Types of Ipos
You always thought that the IPO market was a unitary one-dimensional market? Think again, there are several parts to the IPO market and the IPO market can be classified into several different categories. We all know what is IPO or what is better known as the initial public offer. In this segment we shall also look at something called the types of IPOs or the different categories and classifications of IPOs. Some of the classifications are quite popular.
One such popular classification is the classification between fixed price issue and a book built issue IPO. Here we look at in depth into fixed price issue and book building as two major classifications of an IPO. Most of the issues in India today are book building issues and fixed price issues today are few and far between in the investment app. Hence, when we talk about IPOs in the modern context, we are actually referring to the book built IPOs and not to fixed price IPOs.
Broadly IPOs in the Indian market are classified on two different parameters and we shall look at both these classifications in detail.
- The first is the classification of the IPO based on the IPO issue process or the modus operandi of the IPO. Here you typically have the most popular classification called the fixed price issues and the book built issues.
- The second basis for classification is based on the type of capital raising i.e., whether the IPO actually results in fresh infusion of funds into the company or it is just a transfer of ownership. Here you have three broad categories viz. Fresh issue of shares, Offer for sale (OFS) and a follow-on public offer (FPO).
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How are IPOs segregated by the process of issue?
Typically, Indian companies have two choices. They can either adopt the fixed price method or the book-building method or a combination of two, but it is normally the book building method that has become a lot more popular these days. Especially in the period post 1999, it is book building issues that have rule the roost in India. The book building approach has also become a lot more popular because it results in scientific price discovery through a bidding process. Her is what you need to know about the two IPO issue processes.
- Let us first focus on the less popular Fixed price IPO method, in which the IPO share price is fixed in advance and applications can only be made at that particular price and no other price. This price can be fixed either at par or at a premium i.e. a spread above the par value of the stock. Under the fixed price method, the IPO share price is fixed by the merchant bankers in consultation with the company before it is made available to the public. What is the pricing methodology? The pricing of the fixed price issue is done through a combination of the DCF (discounted cash flows) method and the PECV (price earnings capitalization value) methods. Of course, that is not the final price. It is further fine-tuned with the help of comparable benchmark P/E and P/BV ratios and in addition, intangible factors like brand, reputation, goodwill, model resilience etc are considered.
- The more popular method of fund raising is the Book Building IPO route. Here the final issue price is not set in advance but it is discovered through the process of building the book. In Book Building, the price is fixed at a level which can ensure maximum subscription for the IPO. In a book building issue, there is no fixed price but a price band (with a range of 5%) is set like for example (Rs420 to Rs441). The price band is also roughly determined based on the above combination of DCF and PECV methods with the qualitative and benchmark factors chipping in with their contributions. However, once the range is determined, the actual price discovery happens within the range through book building process. On an average, majority of the issues get discovered at the upper end of band.
It must be noted that fixed price issues are almost non-existed in the market today and the IPO market today is entirely dominated by book building issues only.
Classifying IPOs based on type of capital raising
This raises a very fundamental question; why do companies raise IPO capital? They normally raise capital either to fund their expansion and growth plans or to give an exit route to early investors in the IPO. On the basis of the type of capital raising, IPOs can be classified into 3 categories viz. fresh issue of shares, offer for sale and a hybrid combination of the two.
- The Fresh Issue of shares, as the name suggests, is a type of an IPO wherein the company actually issues fresh shares to the public. The fresh issue entails the issue of new shares and therefore expands the equity capital of the company. As a result, it dilutes the earnings per share of the company since the capital base expands post the fresh issue and the profits get dividend among more shareholders. Fresh issues result in fresh funds coming into the company; net of issue expenses. Typically, fresh issues are taken up for purposes like capital expenditure, organic and inorganic expansion, diversification, debt repayment and at times working capital and realty space too.
- Next we come to the offer for sale (OFS) which is also a type of an IPO, but here the intent is to give an exit to early shareholders. These early shareholders could be promoters or PE investors or family offices. In an offer for sale (OFS), there is no fresh issue of shares but existing shareholders like promoters or early institutional investors take an exit from the company through the IPO. As a result, OFS is a transfer of shares but since the shares with the public increases, it enhances the free float and the liquidity in the stock through listing. OFS enables the company to list on the stock exchanges and thus the company can use the stock as currency. OFS is not equity dilutive, since only ownership gets transferred. The overall capital base remains the same as before in OFS. Normally, most of the IPOs in practice are a combination of fresh issue and OFS.
- The third form of a public issue is a follow on public offer (FPO). The difference here is that these FPOs are done by companies that are already listed on the stock exchanges. It is just for additional fund raising. The FPO is not very popular, but Yes Bank is a recent case of a FPO issue. The FPO entails selling additional shares by the listed company and is also called secondary offering. Such FPOs can either be in the form of a fresh issue or it can be an offer for sale.
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