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In this article, Janvi Ahuja of SLS Pune discusses what happens when an IPO is oversubscribed and how can one profit from IPOs.

Introduction

When a company wants to become a part of shareholder family, they offer shares or convertible securities to new investors and it is called public issue. When these public issues are given for the first time, publicly selling of shares in market is known as Initial public offering. It is done when a company believes that they are not financially viable to take up the business and they are unlisted in SEBI. They make a fresh issue of these shares or convertible security or offers existing shares or convertible security for sale or both for the first time to public, it is an IPO (Initial Public Offering). IPO is also known as Going Public as it paves the way for the investors for issuing of shares. It gives early investors a chance to make high profits by cashing their stockholding.

IPO is mainly used by startup companies, seeking a source of capital for growth and expansion. It was introduced by underwriting investment bank, which aids the issuing company by soliciting potential investors. IPO also helps in public sale of stock. For an investor, IPO is significantly at higher risk as opposed to trading stock, as it is issued in primary market where the investor can get first crack at new security insurance.

An IPO is different from FPO that is further public offering or follows on offer. An IPO is issued by a company newly entering the market which is not listed in SEBI, whereas an FPO is an already listed company either making a fresh issue of shares or convertible security to the public.

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Issue of share is done in two ways

Fixed pricing– Where a prospectus is made and all the details are given, price and quantum of share is mentioned. The company goes public, already determines a price is mentioned at which its shares are offered to investors. The investors know the share price before the companies go public. This price is issued by issuer in consultation with merchant banker on the basis SEBI guidelines. Then the issuer at the outset decides the issue price and mentions it in the offer document. Here the offer document contains full disclosures of the parameters which are taken into account by Merchant Banker and the issuer for deciding the price.

Book building– In this the issue of shares is done on the basis of bid, where the price band and the quantum of good are decided in the red hiring prospectus, it can be equal to above the floor price. When the price of an issue is discovered on the basis of demand received from the prospective investors at various price levels, it is called book building. In this the floor price is decided by merchant banker on the basis of SEBI guidelines, when the price is decided, the investors in same trick size are issued shares at par and the investors in the next trick size are issued share at premium, the company can issue a share more than the nominal value. There is no restriction on the sale of shares at premium.

Green‐Shoe Option- Green Shoe Option is a price stabilizing mechanism in which shares are issued in excess of the issue size, i.e., a maximum of 15%. It is a mechanism to stabilize the issue price post listing. In this a provision is contained in an unwritten agreement that gives the underwriter the right to sell investors more share than originally planned. It is an overall allotment option which can provide additional price stability to a security issued because the underwriter has the ability to increase supply and smooth out price fluctuation. It is only one type of measure permitted by SEBI.

When oversubscription comes into play

When the investors asks for the shares more than the value, it is the term used for the situation in which the security issue is underpriced or is in great demand by investors. When a new security issued is oversubscribed, underwriters or others offering the security can adjust the price or offer more security to reflect the higher than the anticipated demand. It is good to invest in a company whose IPO is Oversubscribed, as it indicates how keen the market players are in the company. It is a reconfirmation of the interest in such a stock. At the same time the oversubscription of shares means exceeding the total number of shares issued by underlying company. If the shares which are oversubscribed, where the permission of stock exchange has been taken, the oversubscription portion money is given back to the applicants forthwith.

Allotment to Qualified Institutional Buyer

A merchant banker holds the authority to allot shares with regard to QIBs. The shares, in any case, are allocated proportionately to applicants. So, if the shares are oversubscribed by four times like the QIB applied for 10, 00,000 shares then he will receive 2, 50,000 shares.

Allotment to Retail Investors

There is an upper limit of INR 2 Lakh for any retail investor who is investing in an IPO. The total numbers of candidates are calculated and if the applicants are more than the number of shares offered for retail investors, the maximum investors who are eligible for the allotment of the minimum bid lot are determined. The total number of equity shares available for allotment to investors is divided by the minimum bid. Example: if shares worth 2 lakh need to be allotted to individual investor and the minimum lot size is INR 10,000/- only maximum of 200 applicants will be allotted the shares with minimum lot of INR 10,000/-

Allotment to non-institutional Buyers

There are individual, trust, companies who bid for more than 2 Lakhs are known as non institutional Bidders. They have an allocation of 15% of shares of the total issue size in Book Building IPO’s.

Guidelines for investing in Newly Formed Company

  • If the company is new make sure you study the performance of the previously established company by same promoter, if they have done well, then chances of new one doing well are also high.
  • Before investing in a company checks its reputation and market standing of the foreign collaboration, if there is any, as the company with foreign collaboration are often good investment.
  • Make sure you invest in a company that have something new to offer, they are introducing new product or industrial process for the first time, or introducing a technologically advanced or better quality product.
  • Invest in a company that operates in high growth sectors of the economy, as incident to failure is likely to be lower for such companies.

How can an investor profit from IPO

Public issues provide for shares at relatively low prices. A newly formed company usually offers for shares subscription at par value, whereas existing companies price their new issues more than 20% to 30% lower than the market price of their existing share.

Similarly, the shares issued at par by new companies also quote at higher premiums soon after being listed in stock exchange. This is the main reason why the public issues are so popular with the investors. They offer opportunities for making easy and quick money in market bull’s phase. So you should feel yourself lucky enough if you get small number of shares, it is with this background in mind that you should calculate the pros for applying in this IPO.

Conclusion

An IPO is when the company gives its share to public. If a company convinces investors to buy certain shares, it invests a lot of profit for future. IPO’s is often issued by smaller, young companies seeking capital for their expansion. An IPO is basis for allotment, where there are two ways for issuing the share Fixed price issue where the price and quantum of shares is pre decided and is fixed, where as in book building the investors bid in the price and then it is fixed, the investors whose price matches with the bidding gets shares on par basis, and the shares in which the investors invested more than the floor price will get the share at premium. In this, one gets profit as when a person initially invests they give a minimum purchase price which later gets increased.

References

 

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