IPO

IPO

Initial Public Offering is when a company is introduced into the publicly

traded stock markets for the first time. In the IPO, the company’s promoters
choose to offer a certain percentage of shares to the public. The reason for
going public and the process of an IPO is explained in detail in Chapters 4
and 5.

The primary reason for going public is to raise capital to fund expansion
projects or cash out early investors. After the IPO is listed on the exchange
and is traded in the secondary market, promoters of the company might still
want additional capital. There are three options available: Rights Issue, Offer
for Sale and Follow-on Public Offer.

Rights Issue

The promoters can choose to raise additional capital from its existing
shareholders by offering them new shares at a discounted price (generally
lower than Market Price). The company offers new shares in the proportion
of shares already held by the shareholders. For example, a 1:4 Rights Issue
would mean that every 4 shares held 1 additional share is offered. Although
this option looks good, it limits the company to raise the capital from a small
number of investors who are already holding shares of the company and
might not want to invest more. A rights issue leads to the creation of new
shares that are offered to the shareholders, which dilutes the value of the
previously held shares.

An example of a Rights issue is South Indian Bank which announced a

1:3(One share for every 3 held) issue for Rs 14 which is 30% lower than the
Market Price the stock was trading (Rs 20 as on Record date 17 Feb 2017).
The bank offered 45.07 lakh shares to the existing shareholders.

The rights issue is covered in detail in Chapter 11, covering key Corporate
Actions.

OFS
The promoters can choose to offer the secondary issue of shares to the
whole market, unlike a rights issue restricted to existing shareholders. The
Exchange provides a separate window through the stockbrokers for the Offer
for Sale. The exchange allows a company to route funds through OFS only if
the Promoters want to sell out their holdings and/or maintain minimum
public shareholding requirements (Govt. PSU have a public shareholding
requirement of 25%).

There is a floor price set by the company, at or above which both Retail and
Non-Retail investors can make bids. The shares are allotted, if bids are at a
cut-off price or above will be settled by the exchange into the investor
Demat account in T+1 days.

An example of an Offer for Sale is NTPC limited, which offered a maximum of

46.35 million shares at a floor price of Rs 168 and was fully subscribed in the
2 day period. The OFS was held on 29th August 2017 for Non-Retail
Investors and 30th August 2017.

FPO

An FPO also has the same intent of raising additional capital after it has been
listed but follows a different mechanism for applying and allotting shares.
Shares can be diluted, and fresh shares can be created and offered in an
FPO. Just like an IPO, an FPO requires that Merchant Bankers be appointed
to create a Draft Red Herring Prospectus which has to be approved by SEBI
after which bidding is allowed in a 3-5 day period. Investors can place their
bids through ASBA and shares are allotted based on the Cut-off Price
decided after the book-building process. Since the introduction of OFS in
2012, FPOs are seldom used due to the lengthy approval process.

The company decides on a Price Band, and the FPO is publicly advertised.
Prospective investors can bid for the issue using the ASBA portal through
Internet Banking or apply offline through a Bank Branch. After the bidding
process is complete, the cut-off price is declared based on the demand and
the additional shares allotted are listed on the exchange for trading in the
secondary markets.

An example of an FPO is of Engineers India Ltd which underwent an issue in

February 2014 with Rs 145-Rs 150. The issue was oversubscribed by 3
times. The shares on the day of the starting date of the issue were trading
at Rs 151.1. The lower price band was at a 4.2% discount from the market
price.

Difference between OFS and FPO

 An OFS is used to offload Promoters’ shares while an FPO is used to

fund new projects.

 Dilution of shares is allowed in an FPO leading to change in

Shareholding structure while OFS does not affect the number of
authorized shares.

 Only the top 200 companies by Market Capitalisation can use the OFS
route to raise funds while all listed companies can use FPO option.
 Ever since SEBI has introduced OFS, FPO issues have come down, and
companies prefer to choose the OFS route to raise funds

Over Subscription

Over subscription, there are three alternatives available to the company with
respect to the allotment:

1. Full Allotment and Rejection of Excess Application: Rejection of some

excess applications and allotment is made in full to other applicants. Those
applicants whose applications are rejected are sent a letter of regret along
with the refund of the money paid by them. Also, the applicants whose
applications are accepted are sent a letter of allotment.

2. Pro-rata Allotment: Proportionate distribution of available shares can be

made by the Board of Directors for allotment among applicants. The
applicants get a lesser number of shares than the shares they have applied
for, proportionately, which is called a pro-rata allotment. The allotment is
based on the ratio between the number of shares to be allotted and the
number of shares applied for.

Pro-rata-allotment-formula
Letter of allotment is delivered to all the applicants and excess application
money received in the application is not refunded rather it is retained and
adjusted towards allotment and calls. If the entire issue price is needed to
be paid along with the application, the excess amount over and above 10%
of the securities offered has to be refunded.

3. Combination of the above two alternatives:

Reject some applications and make pro-rata allotment of the remaining

applicants: In this case letter of regret is sent to the rejected applicants and
a letter of allotment is sent to the ones accepted over.

Full allotment to some applicants and making pro-rata allotment of the left
ones: In this case letter of allotment is sent to all the applicants.

Rejection of some applications, full allotment to some applicants, and

making pro-rata allotment to the remaining ones: Letter of regret is sent to
the rejected ones. And the letter of allotment is sent to the applicants whose
applications have been accepted.

Note: Oversubscription received to the extent of 10% of the net offer made
to the general public is allowable so as to round off the figure to the nearest
multiple of 100, at the time of completing the allotment.

SEBI Guidelines for Over Subscription

There should be a categorization of the applicants on the basis of the

number of shares they have applied for.

Half of the net offer of shares to the public should be made to those
companies or organizations that have made applications for more than 1000
shares.

Half of the net offer of shares to the public should be given to those
applicants, who have made applications of 1000 or less than 1000 shares.

The Board of Directors has the authority to reject some applications on the
grounds of a technicality like incomplete application forms or forms not
bearing signatures or applications with less money.
Any basis for allotment of shares can be adopted, but allotment has to be
made in tradable lots, and the amount over and above received at the time
of application should be adjusted towards allotment and calls, while the
remaining excess sum is to be refunded.

Case 1: If there is a small oversubscription

Let us assume a firm named XYZ has floated an IPO by offering a total of 10
lakh shares with a minimum lot size of 100 shares. According to the norms
of the Securities and Exchange Board of India (SEBI), the allotment to each
retail individual bidder shall not be less than the minimum bid lot. So, the
maximum number of investors who can get at least one lot in this IPO is
10,000 (10,00,000/100).

In the case of a small over subscription, say, a total of 8,000 investors have
bid but 6,000 investors have bid for one lot and the remaining 2,000
investors have bid for three lots each. So, the total shares bid for are 12
lakhs against the available 10 lakh shares. In this scenario, the ABC will allot
one lot (100 shares) to each of the 8,000 investors and the remaining 2 lakh
shares are distributed proportionately to the investors who have bid for
more than one lot.

Case 2: If there is a large oversubscription

Assume that in the above IPO, XYZ got bids for 2 crore shares from 80,000
investors for the same 10 lakh shares. In other words, the IPO has been
oversubscribed by 20 times and the number of investors has also gone up by
10 times.

In this scenario, all investors cannot be allocated at least one lot each as
stipulated by the SEBI. Hence, the allocation will be based on a
computerised lottery draw. Since this is an impartial and randomised lottery
system, some investors will manage to get one lot each, while many will not
be allocated any shares.

Assume 10 investors have applied for an IPO at the cut-off price, i.e., the
offer price at which the shares get issued to the investors. Each of these
investors has placed a bid in the range of 1 to 5 shares. The list of these
investors and shares applied would look something like this:
 Quantity Applied
Investor

Investor 1 1

Investor 2 2

Investor 3 3

Investor 4 3

Investor 5 4

Investor 6 4

Investor 7 4

Investor 8 5

Investor 9 2

Investor 10 1

Total number of shares

29
applied

If the total number of shares to be allotted is 5 then the allotment could be

made in the following manner:

Quantity Quantity Allotted

Investor
Applied

Investor 1 1 0

Investor 2 2 1
Investor 3 3 1

Investor 4 3 0

Investor 5 4 1

Investor 6 4 0

Investor 7 4 0

Investor 8 5 0

Investor 9 2 1

Investor 10 1 1

Total 29 5

Investors (2), (3), (5), (9), and (10) have won the lottery conducted by the
registrar and will receive shares against their IPO application. If an investor
had applied at a price below the upper price band, then the bids would not
have been considered for the allotment lottery.

Under subscription

Under subscription, as the name signifies, is a situation in which the

application received by the company from the public is less than the shares
offered. In this case, the company will keep a record of the actual number of
shares purchased by public

Here, it is to be noted that the condition for a minimum subscription must be

fulfilled by the company i.e. 90% of the issued shares must be subscribed
for by the public, so as to allot shares to the public.

IPO Allotment to Retail Individual Investors

As far as the retail individual investors (RIIs) are concerned, the process of
allocation of shares is different. The maximum amount which retail investors
can apply per IPO is Rs. 2 lakh. In order to determine the total demand for
shares in the retail investor category, all the applications are grouped
together and the total number of applications are calculated. If the number
of applications are more than the number of shares offered for retail
investors, the maximum RIIs who are eligible for the allotment of the
minium bid lot are determined.

The total number of equity shares available for allotment to RIIs is divided
by the minimum bid lot. This gives the maximum number of RIIs who can be
allotted the shares.

For example - If shares worth Rs. 20 lakh need to be allotted to the retail
segment and the minimum lot size is Rs. 10,000, only a maximum of 200
applicants will be allotted the shares with the minimum lot of Rs. 10,000.

If the number of RIIs exceed the maximum RII allottees, the RIIs (in that
category) who will be eligible for the minimum bid lot will be determined on
the basis of draw of lots. This is a computerised process and hence there is
no room for partiality.

High Net-worth Individuals

Usually, HNIs invest a large amount of money in IPOs. Financial institutions

provide funding to HNIs in order to invest in IPOs. It is not necessary that a
HNI will be allotted the exact number of shares that he has applied for. If
there is an over-subscription, the HNIs may be allotted less shares than
what they must have applied for. For example : A particular HNI client has
applied for 10 lakh shares and the HNI quota is over-subscribed by 150
times. The total shares that will be allotted to him will be 6666. This number
arrives by dividing the total number of shares applied for by the number of
times that it has been over-subscribed.

Calculation of Cut-off Price

Swiggy Ltd has raised 1000 shares and indicated a Price band of Rs. 100 to
108. As an investor you buy 100 shares at the price of Rs. 102. Please
calculate the cut-off Price.

Bid Price Number of Shares Applied

100 50
108 500
104 150
101 200
107 100
105 50
102 100
103 300
106 200

Solution:
Step I: Arrange bid price in descending order
Step II: Estimate Cumulative Shares

Bid Price Number of Shares  Cumulative   Cumulative %

Applied Shares Shares

108 500 500 50%

107 100 600 60%
106 200 800 80%
105 50 850 85%
104 150 1000 100%
103 300 1300 130%
102 100 1400 140%
101 200 1600 160%
100 50 1650 165%

Cut of Price 104

Applications above cut-off price will be considered for the allotment process
(Lottery System if it is oversubscribed).
Cut-off Price in Offer for Sale
In OFS promoters only indicate the floor price, investors including retail
investors must place bid over and above floor price. Once bid get closed
promoters identify the cut-off price based on the weighted average.
Example: Promoters decided a floor price of Rs. 100 for the OFS and 5
investors placed their bid mentioned below:
Investors Number of Shares Bid Price Value of Bid
Ramu 500 102 51000
Shamu 700 105 73500
Sonu 1000 103 103000
Monu 200 101 20200
Raju 600 104 62400
Total 3000 310100

Weighted Average =310100/3000=103.36

=103/-