ipo pricing

 IPO Pricing: Demystifying Book Building and Fixed Price Methods

Initial Public Offerings (IPOs) are pivotal moments for companies venturing into the public markets. The pricing of an IPO is a critical aspect that directly impacts investor interest and the company’s ability to raise capital. This comprehensive guide aims to demystify two primary IPO pricing methods: Book Building and Fixed Price. By exploring these methods, potential investors, financial enthusiasts, and companies seeking to go public can gain a deeper understanding of the intricate processes that underlie successful IPOs. Whether you’re new to IPOs or seeking to refine your investment strategies, this exploration of pricing methods will provide valuable insights and tools for informed decision-making in the dynamic world of initial public offerings.

Exploring IPO Pricing Strategies

The pricing of an Initial Public Offering (IPO) is a crucial step in the journey of a company entering the public markets. There are two primary methods for determining IPO prices: Book Building and Fixed Price. Companies can choose between these methods based on their specific preferences and circumstances.

Book Building Method

In the Book Building method, the IPO price isn’t fixed beforehand. Instead, the issuing company specifies a price range (e.g., Rs 75 to Rs 80 per share) within which investors can place their bids. The final IPO price is determined at the end of the bidding period, influenced by the demand at various price levels.

Advantages of Book Building:

  • Efficient price discovery mechanism.
  • Provides valuable insights into the demand for the offering.
  • Realistic pricing based on investor demand, not influenced by management.

Disadvantages of Book Building:

  • Can be costlier compared to a Fixed Price IPO.
  • The process is longer as the price is determined at the end of the bidding period.
  • Most suitable for larger issuances.

Key Features of Book Building:

  • IPO launches without a fixed issue price.
  • The price range is announced at least two business days before the subscription opens.
  • The issuer can revise the price range during the offering.
  • The offering remains open for 3-7 business days, extendable by three days if the price range changes.
  • BSE and NSE provide fully automated online bidding systems for book-building IPOs.

Understanding these pricing methods is essential for companies and investors alike as they navigate the dynamic landscape of IPOs, ultimately influencing their investment decisions and market success.

Understanding IPO Price Bands:

An IPO’s price band represents the range within which investors can submit their bids. Here are key facts and features regarding price bands:

  • A price band includes a lower and upper price (e.g., Rs 75 to Rs 80).
  • The lower end is termed the Floor Price or Base Price, while the upper end is called the Cap Price or Ceiling Price.
  • The difference between these two prices cannot exceed 20%.
  • Retail investors can apply at any price within the specified range or at the Cut-off price.
  • The Cut-off price, finalized at the end of the bidding process, is where shares are allocated.
  • The basis for determining this price is detailed in the prospectus.

Demystifying the Book-Building Process

The book-building process is a collaborative effort between Lead Managers and Underwriters, encompassing several crucial steps:

Book Building Process Steps:

  • The Lead Manager, in consultation with the issuing company, establishes the issue size and price range.
  • Syndicate members are appointed by the Lead Manager and issuing company to manage IPO-related tasks.
  • Investors place bids within the specified price range during the IPO launch.
  • After bid submission concludes, the Lead Manager collects and analyzes all bid data to determine the final issue price using a weighted average method.
  • Details of all bids received (basis of allotment) are disclosed to ensure transparency.
  • Once the Cut-off price is determined, investors who bid at or above this price may receive an allotment, while bids below this price are rejected, and the subscription money is refunded.

Diverse Book Building Types:

Companies may opt for different approaches to book building:

  • 100% Book Built Offer: The entire issue is offered through the book-building process.
  • 75% Book Building: Here, 75% of the net offering is book-built, with the remaining 25% offered at a threshold determined via book building.

Illustrating Book Building with an Example:

Consider a scenario in which a company specifies a price range of Rs 601 to Rs 650 for its IPO of 1 million shares. Investors can bid within this range or at the Cut-off price (for retail investors). Based on demand and supply, the final price (Rs 640, in this instance) is determined using a weighted average method.

Scenario 1: Bidding Above the Cut-off Price

Investors bidding above Rs 640 may receive an allotment and receive refunds for amounts exceeding the minimum price. For instance, a bid at Rs 645 for 10 shares would result in a refund of the excess amount.

Case 2: Bidding Below the Cut-off Price

  • Bids below the Cut-off price are not accepted, and the entire amount is refunded.

Case 3: Bidding at the Cut-off Price

  • Investors who bid at the Cut-off price may receive an allotment. In the case of a full allotment, no refund is issued. In instances of partial allotment, the pro rata amount is refunded for the shares not allotted.

Note: When the demand for the issue is exceptionally high, the maximum price typically becomes the Cut-off price.

Understanding Book Building and Reverse Book Building

Book Building is an IPO method for raising capital from the public, whereas Reverse Book Building is employed when a company aims to repurchase shares from its shareholders.

Reverse Book Building operates on the same principle as Book Building and serves as an efficient pricing mechanism. In this process, shareholders submit sell orders at various prices, and the company determines the final price based on supply and demand. Reverse Book Building is predominantly used in delisting scenarios.

Exploring Fixed Price IPOs:

In the Fixed Price issue method, the offer price is predetermined, such as Rs 75 per share, before the IPO subscription begins. SME companies often opt for fixed price issues, especially for smaller-sized offerings.

Key Features of Fixed Price IPOs

  • The prospectus for a fixed-price IPO includes comprehensive details about the IPO price and the rationale behind its determination.
  • The issuer is required to register the fixed-price IPO prospectus with the Registrar of Companies before opening the subscription.
  • A minimum of 50% of the net offering must be available for retail investors.
  • Fixed price offerings are open for subscription for a duration of 3-10 business days.

Navigating the Fixed Price IPO Process

The fixed-price IPO method is relatively straightforward compared to the book-building method, as there is no need for price discovery. Nevertheless, determining the appropriate price is crucial for the issuing company. The process unfolds as follows:

  • The issuer company appoints a lead manager who, in collaboration, evaluates various factors like the company’s financial health, growth potential, assets, liabilities, and finalizes the issue’s size and IPO price.
  • The bidding process commences as soon as the IPO opens for subscription.
  • Investors submit their bids at the predetermined price.
  • At the end of the bidding period, the lead manager assesses the demand and collaborates with the company’s registrar (RoC) for allotment.
  • The Registrar completes the allotment, credits shares to the Demat accounts, and initiates refunds if applicable.
Illustrating Fixed Price IPOs with Scenarios:

Fixed Price IPOs come with a predetermined offer price, offering a clear-cut understanding for investors. Here are scenarios to illustrate how they work:

Scenario 1: Full Allotment

  • Suppose you applied for 1000 shares at the fixed price of Rs 186 each.
  • If demand permits, you receive a full allotment of 1000 shares.
  • In this case, the entire 1000 shares are credited to your account, and there is no refund.

Scenario 2: No Allotment

  • Alternatively, there might not be enough shares available.
  • You applied for 1000 shares at Rs 186 per share.
  • However, in this case, you don’t receive any allotment.
  • The full amount of Rs 186,000 is refunded to you.

Scenario 3: Partial Allotment

  • Sometimes, you might receive a partial allotment.
  • For instance, you applied for 1000 shares at Rs 186 per share.
  • You receive an allotment of 200 shares, and 800 shares remain unallotted.
  • In this scenario, you receive a refund of Rs 148,800 for the 800 unallotted shares, and 200 shares are credited to your account.
Book Building vs Fixed Price IPO: 

Issuer companies select IPO methods based on preference and issue size. Here are the key distinctions between these methods:

Book Building IPO | Fixed Price IPO
  • Introduced by SEBI in 1995 for efficient pricing. | – A traditional, older method for IPOs.
  • Features a price range determined during the bidding process. | – Sets a fixed IPO price in advance.
  • Offer price determined at the end of bidding. | – Offer price predetermined.
  • Demand known daily as the book builds. | – Demand known at the end of the subscription period.
  • QIBs can bid with 10% at application, balance at allotment. | – QIBs must pay 100% at application.
  • Prospectus filed with RoC after offering completion. | – Prospectus filed with RoC before the issue opens.
  • Popular method. | – Less commonly used.
  • Price range can be revised during an open book-built issue. | – Offering price fixed upon subscription opening.
  • Tends to offer fair pricing based on supply and demand. 
  • Investors bid within the price range. | – Investors subscribe at a fixed price.
  • Mainboard IPO companies often adopt this method. | – SME IPO companies often prefer this method.
FAQS:

Ques: What is IPO pricing?

Ans: IPO pricing refers to the process of determining the price at which shares of a company will be offered to the public during an initial public offering (IPO).

Ques: What are the main IPO pricing methods?

Ans: The two main IPO pricing methods are Book Building and Fixed Price methods.

Ques: How does the Book Building method work?

Ans: In Book Building, the IPO price is not fixed initially. Instead, a price range is specified, and the final price is determined based on the demand for shares at various price levels during the bidding period.

Ques: What is the advantage of Book Building?

Ans: Book Building allows for efficient price discovery based on market demand, potentially resulting in fairer pricing.

Ques: What is the disadvantage of Book Building?

Ans: Book Building can be a lengthy and costly process compared to Fixed Price IPOs.

Conclusion:

Understanding the intricacies of IPO pricing methods, namely Book Building and Fixed Price, is essential for both issuers and investors. Each method comes with its own set of advantages and disadvantages, catering to different preferences and requirements. Book Building offers efficient price discovery based on market demand, potentially resulting in fair pricing, while Fixed Price IPOs provide simplicity and cost-effectiveness, making them attractive for SMEs and smaller issuances. Ultimately, the choice of IPO pricing method depends on the issuer’s goals and the prevailing market conditions. Whether through Book Building or Fixed Price, IPOs remain a significant avenue for companies to raise capital and for investors to participate in the growth of promising ventures.

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