For example, an issuer may announce a price of ₹186 per share. Investors place bids at ₹186 without the option to bid at any other price or cut-off price. After the issue closes, investors receive allotments based on demand.
Scenario 1: You applied for 1000 shares and received a full allotment. All 1000 shares are credited to your account with no refund.
Scenario 2: You did not receive an allotment. You have been refunded the full amount of ₹1,86,000.
Scenario 3: You received a partial allotment of 200 shares. You receive a refund of ₹1,48,800 (186*800 unallotted shares), and 200 shares are credited to your account.
Book Building Method vs Fixed Price Method
| Book Building Method | Fixed Price Method |
| The company announces a price range within which investors can place bids. | The offer price is fixed and decided before the IPO opens for subscription. |
| The final price is set at the end of the bidding process, based on demand at various price levels. | Demand is only known after the subscription period ends. |
| Qualified Institutional Buyers (QIBs) can bid by paying 10% of the application amount upfront and the remaining amount at the time of allotment. | QIBs must pay 100% of the subscription amount at the time of application. |
| The prospectus is filed with the Registrar of Companies (RoC) after the offering is completed. | The prospectus is filed with the RoC before the issue opens. |
| The price range can be revised during the subscription period if needed. | The offering price cannot be changed once the issue is open for subscription. |
| Pricing is typically fair as it is based on actual demand. | The fixed price can sometimes be undervalued or overvalued. |
Conclusion
Understanding IPO pricing mechanisms, such as book building and fixed price offerings, is essential for both investors and companies alike. Book building allows for dynamic price discovery driven by market demand, ensuring a fair valuation. On the other hand, fixed-price offerings set a predetermined price, simplifying the process. Whether you’re entering the market as an investor or considering an IPO for your company, grasping these methods is fundamental. Stay informed and explore opportunities by opening a DEMAT account with Angel One today for the latest updates and upcoming IPO subscriptions.
FAQs
Can the IPO price change?
In a fixed-price IPO, once the price is set, it remains unchanged throughout the subscription period. However, in a book-built IPO, the price range can be revised based on investor demand during the bidding period. If changed, the subscription period must be extended by at least three days.
Is the IPO price the same as the listing price?
No, they are different. The IPO price is the price at which shares are initially offered to the public during the IPO. The listing price, on the other hand, is the price at which these shares start trading on the stock exchange. It can be higher, lower, or equal to the IPO price depending on market demand.
Why does underpricing occur in IPOs?
Underpricing is often used to attract investor interest and ensure oversubscription. It creates a positive market sentiment and encourages trading activity post-listing. Companies may underprice to mitigate risk and achieve broader market participation.
How is the IPO price band decided?
The IPO price band is determined by the issuing company and its lead managers. It considers both qualitative and quantitative factors. SEBI regulations mandate that the price band should not exceed a specified percentage range to ensure fairness and transparency in pricing.
