I want to start by saying that not every company about to issue an IPO can raise funds under the new Book Building System. The book-building system’s primary objective is to provide an incentive for highly profitable companies in Nepal to go Public (Companies like Ncell and other companies with paid-up capital more than 1 Arba).
This is to say that instead of issuing the IPO at the par value of Rs. 100 these large companies will now have an ability to issue their IPOs at a premium(Below, I will discuss how this premium price is defined). It seems that there has been a lot of speculation about what this new system entails for the small investors and how it will impact the stock market in general. In this article, I want to talk about all of that and probably clear up some confusions along the way.
- Requirements for a Company to Issue an IPO under the Book Building system.
- What is a Book Building System
- How will the price of an IPO be defined under the new system
- How will stocks be issued to general investors
- How will this impact the stock market
- How will this affect general investors
Requirements for a Company to Issue an IPO under the Book Building system
As I said at the start of this article, not every company will be able to issue an IPO under this new system. So you don’t have to worry about every new company being able to issue their IPO’s at a premium. Fixed price IPO will remain (i.e., companies issuing stocks at a fixed price of, say Rs.100 or 300), and we will probably end up having a sort of hybrid system where both the book building system and the traditional fixed priced system can coexist.
Now let us talk about the standard guidelines set by the securities board for companies to issue their IPO under the new system :
- The company should have operated at a profit for the last 3 Years.
- Networth per share of the company must be maintained at 150% of the per-share capital (i.e., if the per-share value of a company is Rs. 100 (Equity) then it must have a Networth per Share of Rs 150 (Book Value))
- There should be Approval from the Compay’s AGM to issue IPO through the ”Book Building’ system.
- The company must have secured an average or above-average rating from a rating company here in Nepal (e.g., ICRA)
What is the Book Building System?
The book-building system is simply an alternative way for a company to issue an IPO. In this system, the company will hire an investment banker (Issue manager) to create, collect, and record the demand for an IPO being issued. And based on that demand, along with the company’s internal valuation, it will be able to determine the true value of an IPO (an Average). This valuation process remains completely confidential for the sake of fairness.
Once the average price is decided, the merchant bank then prepares a prospectus calling out potential investors (large scale buyers, mutual funds, other institutional banks) to apply the shares within a specific price range (Called the Price band). The upper limit and lower limit of the price range are defined by adding (or subtracting for the lower limit) 20% to the IPO’s average intended price. In the presence of Book Building System, companies like Shivam can now specify a price range such as Rs 200 (Floor Price) to Rs 300 (Cap Price) and Investors then have to bid within the price range.
In addition to the price range, a tick price is also defined. The tick price refers to the extent to which the share price can change. For example, if the tick price is determined to be Rs 5, then bid for Shivam stocks’ can be placed at Rs 200, Rs 205, Rs 210, Rs 215, and so on until Rs 300. However, there will be no such bid price as Rs 201, Rs 202, Rs 207, Rs 223, etc. At what price to bid is entirely in the hand of the investors.
How will the price of an IPO be defined under the new system?
Now comes the question of how the cutoff price or the price of an IPO is defined. At a minimum, 10 interested institutional investors will be asked to submit their bids. However, they will only be allowed to bid for at most 20% of the total stocks being issued. For instance, an institution may apply for 150000 shares at Rs 210, and another may apply for 180000 shares at Rs 220 and so on.
|Bid Price||Number of Applications (Shares)|
|210||150000 (not Allotted)|
|220||180000 (not Allotted)|
|230 (Max.)||200000 (Allotted)|
In the table above, you can see that the bid price of Rs 230 has the maximum number of applications. Hence the cut off price will be determined at Rs 230, and the buying price of the IPO will be Rs 230. Moreover, the applicants who bid at Rs 210 and Rs 220 (i.e., below the cut off price) will not be allocated any shares.
This entire process is made public in order to keep the process unbiased and at the end, shares are allocated to the eligible bidders.
In the case of under subscription, the merchant banks (underwriters or book-runners) are obliged to buy the remaining shares themselves.
How will stocks be issued to general investors?
After the initial process, general investors will be able to apply for a minimum of 50 units and receive a 10% discount in the cutoff amount decided by the institutional investors and investment bankers. i.e., going back to the previous example, retail investors will be able to apply for a maximum of 50 units of Shivam cements at Rs 207.
How will this impact the stock market?
Hence this process allows companies to bring in higher net revenue, which was impossible under the previous system where companies had to issue an IPO at a fixed price. This all means that now local and international companies have the incentive to go public and issue an IPO in a fair manner. This method helps to raise a large amount of capital, as well as gain price relevant information from potential buyers. The mechanism also helps to broaden the functions of institutional investors as well as investment bankers during the issuance process of an IPO.
This policy was brought in light of the fact that the Nepal government’s one-year-old policy to introduce more manufacturing companies in the stock market has been an utter failure. This is because most of the manufacturing and tech-related companies are hesitant to enter the stock market as they had to issue an IPO at a fixed price.
How will this impact general investors?
I will not sugarcoat the fact that the new Book Building System does favor the large buyers and institutional investors. A retail investor may not have access to a large amount of capital needed to invest in the stocks that may come out under this new system. This is to say that previously you could buy 10 units of stocks at Rs 1000, but now you may require to pay 4000 for the same 10 units. But they are not the same, are they? These are large, established companies that have the potential to provide substantial gains far into the future.
As I already said, many companies will still issue IPOs at the par value of 100; hence, the average investor is not pushed out of the market entirely.
Think of this as a platform for only the elite individuals and the privileged. I will not deny this, but you have understood that companies which will be issuing an IPO under this system would have probably never issued an IPO in the first place. And hoping that an extreme vetting process will be taken by the investment bankers and institutional investors to define the cutoff price these IPOs will be less risky to invest in. And that is why I don’t oppose the new system. You are not taking away the choice of individuals. All you are doing is creating a layer on top of an already existing system.
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