IPOs DOs and DONTs

In equities, investing in a winning stock, ahead of everyone else, is said to be a sure shot way to riches. That’s why
initial public offerings (IPOs) are a craze with the investing public. Companies come out with IPOs either when they
wish to raise money or the promoter wants to sell part of his shareholding. Companies that are already listed too
come out with public issues, known as follow on public offers.

IPOs offer investors an opportunity to participate in the initial price discovery process of a company. Since a
company is eager to make its issue a success, the pricing is generally kept attractive. Of course, there are times
when companies try to make a fast buck by overpricing too. Since most companies keep the price attractive,
investors in IPOs often gain immediately.

But listing gains, the premium at which IPOs usually quote at when they trade, should not be the sole motive for
investing. Investors should only invest in those IPOs whose fundamentals are sound after considering all relevant
factors. Merely investing for listing gains may find the investor holding shares trading at a discount too.

DOs

Ensure that you get a copy of the full prospectus and read it carefully before investing

Check the antecedents of the promoters and if they have other listed companies, check for frequent IPOs

Compare valuation with others in the industry, to make sure that it is indeed an attractive investment option

Ensure that in a book-built issue, you bid at the price you consider appropriate and don’t get carried away by
the hype surrounding an issue

DONTs

Fall prey to positive news announcements around the time of the IPO. These are usually meant to make the
issue seem attractive.

Subscribe to an IPO if you find the price high, if your reasoning is correct, chances are that you will get it at a
lower price in the secondary market

Invest in IPOs based on the current market valuation, while some premium is allowable to current market
conditions, do not invest in a company you would not put money in a normal market

An initial public offering (IPO), referred simply as an "offering" or "flotation", is when a company
(called the issuer) issues common stockor shares to the public for the first time. They are often
issued by smaller, younger companies seeking capital to expand, but can also be done by
large privately-owned companies looking to become publicly traded.

In an IPO the issuer may obtain the assistance of an underwriting firm, which helps it determine
what type of security to issue (common orpreferred), best offering price and time to bring it to
market.

An IPO can be a risky investment. For the individual investor it is tough to predict what the stock
or shares will do on its initial day of trading and in the near future since there is often little
historical data with which to analyze the company. Also, most IPOs are of companies going
through a transitory growth period, and they are therefore subject to additional uncertainty
regarding their future value.
Reasons for listing
When a company lists its shares on a public exchange, it will almost invariably look to issue
additional new shares in order at the same time. The money paid by investors for the newly-
issued shares goes directly to the company (in contrast to a later trade of shares on the
exchange, where the money passes between investors). An IPO, therefore, allows a company to
tap a wide pool of stock market investors to provide it with large volumes of capital for future
growth. The company is never required to repay the capital, but instead the new shareholders
have a right to future profits distributed by the company and the right to a capital distribution in
case of a dissolution.

The existing shareholders will see their shareholdings diluted as a proportion of the company's
shares. However, they hope that the capital investment will make their shareholdings more
valuable in absolute terms.

In addition, once a company is listed, it will be able to issue further shares via a rights issue,
thereby again providing itself with capital for expansion without incurring any debt. This regular
ability to raise large amounts of capital from the general market, rather than having to seek and
negotiate with individual investors, is a key incentive for many companies seeking to list.

There are several benefits to being a public company, namely:

 Bolstering and diversifying equity base

 Enabling cheaper access to capital
 Exposure and prestige
 Attracting and retaining the best management and employees
 Facilitating acquisitions
 Creating multiple financing opportunities: equity, convertible debt, cheaper bank loans,
etc.
 Increased liquidity for equity holder

Procedure
IPOs generally involve one or more investment banks known as "underwriters". The company
offering its shares, called the "issuer", enters a contract with a lead underwriter to sell its shares
to the public. The underwriter then approaches investors with offers to sell these shares.

The sale (allocation and pricing) of shares in an IPO may take several forms. Common methods
include:
  Best efforts contract
 Firm commitment contract
 All-or-none contract
 Bought deal
 Dutch auction
 Self distribution of stock

A large IPO is usually underwritten by a "syndicate" of investment banks led by one or more
major investment banks (lead underwriter). Upon selling the shares, the underwriters keep
a commission based on a percentage of the value of the shares sold (called the gross spread).
Usually, the lead underwriters, i.e. the underwriters selling the largest proportions of the IPO, take
the highest commissions—up to 8% in some cases.

Multinational IPOs may have as many as three syndicates to deal with differing legal
requirements in both the issuer's domestic market and other regions. For example, an issuer
based in the E.U. may be represented by the main selling syndicate in its domestic market,
Europe, in addition to separate syndicates or selling groups for US/Canada and for Asia. Usually,
the lead underwriter in the main selling group is also the lead bank in the other selling groups.

Because of the wide array of legal requirements, IPOs typically involve one or more law firms with
major practices in securities law, such as the Magic Circle firms of London and the white shoe
firms of New York City.

Usually, the offering will include the issuance of new shares, intended to raise new capital, as well
the secondary sale of existing shares. However, certain regulatory restrictions and restrictions
imposed by the lead underwriter are often placed on the sale of existing shares.

Public offerings are primarily sold to institutional investors, but some shares are also allocated to
the underwriters' retail investors. A broker selling shares of a public offering to his clients is paid
through a sales credit instead of a commission. The client pays no commission to purchase the
shares of a public offering; the purchase price simply includes the built-in sales credit.

The issuer usually allows the underwriters an option to increase the size of the offering by up to
15% under certain circumstance known as the greenshoe or overallotment option.

[edit]Auction

This section does not cite any references or sources.

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be challenged andremoved. (December 2006) (Find sources: Initial public offering – news, books, scholar)
A venture capitalist named Bill Hambrecht has attempted to devise a method that can reduce the
inefficient process. He devised a way to issue shares through a Dutch auction as an attempt to
minimize the extreme underpricing that underwriters were nurturing. Underwriters, however, have
not taken to this strategy very well which is understandable given that auctions are threatening
large fees otherwise payable. Though not the first company to use Dutch auction, Google is one
established company that went public through the use of auction. Google's share price rose 17%
in its first day of trading despite the auction method. Brokers close to the IPO report that the
underwriters actively discouraged institutional investors from buying to reduce demand and send
the initial price down. The resulting low share price was then used to "illustrate" that auctions
generally don't work. Perception of IPOs can be controversial. For those who view a successful
IPO to be one that raises as much money as possible, the IPO was a total failure. For those who
view a successful IPO from the kind of investors that eventually gained from the underpricing, the
IPO was a complete success. It's important to note that different sets of investors bid in auctions
versus the open market—more institutions bid, fewer private individuals bid. Google may be a
special case, however, as many individual investors bought the stock based on long-term
valuation shortly after it launched its IPO, driving it beyond institutional valuation.

[edit]Pricing

The underpricing of initial public offerings (IPO) has been well documented in different markets
(Ibbotson, 1975; Ritter 1984; Levis, 1990; McGuinness, 1992). While Issuers always try to
maximize their issue proceeds, the underpricing of IPOs has constituted a serious anomaly in the
literature of financial economics. Many financial economists have developed different models to
explain the underpricing of IPOs. Some of the models explained it as a consequences of
deliberate underpricing by issuers or their agents. In general, smaller issues are observed to be
underpriced more than large issues (Ritter, 1984, Ritter, 1991, Levis, 1990) Historically, IPOs
both globally and in the United States have been underpriced. The effect of "initial underpricing"
an IPO is to generate additional interest in the stock when it first becomes publicly traded.
Through flipping, this can lead to significant gains for investors who have been allocated shares
of the IPO at the offering price. However, underpricing an IPO results in "money left on the
table"—lost capital that could have been raised for the company had the stock been offered at a
higher price. One great example of all these factors at play was seen with theglobe.com IPO
which helped fuel the IPO mania of the late 90's internet era. Underwritten by Bear Stearns on
November 13, 1998, the stock had been priced at $9 per share, and famously jumped 1000% at
the opening of trading all the way up to $97, before deflating and closing at $63 after large sell
offs from institutions flipping the stock . Although the company did raise about $30 million from
the offering it is estimated that with the level of demand for the offering and the volume of trading
that took place the company might have left upwards of $200 million on the table.

The danger of overpricing is also an important consideration. If a stock is offered to the public at a
higher price than the market will pay, the underwriters may have trouble meeting their
commitments to sell shares. Even if they sell all of the issued shares, if the stock falls in value on
the first day of trading, it may lose its marketability and hence even more of its value.

Investment banks, therefore, take many factors into consideration when pricing an IPO, and
attempt to reach an offering price that is low enough to stimulate interest in the stock, but high
enough to raise an adequate amount of capital for the company. The process of determining an
optimal price usually involves the underwriters ("syndicate") arranging share purchase
commitments from leading institutional investors.

[edit]Issue price
A company that is planning an IPO appoints lead managers to help it decide on an appropriate
price at which the shares should be issued. There are two ways in which the price of an IPO can
be determined: either the company, with the help of its lead managers, fixes a price or the price is
arrived at through the process of book building.

Note: Not all IPOs are eligible for delivery settlement through the DTC system, which would then
either require the physical delivery of thestock certificates to the clearing agent bank's custodian,
or a delivery versus payment (DVP) arrangement with the selling group brokerage firm..

[edit]Quiet period
Main article: Quiet period

There are two time windows commonly referred to as "quiet periods" during an IPO's history. The
first and the one linked above is the period of time following the filing of the company's S-1 but
before SEC staff declare the registration statement effective. During this time, issuers, company
insiders, analysts, and other parties are legally restricted in their ability to discuss or promote the
upcoming IPO.[2]

The other "quiet period" refers to a period of 40 calendar days following an IPO's first day of
public trading. During this time, insiders and any underwriters involved in the IPO are restricted
from issuing any earnings forecasts or research reports for the company. Regulatory changes
enacted by the SEC as part of the Global Settlement enlarged the "quiet period" from 25 days to
40 days on July 9, 2002. When the quiet period is over, generally the underwriters will initiate
research coverage on the firm. Additionally, the NASD and NYSE have approved a rule
mandating a 10-day quiet period after a Secondary Offering and a 15-day quiet period both
before and after expiration of a "lock-up agreement" for a securities offering.

[edit]Stag profit
Stag profit is a stock market term used to describe a situation before and immediately after a
company's Initial public offering (or any new issue of shares). A stag is a party or individual who
subscribes to the new issue expecting the price of the stock to rise immediately upon the start of
trading. Thus, stag profit is the financial gain accumulated by the party or individual resulting from
the value of the shares rising.

For example, one might expect a certain I.T. company to do particularly well and purchase a large
volume of their stock or shares before flotation on the stock market. Once the price of the shares
has risen to a satisfactory level the person will choose to sell their shares and make a stag profit.

Factors to watch before investing in IPO

Is this an IPO or an FPO?
• In IPOs, initial public offers, company decides the price and the collective secondary market
discovers the true price post-listing after more information inflows/analysis.
• In FPOs, follow on public offers, the price is already discovered; gains/losses can only be marginal;
no new information for the market to analyze/process.
Is this a fixed-price or a book-building issue?
• The methodology, classes of investors and issue pricing are totally different.
• There is no book or price discovery in a fixed-price issue.
• There are no reservations for FIIs/HNIs in a fixed-price issue; 50% of the issue is reserved for small
investors (in book building, it is 35%).
• Fixed-price issues are typically small.
Issues in 2004-05 (Rs in crore) Source: Prime Database
Issue No. of Issue Average size
Type Issues Amount of Issue
Fixed Price 10 378.82 37.88
Book Building 19 21,052.74 1,108.04

Is this a “good” promoter?

• Get to “know” the promoter – that’s the key.
• If the promoter is okay, almost all other factors will automatically get taken care of.
• If there is any foreign collaboration of repute, it helps.
What is the promoters’ background and experience?
• Experience in the same business/industry (promoting individuals/ promoting companies)

Is the promoter a liability or an asset?

• Are there any material defaults/ litigations against the company or its promoters?
• Persons/Companies that have not been compliant with laws of the land reflect a worrisome
mindset.
 • If you find too many defaults/litigations of a material nature or even one of a very serious nature, a
the issue.
– Criminal proceedings against the promoters.
• Check out record of past defaults of companies/ individuals at www.watchoutinvestors.com.
What is the status of the issuing company?
• Holding company
• Main company
How has been the performance of the company?
• Number of years in the business
• Size of the company
• Growth rate
• Market share and growth
Are the financials, specially the recent ones, reliable?
• Many resort to window dressing; high sales often lie in sundry debtors, profits could be because of
a very high “other income” or “unusual income”.
• Beware of bloated previous year’s financials; amazing how almost every company performs so
exceedingly well in the year and quarter preceding the issue!
• Look at aging of sundry debtors (and earlier write-offs).
• Look for changes in accounting policies (depreciation etc.), in financial year.
• Look if there are any significant Notes to the Accounts.
• Look if there are any significant qualifications by the auditors.
What to look for in the Balance Sheet?
• Fixed assets
• Investments
• Loan and advances
Why does a company in the first place decide to come out with an IPO?
There could be various reasons. The most common reason is they need funds. That is fairly logical. But
there are companies that come out with issues like the public sectors units, which are disinvesting, where
the government is disinvesting. You could have banks where they are raising funds to enhance their capital
adequacy. So the objectives may be different but the fact is that they need funds for projects or for a specific
objective.
What could be the major 4-5 objectives? Why does a company need to do an IPO?
You would see that during a boom time, if you look very closely, you might get a feeling that this company
does not actually need to raise funds. That brings us to the first point that when you look at an IPO, you
need to look very closely at the fact that, is the company raising funds because it can do so in the market, or
whether it is raising funds because it needs to from the market? If the second is the case, then you have a
good IPO on hand. You could proceed to look at the further nitty-gritty of the IPOs. Some other reasons
could be expansion, diversification, new projects, there could be a wide variety of reasons but the important
thing for an investor to do, is to, sort of, do a due diligence on those.
What is the difference between public offering, PO, and IPO?
I think it's just a terminology mistake. An IPO means that the company is hitting the market for the very first
time, that's why the word "Initial" is there. Whereas the company like, lets hypothetically talk of some of the
banks, for example Dena Bank, which recently had a public issue, it was not an IPO because it had already
made it's initial public offering sometimes back, this was it's subsequent public offering.
What's the difference between fixed price IPO and book-built issue?

Typically you would have seen, if you look at the historical trend in recent times, most of the banking IPOs
have been fixed price IPOs. To start with the distinction, a book-built IPO is one where a book is opened and
there are bids invited. There is a price range that is indicated - a minimum price range and the upper-end of
the price range. So investors of all class, ie. you have the institutional investors, you have the high networth
investors and the retail investors, all of whom bid for the issue at a price, that is, somewhere between the
lowest level, that's the lower band and the upper band and depending on the number of applications
received, the maximum number of bids received at a specific price, the price settles there. But in case of
fixed price issue, it's somewhat of a no-brainer because the issue price is fixed, it is offered to you, you
could take it or leave it. You needn't think of whether you should bid for a higher figure or a lower figure.
Of all the IPOs that had happened in December, which method was commonly used - book-built or
fixed price? Which would you prefer personally?
I think the first book-built IPO was Hughes Software, if I am not mistaken, I think it was way
back in 1997. Thereafter, the trend has been largely in favour of book-built IPOs. And
internationally, the trend is towards book-built IPOs. In the Indian context it's really the banks
that have thrived on fixed price IPOs. Now, why is that the case? It really is the function of
the audience that you are addressing. If you are addressing an audience, that is
predominantly the retail investor base, fixed price IPO is what sells.
Whereas, if you are looking at the wider spectrum, you are looking at institutional investors
predominantly, you are looking at the high networth investors, then indicate a minimum (value) and try and
extract more by having a book-built IPO, the trend very clearly is towards book-built public offering.
In book-built, do you think there is a better price discovery mechanism, in the sense that depending
upon the demand and the number of the bids that they have got, they will discover a price, does it
have more depth?
It would depend, there are always two sides to every story. For the company, definitely it's a lot better. For
the investor, especially the retail investor, those retail investors who go by crowd mentality and would want
to bid simply because an institution bids at a certain price, I think there is a trend, based on studies that we
have done, we have found that most retail investors bid at the cut-off price, which means that whatever price
that it settles at, you bid at that price. So in that case the retail investor is not really doing his homework and
there is a possibility that if he gets the wrong end of the stake, he could be badly hurt.
In that sense, when it's not a fixed price and it's book-built, you have a cut-off price and you have the
option to not bid for it in case it's higher than you had estimated?
Yes absolutely. Say for example, you have estimated, lets assume a price band of Rs 100-Rs 125 for a
issue XYZ. Suppose your calculations and the evaluations of the company indicate that a fair price is Rs
110, you go and bid Rs 110 and then find that the discovered price was Rs 120, you are automatically
eliminated from the allotment process, which is fair enough. You are out of the allotment process because
you didn't expect or rather you won't be willing to pay Rs 120. But the point I am trying to make is investors
are using the easy option of simply bidding at the cut-off price, which is fine in the market, that is, (showing)
a trend of moving upwards, but somewhere down the line it could prove costly.
What are the disadvantages for a retail investor?
At the outset, I'm all for the book-built type of issues because finally the retail investor have the same
objective as an institutional investor, that is, make money. So he should also be prepared to lose
money, just as the institutional investor does. Having said that, I think the system that we follow in India is
loaded in favour of the institutional investors because whereas the retail investor needs to make a full
payment, say for example, if you were to make a bid at Rs 100, in case of the IPO, where the price band is
Rs 100- Rs 125. If you make a bid at Rs 100, say for 100 shares, you need to make that full payment by
cheque at the time you are making an application, you can revise your bid three-times. But you need to
make a full payment at the time of making the bid. Whereas institutions can go and bid for a huge number of
shares and need to pay only subsequently, there is no money that is put down. So that puts the institutional
investor at a very big, distinctive advantage over the retail investor.
The issue is typically open for seven days. If you are not allotted, how quickly can you expect the
refund?
I think as a benchmark you could say 21 days. There are companies that do it faster. There are companies
that take a little longer. As a benchmark, take around 21-days, which is how much time the entire process
and the conversion process takes, by which time the allotments go out, the shares moves to the demat
accounts, so you can take that as a benchmark.
How would you analyse an IPO?
Typically you would look at the financial performance of the company, not just for that year but for the past
few years also. So what do you need to do is, go back to the industry. You need to look at the growth that is
there in industry and look at the company, whether it fits into a 'top performer' (category) in the industry and
whether those growth rates are justified. As a Chartered Accountant, I know for a fact how easily figures can
be manipulated. You can easily boost the topline or bottomline, all within the law. So investors who take
figures at face-value, often find themselves coming to grief at a subsequent date. So you need to breakdown
those figures, rework on them and then work the pricing out. You need to be sure that those figures are real
and not hyped up figures.
What is your experience when a company decides to do an IPO - its valuation vis-à-vis its listed
peers? Is it expected to be a little more expensive? How do you look at that?

Ideally, an IPO should be cheaper than that market peers. One of the common mistakes that I personally
feel, merchant bankers make is that, they go and price the IPO as tightly as possible, typically what would
be the incentive for you and me as a retail investor to invest in a IPO. If its fully priced as compared to its
peers, you would rather go for the known devil rather than an unknown devil. It needs to be marginally
underpriced, so that there is some icing left on the cake when you are investing in that IPO. So, if we are
talking of a P/E multiple of 10 in an industry, it should ideally be around 7-8 so that there is marginal upside
left, even on the listed price.
Would you watch out for any ratio?
There would be an entire gamut of financial parameters to be looked at. The debt-equity ratio is
important. You would want to look at whether the company will reel under interest burden
subsequently. In fact, there are companies that come out with IPOs to extinguish their debt, which is a smart
thing to do in certain cases. So in that case, the interest burden goes away and the bottomline automatically
increases. Beyond that, the other ratios you would typically look at are the operating profit margins and the
gross margins. You could go across the entire gamut of ratios.
What factors would you look at when you talk about qualitative factors?
I think the most important factor is the management factor. I think when you interact with the management,
when you look at the track record of the management, you get a very good insight into what the company is
in and what it will be. Really the stock markets are all about the future. If you go back from the management
meeting, feeling that you are not comfortable of what the promoters are saying or it's not in sync with market
realities, you probably closed your mind out from that IPO. You often get that feeling when you talk to
promoters, especially when he is out of sync with market realities and pricing and so on. You walk away with
the feeling that there is something wrong about this issue or company. So management is one factor.
How does a retail investor really get information?
The retail investor has the disadvantage of not having interacted with the promoter. But I would think that the
Sebi guidelines are quite stringent. You have fairly elaborate track records about the promoter, the
companies that he/she has promoted and how they have faired. There is a fair amount of information in the
prospectus but most people don't bother to read the prospectus while investing in an IPO. If you do that, at
least you will get the pulse of where the promoter stands. At the end of the day, you would like a promoter,
who is professionally qualified and has experience in that relevant field and so on. These are some of the
qualitative factors that you would look at. And of course, the retail investor definitely would not interact
directly with the promoter but probably use the reports and other things on the promoter to gauge what the
vision of the promoter is. But finally it's the track record that a retail investor has to rely on.
What about Sebi's role - is it proactive and effective?
As one who has watched IPOs for 10-12 years, I think it's very tough today for a completely bogus company
to come out with an IPO, as compared to 9-10 years ago, when you had fly-by-night operators, who came
out with issues which were very obviously bogus and still managed to get it through to the markets. Today,
Sebi guidelines are fairly stringent. There is lot of transparency in the prospectus. At the end of the day, the
investor is to blame or take the credit because if you are going to invest without reading the prospectus, it's
like a running across (a street) blindfolded. You know the risks, it's the same here. So there is fair amount of
information and investors should read the prospectus. I think Sebi guidelines are excellent in this regard and
there is lot of transparency.
So we can say that as soon as a company decides to go for an IPO, at some stage, Sebi has
already looked into the matter and to that extent, the retail investor can be assured.
Let's be clear about Sebi's role. Sebi vets the prospectus. Sebi is, by no means, saying that this is a
good issue or this is a bad issue. We must understand that as opposed to the old days, where you had the
Controller of Capital issues, CCI, pricing the issues, today you are in a free market and you could demand
the sky. As long as the document vetted is factual, you can go ahead and demand the price that you feel is
accurate or your merchant banker feels is accurate.
What are the other factors you would look at, to figure out if it's investment worthy?
Actually the P/E is one aspect. Certainly you would look at the P/E, you would look at the price to book, you
would look at the traditional parameters. But beyond that you would look at the business model and how
robust it is going forward. Whether it can continue to deliver the kind of earnings per share, EPS, it has
delivered in the year before the IPO, especially on the enhanced equity based because most companies
have an enhanced equity post-IPO. Whether it can still deliver? How viable that project is? So it's an
ongoing exercise. We cannot take pricing in isolation. It's all sequential - you look at the management, you
look at the project etc.
When you look at the project, you need to look at typically, why a company is issuing an IPO in a bull
market, Many times it's just raising funds because it can. So they would typically indicate a reason like going
in for expansion. Here if you look at the balance sheet of the company, you would very often find that its
capacity utilisation is barely 20%-30%. So these are the factors that one should look at. And finally, the
pricing is really the culmination of the whole process. So you cannot look at the pricing totally in isolation and
say that 'okay, if the pricing is right, everything else about the issue is okay'. It's other way round. If
everything else about the issue is right, then you look at the pricing.