IPO Pricing Methods

Understanding IPO Pricing

Setting the right price for an Initial Public Offering (IPO) is crucial and needs to be done before the IPO launch. If set too high, potential investors might shy away due to the risk of financial loss. Conversely, a price that's too low might raise doubts about the company’s performance, as investors often associate low prices with low value. Therefore, determining a fair IPO price is essential for achieving a successful listing.

Methods of IPO Pricing

IPO pricing is typically determined through one of two main methods: Book Building or Fixed Price. Companies have the flexibility to choose between these methods based on their preferences. However, if a company doesn't meet the profitability criteria set by SEBI, it must opt for a Qualified Institutional Buyer (QIB) route, making the book-building method mandatory.

Book Building Explained

In the book-building method, the IPO price isn't predetermined. Instead, the company sets a price range, say Rs 75 to Rs 80 per share, and invites bids within this range. The final share price is established after the bidding period concludes, based on demand at different price levels.

Advantages of Book Building

• Efficient Price Discovery: This method helps in determining the best price based on current demand.
• Credibility Assessment: The company can gauge investor interest and its market reputation.
• Market-Driven Pricing: Prices are set by market demand, not solely by company management.

Disadvantages of Book Building

• Higher Costs: More expensive compared to fixed price issues.
• Time-Consuming Process: Takes longer to determine the final price post-bidding.
• Best Suited for Large Volumes: Ideal for large share issuances.

Key Features of Book Building

• Initiates without a fixed final price.
• A price range is announced at least two business days before the IPO opens.
• Issuers may adjust the price range during the offer period.
• The IPO 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 these IPOs.

Understanding IPO Price Bands

The IPO price band defines the range within which bids are accepted. Key points include:

• Price Range: Includes a lower (Floor Price) and an upper limit (Cap Price).
• Difference Limit: The gap between floor and cap prices shouldn’t exceed 20%.
• Retail Flexibility: Retail investors in mainboard IPOs can bid at any price within the range or at the cutoff. SME IPO investors must specify a price.
• Cutoff Price: The final price within the range for share allocation, revealed post-bidding.
• Prospectus Details: The basis for price determination is clearly outlined in the IPO prospectus.

Steps in the Book Building Process

1. The lead manager collaborates with the issuing company to set the issue size and price range.
2. Syndicate members are appointed to handle IPO-related tasks.
3. Investors place bids within the price range once the IPO starts.
4. Post-bidding, the lead manager calculates the final price using a weighted average.
5. Transparency is ensured by publishing bid details and price derivations.
6. Investors who bid at or above the cutoff price may receive allocations, while lower bids are refunded.

Types of Book Building

Companies can issue IPOs through:

• 100% Book Built Offer
• 75% Book Building

Book Building Example

Consider a company issuing 1 million shares with a price range of Rs 601 to Rs 650. Investors can bid within this range or at the cutoff price. The final price, say Rs 640, is determined based on demand.

Bidding Scenarios

• Above Cutoff Price: Investors bidding above Rs 640 might receive share allotments, with excess amounts refunded.
• Below Cutoff Price: Such bids are rejected, and full refunds issued.
• At Cutoff Price: Especially for retail investors in mainboard IPOs, bidding at the cutoff may result in share allotment without refunds unless partially allotted.

Reverse Book Building

While book-building raises capital, reverse book-building facilitates share buybacks. It operates on similar principles, determining the buyback price based on shareholder sell orders and is mainly used for delisting.

Fixed Price Issue Overview

In a fixed price issue, the offer price is predetermined, like Rs 75 per share. This method has been favored by SME companies for its simplicity and smaller issue sizes, though the trend is shifting towards book-building for better price transparency.

Key Features of Fixed Price IPOs

• Prospectus: Includes all details about the IPO and price setting rationale.
• Regulatory Filing: Requires registration with the Registrar of Companies before opening.
• Retail Allocation: At least 50% of the net offering must be available to retail investors.
• Subscription Period: Open for 3-10 business days.

Fixed Price IPO Process

• Price Setting: Lead managers and issuers decide the price based on company evaluation.
• Bidding: Begins when the IPO opens.
• Demand Assessment: Post-bidding, demand is evaluated for share allotment.
• Allotment and Refunds: Shares are credited to investors’ accounts, and any excess payments are refunded.

Fixed Price Example

Suppose the issuer sets a price of Rs 186. Investors bid at this price, with allotments and refunds processed based on demand.

• Full Allotment: All shares are allotted, with no refunds.
• No Allotment: Full refunds are issued.
• Partial Allotment: Refunds are issued for unallotted shares.

Comparing Book Building and Fixed Price IPOs

Companies select their preferred IPO method based on issues size and strategic goals. Here's a comparison:

This structured approach to understanding IPO pricing methods helps investors and companies make informed decisions based on their specific needs and market conditions.