The month of February may well turn out to be a bit hectic for the retail investor like you and I.
The reason being a score of companies will be out there to sell their shares and garner thousands of crores of rupees from this sale.
Initial Public Offerings, IPOs, for all you know is the way through which companies raise money from the general public to meet some of their expenses like starting a new factory, buying machinery or prepaying costly debt.
However, have you ever read an IPO application form?
If you have then you must have come across terms like price band, book-runner to the issue, face value, premium, primary market, secondary market and registrar to the issue et al?
Well, if they sounded like Greek or Latin to you then you must read about all these terms now.
What is an IPO?
IPO stands for initial public offering. Any company, let say for instance, the Power Finance Corporation (PFC) needs money to lend funds to power producers in India.
It offers shares to the general public and financial institutions like mutual funds and qualified institutional buyers in a given range (say between Rs 73 Rs 85) referred to as the price band.
An IPO lets a company sell its shares to the public and get money in return. It is so called because it is the first time that a company sells its shares to the public.
The IPO market is also referred to as the primary market in some parlance.
The shares that a company offers as part of its IPO can be fresh shares or existing shares.
Fresh shares come into existence when a company having reserves (free cash) converts them into shares. Let's suppose that a company makes a profit of Rs 100 in the first year of its operations.
Now let's assume that it needs only Rs 50 for its business operations like paying wages, purchasing raw material etc. The remaining Rs 50 becomes idle cash which the company can pool in its cash reserves or convert this Rs 50 into five shares of Rs 10 each.
Simply put it is a financial conversion whereby the value of money gets converted into shares. These five shares then become fresh shares.
Apart from this an IPO can also include an "offer for sale" from original shareholders who may want to either partially or completely exit the company.
They are generally investors who seed the company (provide it with requisite money) in its initial stage of growth and may want to exit during an IPO making some profits. Confusing? Read on.
Say your brother wanted to start a company and was in need of money to start his business. He approaches you for cash and tells you that you will get shares of his company in lieu of and in proportion to the money you put in.
Say you put in Rs 10,000 and the face value of every share is Rs 10. On this your brother is going to charge you Rs 15 extra as premium (this will take cost of one share at Rs 25) because he believes that one year after his business starts making profits, the value of his company's shares can even double to Rs 50.
If you agree to what your brother says then you will get 400 shares of his company (Rs 10,000/25, that is your total investment divided by cost of one share). Remember that even though the original price (the face value) of one share was Rs 10, you were charged a premium of Rs 15 taking the per share price to Rs 25.
Now your brother's company has made some profits in the first two years of doing business and wants some more money for expansion plans (say he wants to add a building to the existing factory complex or wants to purchase a new machine).
He decides to take his company public now (that is plans an IPO). Remember that you own 400 shares of this company. Since his company is making profits he wants to sell his shares at Rs 50 a piece.
He is confident that the general public and financial institutions (like mutual funds various insurance companies) will pay Rs 25 more than you did for getting ownership of a profitable and growing company.
Now, you too pitch in and tell him that you would like to sell all or part of your 400 shares to the public. This sale of 400 shares from you (an original investor) will be the 'offer for sale' shares. And you get Rs 50 per share instead of Rs 25 that you paid when the business just got started.
Normally, existing shareholders exit a company (sell their ownership of the company) to make profits. In the above example you made a profit of Rs 25 on investment of Rs 25. That is a 100% gain in the span of two years.
Usually, in a bull market or depending on the advise of merchant bankers, a company offers its shares at a premium to the face value.
If the issue lists at a price more than the issue price it is said to have listed at a premium. Otherwise, the issue is said to have listed at a discount to the IPO price.
What is listing?
Listing is a process whereby shares offered to the public in an IPO become eligible to be traded in the secondary market (the Bombay Stock Exchange, the National Stock exchange). Generally, there is a gap of 15-20 days between the closing and listing date of an IPO.
If the closing date of an IPO is February 5 then the stock gets listed by February 15-20 on the BSE, NSE or both. Earlier this gap was more than 40 days but technology and improved processes has helped reduce this gap.
Having said that we are nowhere near the benchmark set by developed markets like Hong Kong and Singapore (both sophisticated and huge financial markets) where the gap between closing date and listing date is not more than three days.
Before IPO shares are listed on the secondary markets, the book runners and registrar's to the IPO issue has to make sure that the allotment of shares are done in a transparent manner and investors get the allotted shares into their dematerialised accounts.
This helps investors buy or sell the shares of this company in the secondary market.
What is a secondary market?
Secondary market is the place or rather an exchange where stocks can be bought or sold at market determined rates in a transparent manner.
If you want to buy a particular number of shares for a particular price you can punch in your order; if a seller meets your requirements the order is executed automatically without any human intervention. Thus there is complete transparency.
This orders can be punched either by your broker/sub broker or you can yourself do it online using products offered by a host of brokerage houses.
Also when you get an IPO allotment in the primary market, you will need to go to the secondary market for selling them. You can do this either offline or online depending on your comfort and convenience. In both the cases you need to be registered with a broker.
What is an FPO?
Not to be confused with the IPO. FPO stands for follow on public offer. A company that is already listed on the stock exchanges can also approach investors for funds.
If Infosys tomorrow comes with another public offer it will be an FPO as Infosys is already a listed company.
Normally, FPOs are offered at a discount to the existing market price of that company. This is to make a particular issue attractive for the potential investors.
A premium, though, can also be charged in some cases if the company and its book runners think so.
What is face value and premium?
Face value is the nominal value of a share. Every share gives you a proportionate ownership of a company. However, it gives you no direct control over the day-to-day working of the company.
It is also known as the 'par value' of a share. A share can have a face value of Rs 100, Rs 10, Rs 5, Rs 4, Rs 2 or Rs 1 depending on the management of the company selling shares.
Important thing to note here is that a dividend announced by a company is always on its face value.
So a 20% dividend on a share of face value Rs 100 (Rs 20) will always be more than 80% dividend announced on a share of face value Rs 10 (Rs 8).
Premium is the additional amount charged by a company from investors over and above its face value for buying that company's shares.
There is no limit to the premium demanded by a company but there are market dynamics like a company's net profits, its business model and quality of management that decide on the premium apart from a host of other factors.
In recent times companies don't fix the price of their IPO issue; they rather fix a price band and let the market decide the fixed price of an issue.
What is a price band?
A price band is the range between which investors can bid while applying for an IPO. This range comprises of a floor price and a cap price.
Investors are free to bid for a company's shares either at the floor price, cap price or at any price in between the price band.
For instance, in the case of GBN (having price band of Rs 230-250), Rs 230 is the floor price or the lower end of the price band and Rs 250 is the cap price or the upper end of the price band.
Akruti Nirman's price band, on the other hand, was Rs 475-540.
Note the difference between the two ends of a price band differ from one company to another. As in the above example, the difference between GBN's price band was just Rs 20 and for Akruti Nirman it was Rs 65.
Investors who bid for prices lower than the floor price or higher than the cap price are held ineligible and their applications are cancelled.
What is a book-built issue?
It is a process whereby a merchant banker tries to determine the appetite of investors (both retail (you and I) and institutional (mutual funds, insurance companies etc)) for a particular IPO issue and fix the price of that issue.
If the merchant banker finds that a majority of investors have bid at the upper end of the price band for maximum number of shares on sale in the IPO, the upper end is fixed as the price of the issue and vice versa. However, a price in between this range can also be fixed.
Most of the IPOs till now have been fixed at their cap prices. Cairn India's issue was a notable exception in recent times, which was fixed at the floor price of Rs 160. It had a price band of Rs 160-190.
Who is a book runner to the issue?
A book runner is an institution (say Kotak mahindra Capital or Enam Financial) that manages the book-built issue of a company. It keeps a record of all the bids from investors and helps that company determine the final issue price.
While a company going public (coming out with an IPO) needs to have a minimum of one book running lead manager there can be more than one book-runners for an issue as well.
Enam Financial Consultants, JM Morgan Stanley, Edelweiss Capital and Ambit Corporate
Finance were the book running lead managers to the Cinemax India IPO; Power Finance Corporation is being lead managed by Enam Financial Consultants and ICICI Securities Ltd.
Who is a registrar to the issue?
Registrar is an institution or a company appointed by the company issuing an IPO that makes sure that shares allotted to investors are credited into their dematerialised accounts before an issue is listed.
They also undertake the responsibility of returning money back to investors in case they don't get any allotment or get partial allotment.
Karvy Computershare Pvt. Ltd. was the registrar to the PFC issue that opened on January 31 and closed on February 6.
How to apply for an IPO?
With technology improving by leaps and bounds, applying for an IPO is as easy as clicking the mouse button. The entire lot of online brokerages like www.icicidirect.com, www.5paisa.com, www.hdfcsecurities.com offer online application of IPOs if you are a registered trader/investor with them.
Of course, you need to have the requisite amount in your online trading account and bingo you can apply for an IPO at the click of your mouse.
The traditional ways of doing it include collecting IPO application forms from street vendors, insurance agents and sub brokers. There are a host of other intermediaries involved in helping you fill an IPO issue.
If you are applying online, the amount equivalent to the number of shares for which you have applied gets deducted from your trading account.
Am I sure to get an allotment on application?
No. Applying for an IPO is no guarantee that you will be allotted shares of that company. You are not the only person applying for that hot IPO issue.
It is a common for an IPO now to get subscribed in multiples of the number of shares on offer. That is the number of shares demanded are far greater in number than those on offer.
It is quite often that we come across terms like an issue was subscribed 7.5 times or 18.9 times the number of shares on offer.
What it means is for every one share that the company wants to sell via the IPO, it receives bids for 7.5 shares or 18.9 shares.
It is exactly because of such high subscription figures that IPO shares list at a huge premium to the fixed price. Investors who do not get enough of a company's shares during the IPO outbid each other when the issue lists in the secondary market.
If you apply for 1000 shares, it is quite possible that you may get allotted only 10 shares or perhaps not even that.
The allotment process is discretionary and you should consider yourself lucky if you get some shares when an issue is subscribed in multiples of shares offered.
Do I get my money back if I'm not allotted any shares?
Yes, of course. It is your money and you get it back partially or completely depending on your allotment.
The registrars to the issue and, of course, the companies for whose IPOs you have applied are responsible for returning your money back in case of nil allotment.
Normally, investors get either shares credited into their demat account or money back into their bank account (if they have applied online) or a cheque by a registered AD before the IPO lists on the exchanges.
Do I need to have a PAN number for applying in an IPO?
Yes, you do. Because without your Permanent Account Number (PAN) you cannot open a demat account now.
The market regulator, the Securities and Exchange Board of India (SEBI), has made it mandatory from January 1, 2007 for all demat account holders to submit their PAN details for buying or selling shares in both the primary and secondary market.
So, even if you have a demat account without PAN details, your account will be frozen till the time you furnish your PAN number and make it active again.