Primary Markets

In
India

Presented By
Prraney Surana
Swapnil Chichani
Contents

• Capital Market
• Need to Issue Shares to the Public
• Primary Market
• Features of Primary Market
• Public Issue and Private Placement
• Various Issues in Primary Market
• Methods of Issuing Securities in Primary Markets
• Rights Issue
• Preferential Issue
• Initial Public Offer (IPO)
• Risk in Primary Markets
• International Primary Market Association
Introduction : Capital Markets

• A capital market is a market for securities (debt or equity),

where business enterprises (companies) and governments can
raise long-term funds. It is defined as a market in which
money is provided for periods longer than a year, as the
raising of short-term funds takes place on other markets (e.g.,
the money market).

• Capital markets may be classified as primary markets and

secondary markets. In primary markets, new stock or bond
issues are sold to investors via a mechanism known as
underwriting. In the secondary markets, existing securities are
sold and bought among investors or traders, usually on a
securities exchange, over-the-counter, or elsewhere.
Why do companies need to issue
shares to the public?
• Most companies are usually started privately by their
promoter(s). However, the promoters' capital and the
borrowings from banks and financial institutions may not be
sufficient for setting up or running the business over a long
term. So companies invite the public to contribute towards the
equity and issue shares to individual investors. The way to
invite share capital from the public is through a 'Public Issue'.
Simply stated, a public issue is an offer to the public to
subscribe to the share capital of a company. Once this is done,
the company allots shares to the applicants as per the
prescribed rules and regulations laid down by SEBI.
Primary Markets

• The primary market is that part of the capital markets that

deals with the issuance of new securities. Companies,
governments or public sector institutions can obtain funding
through the sale of a new stock or bond issue. This is typically
done through a syndicate of securities dealers. The process of
selling new issues to investors is called underwriting.

• Features of primary markets are:

• This is the market for new long term equity capital. The
primary market is the market where the securities are sold
for the first time. Therefore it is also called the new issue
market (NIM).
Features of Primary Market
• In a primary issue, the securities are issued by the company
directly to investors.
• The company receives the money and issues new security
certificates to the investors.
• Primary issues are used by companies for the purpose of
setting up new business or for expanding or modernizing the
existing business.
• The primary market performs the crucial function of facilitating
capital formation in the economy.
• The new issue market does not include certain other sources of
new long term external finance, such as loans from financial
institutions. Borrowers in the new issue market may be raising
capital for converting private capital into public capital; this is
known as "going public."
Difference between public issue and
private placement?
• When an issue is not made to only a select set of
people but is open to the general public and any
other investor at large, it is a public issue. But if the
issue is made to a select set of people, it is called
private placement. As per Companies Act, 1956, an
issue becomes public if it results in allotment to 50
persons or more. This means an issue can be
privately placed where an allotment is made to less
than 50 persons.
Various Issues In Primary Market
Methods of Issuing Securities in
Primary Markets
• Initial Public Offer
• Rights issue (for existing companies)
• Preferential Issue
Rights Issue

• Issuing rights to a company's existing shareholders to buy a

proportional number of additional securities at a given price
(usually at a discount) within a fixed period.

• A rights issue is directly offered to all shareholders of record or

through broker dealers of record and may be exercised in full
or partially. Subscription rights may either be transferable,
allowing the subscription-right-holder to sell them privately, on
the open market or not at all. A right issuance to shareholders
is generally issued as a tax-free dividend on a ratio basis (e.g.
a dividend of one subscription right for one share of Common
stock issued and outstanding). Because the company receives
shareholders' money in exchange for shares, a rights issue is a
source of capital.
Example

• An investor: Mr. A had 100 shares of company X at a total

investment of $40,000, assuming he purchased the shares at
$400 per share.

• Assuming a 1:1 subscription rights issue at an offer price of

$200, Mr. A will be notified by a broker dealer that he has the
option to subscribe for an additional 100 shares of Common
stock of the company at the offer price. Now, if he exercises
his option, he would have to pay an additional $20,000 in
order to acquire the shares, thus effectively bringing his
average cost of acquisition for the 200 shares to $300 per
share ((40,000+20,000)/200=300). Although the price on the
stock markets should reflect a new price of $300 (see below),
the investor is actually not making any profit nor any loss.
Example

• The company: Company X has 100 million outstanding

shares. The share price currently quoted on the stock
exchanges is $400 thus the market capitalization of the stock
would be $40 billion (outstanding shares times share price).
• If all the shareholders of the company choose to exercise their
stock option, the company's outstanding shares would increase
to 200 million. The market capitalization of the stock would
increase to $60 billion (previous market capitalization + cash
received from owners of rights converting their rights to
shares), implying a share price of $300 ($60 billion / 200
million shares). If the company were to do nothing with the
raised money, its Earnings per share (EPS) would be reduced
by half. However, if the equity raised by the company is
reinvested (e.g. to acquire another company), the EPS may be
impacted depending upon the outcome of the reinvestment.
Preferential issue

• An issue of shares set aside for designated buyers, for

example, the employees of the issuing company.

• A Preferential issue is an issue of shares or of convertible

securities by listed companies to a select group of persons
under Section 81 of the Companies Act, 1956 which is neither
a rights issue nor a public issue. This is a faster way for a
company to raise equity capital. The issuer company has to
comply with the Companies Act and the requirements
contained in the Chapter pertaining to preferential allotment in
SEBI guidelines which inter-alia include pricing, disclosures in
notice etc.
Initial Public Offer

• A company's new offering is placed on the primary market

through an initial public offer.
• An Initial Public Stock Offering (IPO) is simply an
"offering" or "flotation," when a company (called the issuer)
issue Common stocks or shares to the public for the first time.
It can be issued by small, young companies as well as by large
privately-owned companies.
• An IPO for an Investor can be pretty risky!!!
Initial Public Offer

• The sale of an IPO takes place in

several forms. Some Common Methods
are:
• Best Efforts Contract: In the best efforts contract the
underwriter agrees to sell as many shares as possible at the
agreed-upon price.
• Firm Commitment Contract: In the firm commitment
contract the underwriter guarantees the sale of the issued
stock at the agreed-upon price. For the issuer, it is the
safest but the most expensive type of the contracts, since
the underwriter takes the risk of sale.
Initial Public Offer

• All or None Contract: Under the all-or-none contract the

underwriter agrees either to sell the entire offering or to
cancel the deal.
• Bought Deal: A bought deal occurs when an underwriter,
such as an investment bank or a syndicate, purchases
securities from an issuer before a preliminary prospectus is
filed. The investment bank (or underwriter) acts as principal
rather than agent and thus actually "goes long" in the
security. The bank negotiates a price with the issuer.
• Self Distribution of Stock: The company itself involves into
Stock Distribution however this cant be done when the
volumes are large.
Initial Public Offer
A large IPO is usually underwritten by a
“syndicate” of investment banks led by
Issuer one or more major investment banks .
Upon selling the shares, the
underwriters keep a commission based
on a percentage of the value of the
shares sold (called the gross spread).
Usually, the lead underwriters, i.e. the
Underwriters underwriters selling the largest
proportions of the IPO, take the highest
commissions—up to 8% in some cases.

However, should the Underwriters not

be able to find enough investors, they
Investors will have to hold some securities
themselves.
Initial Public Offer

• Pricing
• The underpricing of initial public offerings (IPO) has been
well documented in different markets. Many financial
economists have developed different models to explain the
underpricing of IPOs.
• The effect of "initial underpricing" an IPO is to generate
additional interest in the stock when it first becomes
publicly traded. Through flipping, this can lead to significant
gains for investors who have been allocated shares of the
IPO at the offering price.
• However, underpricing an IPO results in "money left on the
table"—lost capital that could have been raised for the
company had the stock been offered at a higher price.
Initial Public Offer

• One great example of all these factors at play was seen

with “theglobe.com” IPO which helped fuel the IPO mania of
the late 90's internet era. Underwritten by Bear Stearns on
November 13, 1998 the stock had been priced at $9 per
share, and famously jumped 1000% at the opening of
trading all the way up to $97, before deflating and closing
at $63 after large sell offs from institutions flipping the
stock . Although the company did raise about $30 million
from the offering it is estimated that with the level of
demand for the offering and the volume of trading that took
place the company might have left upwards of $200 million
on the table.
Initial Public Offer

• The danger of overpricing is also an important

consideration. If a stock is offered to the public at a higher
price than the market will pay, the underwriters may have
trouble meeting their commitments to sell shares. Even if
they sell all of the issued shares, if the stock falls in value
on the first day of trading, it may lose its marketability and
hence even more of its value.
• The process of determining an optimal price usually
involves the underwriters ("syndicate") arranging share
purchase commitments from leading institutional investors.
Initial Public Offer

• Initial Price
• A company that is planning an IPO appoints lead managers
to help it decide on an appropriate price at which the shares
should be issued. There are two ways in which the price of
an IPO can be determined: either the company, with the
help of its lead managers, fixes a price or the price is
arrived at through the process of book building.
• Book building refers to the process of generating,
capturing and recording investor demand for shares during
an IPO (or other securities during their issuance process) in
order to support efficient price discovery. Usually, the
issuer appoints a major investment bank to act as a major
securities underwriter or book runner.
Initial Public Offer

• Some of the Largest IPO’s

• Industrial and Commercial bank of China-
$21.6B in 2006
• NTT Mobile Communications- $18.4B in
1998
• Visa Inc.- $17.9B in 2008
• AT&T- $10.6B in 2000
• Rosneft- $10.4B in 2006
Risk in Primary Markets

• As the saying goes, A known Devil is much better than an

Unknown Devil.
• It is highly risky and also much more riskier than secondary
market.
• It is highly risky hope that the differential premium existing in
the secondary market does not vanish before fresh shares find
their way to the market.
• One such example can be seen as that happened in 2005
between India Info line, which made an IPO, and Jindal
Polyfilms that made a subsequent public offer.
• Though both the offerings came out at the same time, JPFL
suffered with its investors not able to do anything apart from
seeing their vanishing premiums whereas India Info line came
out with flying colors.
International Primary Market
Association
• International Primary Market Association (IPMA) monitors
primary market activities around the world. In 2005, the
International Securities Market Association merged with the
IPMA and formed the International Capital Market Association.
• Main objectives of IPMA are:
• to develop an efficient capital market in Europe.
• to provide protection to investors of the capital market.
References and Bibliography

• www.rediff.com/money/2005
• www.sharekhan.com
• www.nseindia.com
• www.bseindia.com
• www.moneycontrol.com
• www.sharegyan.com
• www.investopedia.com
• Wikipedia Pages
• Primary Markets
• Capital Markets
• IPO
• IPO pricing
• And
THANK YOU