A

PROJECT REPORT
ON

A STUDY OF AN INITIAL PUBLIC OFFER

In partial fulfilment of the requirements of

Post Graduate Diploma in Business Management
Conducted by
Rizvi Academy of Management

SUBMITTED BY:
VINAYAK SANIL
PGDBM FINANCE 2008-10

RIZVI ACADEMY OF MANAGEMENT

RIZVI EDUCATION COMPLEX
OFF CARTER ROAD, BANDRA (WEST)
MUMBAI 400050.

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Acknowledgement

At the onset of making a career in the avenue of Finance, an experience in the same was
extremely necessary in the form of a Final Project.
In carrying out my final project entitled "A Study of an Initial Public Offer", I have received
help, assistance and guidance from many sources. I take this opportunity to thank all those
who took keen interest in it and enabled the completion of this project successfully.
I would like to extend my sincere thanks to Prof. Danish Memon for facilitating this project
for me and for providing guidance through the duration of the project.
I would also like to thank Prof. Dr. Kalim Khan for continuously helping and motivating us
to do well throughout the course.
Last but not the least I would like to thank the office staff and other people in the institute for
their valuable support and co-operation.

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CERTIFICATE

This is to certify that the project titled A Study of an Initial Public Offer, submitted by
Vinayak Sanil to Rizvi Academy of Management, Mumbai is in partial fulfilment of
requirements of the Degree of Post Graduate Diploma in Business Management (PGDBM).

He has carried out the project during the academic year 2008 2010, under our supervision
and guidance.

Prof. Danish Memon

Prof. Kalim Khan

Project Guide

Director

Place: Mumbai
Date: 15th May 2010.

RIZVI ACADEMY OF MANAGEMENT

Rizvi Educational Complex, Off Carter Road, Bandra (W), Mumbai 400050.
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DECLARATION

I Vinayak Sanil student of PGDBM - Finance 2008-10 hereby declare that I have completed
the project on A Study of an Initial Public Offer

The information submitted is true and original to the best of my knowledge.

Signature of Student

Vinayak Sanil

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Sr. No

CHAPTER

Page No

1) Why Business need Finance

7-9

2) Sources of Finance

10 - 11

3) The Capital Market

12 - 12

4) Initial Public Offering

13 - 13

5) Reasons for going Public

14 - 14

6) Significance of an IPO

15 - 16

6.1 Significance to the company

15

6.2 Significance to the Shareholders

16

7) The Risk factor in IPO

17 - 18

7.1 Risk Assessment

18

8) The Eligibility Norms for making an IPO

8.1 Promoters contribution and lock-in requirements

20 - 22
22

9) IPO Grading

24 - 25

10) Analysing of an IPO Investment

26 - 26

10.1 Potential Investors & their objective

11) IPO Investment Strategies

26
28 - 28

11.1 Strategies to be considered before investing in the IPO

12) Pricing of an IPO

28
32 - 33

12.1 Process

32

12.2 IPO Pricing Differences

32

12.3 Underpricing

33

12.4 Overpricing

33

13) Steps to go Public

34 - 35

14) Book Building Process

36 - 43

14.1 The Process

38
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14.2 How is the price fixed

39

14.3 How are shares allocated

40

14.4 Documents Required

42

15) Case Study on HDIL

44 - 55

16) Past Issues in 2010

56 - 57

17) IPO Glossary

58 - 60

18) Conclusion

61 - 62

19) Recommendations

63 - 63

20) Bibliography

64 - 64

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CHAPTER 1: WHY BUSINESS NEEDS FINANCE

Finance is the money available to spend on business needs. Right from the moment someone
thinks of a business idea, there needs to be cash. As the business grows there are inevitably
greater calls for more money to finance expansion. The day to day running of the business
also needs money. The main reasons a business needs finance are to:
Start a business
Depending on the type of business, it will need to finance the purchase of assets, materials
and employing people. There will also need to be money to cover the running costs. It may be
some time before the business generates enough cash from sales to pay for these costs.
Finance expansions to production capacity
As a business grows, it needs higher capacity and new technology to cut unit costs and keep
up with competitors. New technology can be relatively expensive to the business and is seen
as a long term investment, because the costs will outweigh the money saved or generated for
a considerable period of time. And remember new technology is not just dealing with
computer systems, but also new machinery and tools to perform processes quicker, more
efficiently and with greater quality.
To develop and market new products
In fast moving markets, where competitors are constantly updating their products, a business
needs to spend money on developing and marketing new products e.g. to do marketing
research and test new products in pilot markets. These costs are not normally covered by
sales of the products for some time, so money needs to be raised to pay for the research.
To enter new markets
When a business seeks to expand it may look to sell their products into new markets. These
can be new geographical areas to sell to (e.g. export markets) or new types of customers. This
costs money in terms of research and marketing e.g. advertising campaigns and setting up
retail outlets.
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Take-over or acquisition
When a business buys another business, it will need to find money to pay for the acquisition
(acquisitions involve significant investment). This money will be used to pay owners of the
business which is being bought.
Moving to new premises
Finance is needed to pay for simple expenses such as the cost of renting of removal vans,
through to relocation packages for employees and the installation of machinery.
To pay for the day to day running of business
A business has many calls on its cash on a day to day basis, from paying a supplier for raw
materials, paying the wages through to buying a new printer cartridge.
Choosing the Right Source of Finance
A business needs to assess the different types of finance based on the following criteria:
Amount of money required a large amount of money is not available through some
sources and the other sources of finance may not offer enough flexibility for a smaller
amount.
How quickly the money is needed the longer a business can spend trying to raise the
money, normally the cheaper it is. However it may need the money very quickly (say if had
to pay a big wage bill which if not paid would mean the factory would close down). The
business would then have to accept a higher cost.
The cheapest option available the cost of finance is normally measured in terms of the
extra money that needs to be paid to secure the initial amount the typical cost is the interest
that has to be paid on the borrowed amount. The cheapest form of money to a business comes
from its trading profits.
The amount of risk involved in the reason for the cash a project which has less chance
of leading to a profit is deemed more risky than one that does. Potential sources of finance

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(especially external sources) take this into account and may not lend money to higher risk
business projects; unless there is some sort of guarantee that their money will be returned.
The length of time of the requirement for finance - a good entrepreneur will judge whether
the finance needed is for a long-term project or short term and therefore decide what type of
finance they wish to use.

CHAPTER 2: SOURCES OF FINANCE

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Sources of finance in India can be broadly classified as long term sources of finance, shortterm sources of finance, and medium term sources of finance. Therefore, long-term source of
finance is used to finance long term assets, medium term source of finance is used to finance
medium term assets, and short-term source of finance is used to finance short-term assets.
Theoretically such classification is easy to understand. But practically there is some
overlapping of such sources of finances. Moreover, nature as well as the character of the
business defines what long-term finance requirement is and what short-term finance
requirement is. Generally, however, the term long-term assets include plant and machinery,
buildings, etc.
These assets last well over 10 years. To finance such assets long-term source of finance
options would be equity, and some term loans. Share capital or equity is apparently the
cheapest of sources of finance in India, but there are built in expectations of the shareholders.
Money from issue of debentures, and share premiums, as well as retained earnings is mostly
used to finance such long-term assets. Banks may offer term loans, and similarly, financial
institutions may also offer long-term loans. When such sourcing is done from internal funds,
such as retained earnings, and equity, then it is termed as internal finance. When such money
are raised from outside, such as banks, it becomes external financing. When it is external
source of finance, then the lender may require that an asset be mortgaged, pledged or
hypothecated.
When it comes to medium term assets such as vehicles, a medium term source of finance
becomes essential. Banks and other private financiers again offer such finance. Automobile
finance is one such type of medium term source of finance in India. Both public sector and
private sector banks offer such loans. At times, such assets are financed through some fixed
deposits. Individuals deposit amounts with companies and earn a steady return in form of
interest, instead of earning as dividends. For availing medium term finance, a crucial factor
would provision of collateral security. Vehicles may be offered as security for the automobile
finance. But if additional medium term funds are required for the business, and there are no
securities to offer, then opting for fixed deposits to finance such requirement helps.
Short-term assets are sundry debtors, stocks, investments, cash and bank balances. Attempt is
made to balance these with corresponding liabilities such as sundry creditors. Any deficit is
covered through working capital finance, which is generally offered by banks. Assets need to
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be pledged with the bank to avail such finance. In southern India, chits are also used to
finance some businesses. Entrepreneurs themselves bring in share application money in
limited companies. By delaying payments for supply of materials, and other purchases,
businesses obtain short-term finance at cheaper rate. Generally, the suppliers are aware of
such delays, and therefore, they add such margins to the sale price. As yet debt factoring is
new concept, which is not very common, though something similar does exist in the working
capital finance.

CHAPTER 3: THE CAPITAL MARKET

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A capital market is a market for securities (debt or equity), where business enterprises
(companies) and governments can raise long-term funds. It is defined as a market in which
money is provided for periods longer than a year, as the raising of short-term funds takes
place on other markets (e.g., the money market). The capital market includes the stock market
(equity securities) and the bond market (debt). The primary role of the capital market is to
channelize investments from investors
who have surplus funds to the ones who are running a deficit? SEBI the financial regulator
oversee the capital markets in their designated jurisdictions to ensure that investors are
protected against fraud, among other duties.
Capital markets may be classified as primary markets and secondary markets.
In primary markets, new stock or bond issues are sold to investors via a mechanism known as
underwriting.
In the secondary markets, existing securities are sold and bought among investors or traders,
usually on a securities exchange, over-the-counter, or elsewhere.

CHAPTER 4: INITIAL PUBLIC OFFERING

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The first public offering of equity shares or convertible securities by a company, which is
followed by the listing of a companys shares on a stock exchange, is known as an Initial
Public Offering. In other words, it refers to the first sale of a companys common shares to
investors on a public stock exchange, with an intention to raise new capital.
The most important objective of an IPO is to raise capital for the company. It helps a
company to tap a wide range of investors who would provide large volumes of capital to the
company for future growth and development. A company going for an IPO stands to make a
lot of money from the sale of its shares which it tries to anticipate how to use for further
expansion and development. The company is not required to repay the capital and the new
shareholders get a right to future profits distributed by the company.
Companies fall into two broad categories: Private and Public.
A privately held company has fewer shareholders and its owners don't have to disclose much
information about the company. When a privately held corporation needs additional capital, it
can borrow cash or sell stock to raise needed funds. Often "going public" is the best choice
for a growing business. Compared to the costs of borrowing large sums of money for ten
years or more, the costs of an initial public offering are small. The capital raised never has to
be repaid. When a company sells its stock publicly, there is also the possibility for
appreciation of the share price due to market factors not directly related to the company.
Anybody can go out and incorporate a company: just put in some money, file the right legal
documents and follow the reporting rules of jurisdiction such as Indian Companies Act 1956.
It usually isn't possible to buy shares in a private company. One can approach the owners
about investing, but they're not obligated to sell you anything.
Public companies, on the other hand, have sold at least a portion of themselves to the public
and trade on a stock exchange. This is why doing an IPO is also referred to as "going public."

CHAPTER 5: REASONS FOR GOING PUBLIC

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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 newlyissued shares goes directly to the company. 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 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.
Benefits of being a public company

Bolster and diversify equity base

Enable cheaper access to capital

Exposure and prestige

Attract and retain the best management and employees

Facilitate acquisitions

Create multiple financing opportunities: equity, convertible debt, cheaper bank loans,
etc.

CHAPTER 6: SIGNIFICANCE OF AN IPO

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Investing in IPO has its own set of advantages and disadvantages. Where on one hand, high
element of risk is involved, if successful, it can even result in a higher rate of return. The rule
is: Higher the risk, higher the returns.
The company issues an IPO with its own set of management objectives and the investor looks
for investment keeping in mind his own objectives. Both have a lot of risk involved. But
then investment also comes with an advantage for both the company and the investors.
The significance of investing in IPO can be studied from 2 viewpoints for the company and
for the investors. This is discussed in detail as follows:

6.1 Significance to the company

When a privately held corporation needs additional capital, it can borrow cash or sell stock to
raise needed funds. Or else, it may decide to go public. "Going Public" is the best choice
for a growing business for the following reasons:

The costs of an initial public offering are small as compared to the costs of borrowing
large sums of money for ten years or more,

The capital raised never has to be repaid.

When a company sells its stock publicly, there is also the possibility for appreciation
of the share price due to market factors not directly related to the company.

It allows a company to tap a wide pool of investors to provide it with large volumes of
capital for future growth.

6.2 Significance to the Shareholders

The investors often see IPO as an easy way to make money. One of the most attractive
features of an IPO is that the shares offered are usually priced very low and the companys
stock prices can increase significantly during the day the shares are offered. This is seen as a
good opportunity by speculative investors looking to notch out some short-term profit. The
speculative investors are interested only in the short-term potential rather than long-term
gains.
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CHAPTER 7: THE RISK FACTOR IN IPO

Investing in IPO is often seen as an easy way of investing, but it is highly risky and many
investment advisers advise against it unless you are particularly experienced and
knowledgeable. The risk factor can be attributed to the following reasons:

Unpredictable
The Unpredictable nature of the IPOs is one of the major reasons that investors
advise against investing in IPOs. Shares are initially offered at a low price, but they
see significant changes in their prices during the day. It might rise significantly
during the day, but then it may fall steeply the next day.

No past track record of the company

No past track record of the company adds further to the dilemma of the shareholders
as to whether to invest in the IPO or not. With no past track record, it becomes a
difficult choice for the investors to decide whether to invest in a particular IPO or not,
as there is basis to decide whether the investment will be profitable or not.

Potential of Stock Market

Returns from investing in IPO are not guaranteed. The Stock Market is highly
volatile.

Stock Market fluctuations widely affect not only the individuals and

household, but the economy as a whole. The volatility of the stock market makes it
difficult to predict how the shares will perform over a period of time as the profit and
risk potential of the IPO depends upon the state of the stock market at that particular
time.

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7.1 Risk Assessment

The possibility of buying stock in a promising start-up company and finding the next success
story has intrigued many investors. But before taking the big step, it is essential to understand
some of the challenges, basic risks and potential rewards associated with investing in an IPO.
This has made Risk Assessment an important part of Investment Analysis. Higher the desired
returns, higher would be the risk involved. Therefore, a thorough analysis of risk associated
with the investment should be done before any consideration.
For investing in an IPO, it is essential not only to know about the working of an IPO, but we
also need to know about the company in which we are planning to invest. Hence, it is
imperative to know:

The fundamentals of the business

The policies and the objectives of the business
Their products and services
Their competitors
Their share in the current market
The scope of their issue being successful

It would be highly risky to invest without having this basic knowledge about the company.
There are 3 kinds of risks involved in investing in IPO:

Business Risk
It is important to note whether the company has sound business and management
policies, which are consistent with the standard norms. Researching business risk
involves examining the business model of the company.

Financial Risk
Is this company solvent with sufficient capital to suffer short-term business setbacks.
The liquidity position of the company also needs to be considered. Researching
financial risk involves examining the corporation's financial statements, capital
structure, and other financial data.

Market Risk
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It would beneficial to check out the demand for the IPO in the market, i.e., the appeal
of the IPO to other investors in the market. Hence, researching market risk involves
examining the appeal of the corporation to current and future market conditions.

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CHAPTER 8: ELIGIBLITY NORMS FOR MAKING AN IPO

Filing of Offer Document

Draft Prospectus has been filed with SEBI through a Merchant Banker, at least 30
days prior to the filing of the Prospectus with the Registrar of Companies (ROC)
If SEBI suggests changes, Company or Lead Manager to carry out such changes
before filing it with ROC
SEBI would issue observations within 30 days from the date of receipt draft
prospectus
Company should also make an application for listing of the stock exchange
Exception to the above: Public issue of securities or rights issue by a listed company,
where:
Stocks have been listed for atleast 3 years
Average market capitalisation is atleast Rs 10,000 crore in the recent previous year
Company has redressed atleast 95% of shareholder/ investor complaints received till
the end of the recent previous quarter
Company has complied with listing agreement for atleast previous 3 years
No pending prosecution proceedings or showcause notice by SEBI

IPOs by Unlisted Companies should meet the following criteria:

Company has net tangible assets of atleast Rs 3 crore in each of the preceding 3 full
years
Company has a track record of distributable profits in the immediately preceding 3
out of 5 years
Company has a net worth of at least Rs 1 crore in each of the preceding 3 years

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An unlisted company not complying with any of the above can make an IPO if:
The issue is made through book-building process, with at least 50% of net offer to
public being allotted to the Qualified Institutional Buyers (QIBs), failing which the
full subscription money shall be refunded
OR
The entity has at least 15% participation by Financial Institutions/ Scheduled
Commercial Banks, and at least 10% of the issue size shall be allotted to QIBs, failing
which the full subscription money shall be refunded
AND
The minimum post-issue face value capital of the company shall be Rs. 10 crores
An unlisted public company shall not make an allotment pursuant to a public issue if
the prospective allottees are less than one thousand (1000) in number.
Public Issue by listed companies to comply with the following:
Aggregate of the proposed issue and all previous issues made in the same financial
year in terms of size (i.e., offer through offer document + firm allotment + promoters
contribution through the offer document), issue size does not exceed 5 times its preissue net worth as per the audited balance sheet of the last financial year
In case there is a change in the name of the issuer company within the last 1 year
(reckoned from the date of filing of the offer document), the revenue accounted for by
the activity suggested by the new name is not less than 50% of its total revenue in the
preceding 1 full-year period.
Exceptions to the above
A banking company
An infrastructure company, whose project has been appraised by a Infrastructure
Development Finance Corporation (IDFC) or Infrastructure Leasing and Financing
Services Ltd. (IL&FS)
Not less than 5% of the project cost is financed by any of the institutions referred
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8.1 Promoters contribution and lock-in requirements

In a public issue by an unlisted or listed company, the promoters shall contribute not
less than 20% of the post issue capital
Promoters shall bring in the full amount of the promoters contribution at least one
day prior to the issue opening date, which shall be kept in an escrow account, and the
said contribution/ amount shall be released to the company along with the public issue
proceeds
If the promoters contribution has been brought prior to the public issue, the company
shall give the cash flow statement in the offer document disclosing the use of such
funds
Where the promoters minimum contribution exceeds Rs.100 crores, the promoters
shall bring in Rs.100 crores before the opening of the issue and the remaining
contribution shall be brought in by the promoters when calls are made to the public
In case of any issue of capital to the public the minimum promoters contribution shall
be locked in for a period of 3 years
The lock-in shall start from the date of allotment in the proposed public issue and the
last date of the lock-in shall be reckoned as 3 years from the date of commencement
of commercial production or the date of allotment in the public issue whichever is
later
In case of a public issue by unlisted or listed company, if the promoters contribution
in the proposed issue exceeds the required minimum contribution, such excess
contribution shall also be locked in for a period of one year
The entire pre-issue capital, other than that locked-in as minimum promoters
contribution, shall be locked-in for a period of one year from the date of allotment
Exception:
Shares held by the Venture Capital Fund or the Foreign Venture Capital Investor, as
the case may be, for a period of at least one year as on the date of filing draft
prospectus

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 Securities issued to institutional investors shall be locked-in for 1 year from the date
of commencement of commercial production or the date of allotment, whichever is
later
Locked-in Securities held by promoters may be pledged only with banks or financial
institutions as collateral security for loans granted by such banks or financial
institutions
The securities may be pledged if the loan has been granted by such banks or financial
institutions for the purpose of financing one or more of the objects of the issue
Shares held by the person other than the promoters, prior to Initial Public Offering
(IPO), which are locked in, may be transferred to any other person holding shares hich
are locked under the same guidelines
Shares held by promoter(s) which are locked in as per the relevant provisions of this
chapter, may be transferred to and amongst promoter/ promoter group or to a new
promoter or persons in control of the company, subject to continuation of lock-in

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CHAPTER 9: IPO GRADING

IPO grading is the grade assigned by a Credit Rating Agency registered with SEBI, to the
initial public offering (IPO) of equity shares or any other security which may be converted
into or exchanged with equity shares at a later date. The grade represents a relative
assessment of the fundamentals of that issue in relation to the other listed equity securities in
India. Such grading is generally assigned on a five-point point scale with a higher score
indicating stronger fundamentals and vice versa as below.
IPO grade 1: Poor fundamentals
IPO grade 2: Below-average fundamentals
IPO grade 3: Average fundamentals
IPO grade 4: Above-average fundamentals
IPO grade 5: Strong fundamentals
IPO grading has been introduced as an endeavour to make additional information available
for the investors in order to facilitate their assessment of equity issues offered through an
IPO. The most important thing about IPO Grading is that it doesnt consider price. I feel that
this is an important aspect because everything is relative to price. What good is a company
with strong fundamentals, if they are over charging you?
Most companies that come out with IPOs these days are not leaving anything on the table for
investors, so that makes the price aspect even more important. That means you cant take a
look at the IPO grading, and make a decision to buy. If the company has poor fundamentals
or below average fundamentals, then you can decide not to participate in the IPO, but you
cant take a decision to buy based on the grading alone.
A company rated 5 has strong fundamentals, but how do they stack up relative to the price?
The IPO grading doesnt tell you that. It doesnt tell you whether the company has left
anything on the table for the investors or not, and therefore you dont know whether the issue
is worth subscribing or not.
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IPO grading takes into account the prospects of the company, industry it operates in,
financials, management strength, corporate governance, litigation history and the prospects of
its new projects.
A company which takes out an IPO needs to get their issue graded, and doesnt have an
option to reject the grading. If they dont like the grading, they can get a second opinion, but
have to disclose everything that they got in the offer document. The company does pay the
rating agency for the grading, so there is a conflict of interest, which is characteristic of this
industry.
IPO grading was introduced to help investors with one more data point, and enable them to
make a better decision. It is a useful thing to know about, but without including price in the
score, it lacks a serious element needed to make a decision.
No unlisted company shall make an IPO unless the following conditions are satisfied as on
the date of filing of Prospectus:
The unlisted company has obtained grading for the IPO from at least one credit rating
agency
Disclosures of all the grades obtained, along with the rationale/ description furnished
by the credit rating agency for each of the grades obtained, have been made in the
Prospectus
The expenses incurred for grading IPO have been borne by the unlisted company
obtaining grading for IPO

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CHAPTER 10: ANALYSING AN IPO INVESTMENT

10.1 Potential Investors & their objective

Initial Public Offering is a cheap way of raising capital, but all the same it is not considered
as the best way of investing for the investor. Before investing, the investor must do a proper
analysis of the risks to be taken and the returns expected. He must be clear about the benefits
he hope to derive from the investment. The investor must be clear about the objective he has
for investing, whether it is long-term capital growth or short-term capital gains.
The potential investors and their objectives could be categorized as:

INCOME INVESTOR
An income investor is the one who is looking for steadily rising profits that will be
distributed to shareholders regularly. For this, he needs to examine the company's
potential for profits and its dividend policy.

GROWTH INVESTOR
A growth investor is the one who is looking for potential steady increase in profits
that are reinvested for further expansion. For this he needs to evaluate the company's
growth plan, earnings and potential for retained earnings.

SPECULATOR
A speculator looks for short-term capital gains. For this he needs to look for
potential of an early market breakthrough or discovery that will send the price up
quickly with little care about a rapid decline.

INVESTOR RESEARCH
It is imperative to properly analyze the IPO the investor is planning to invest into. He
needs to do a thorough research at his end and try to figure out if the objective of the
company match his own personal objectives or not. The unpredictable nature of IPOs

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and volatility of the stock market adds greatly to the risk factor. So, it is advisable
that the investor does his homework, before investing.
The investor should know about the following:

BUSINESS OPERATIONS
What are the objectives of the business?
What are its management policies?
What is the scope for growth?
What is the turnover of the labour force?
Would the company have long-term stability?

FINANCIAL OPERATIONS
What is the companys credit history?
What is the companys liquidity position?
Are there any defaults on debts?
Companys expenditure in comparison to competitors.
Companys ability to pay-off its debts.
What are the projected earnings of the company

MARKETING OPERATIONS
Who are the potential investors?
What is the scope for success of the IPO?
What is the appeal of the IPO for the other investors?
What are the products and services offered by the company?
Who are the strongest competitors of the company?

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CHAPTER 11: IPO INVESTMENT STRATEGIES

Investing in IPOs is much different than investing in seasoned stocks. This is because there is
limited information and research on IPOs, prior to the offering. Making an IPO involves
immense research, planning and strategising. One must bear in mind that here the ownership
and management of the organisation is not just focused on a particular person(s), but instead
distributed and diluted on a larger scale and hence the stakes are automatically higher. So, an
error even on a miniscule level can have drastic repercussions.
11.1 Strategies to be considered before investing in the IPO:
1. Choosing the Perfect Time
Before even plunging into the intricacies of the pre-IPO arrangements, choosing the
ideal time to go public is of core importance. The timing of going public is very
crucial in the pre-IPO process. One should look into many aspects before the plunge
like looking into the prevailing market sentiment.
In the 1980's and early 1990's when branding and marketing were non-existent,
liquidity in the market, behaviour of the secondary market and merchant bankers'
advice were instrumental in deciding the right time for the IPO.
2. Choosing the Right Team
Forming the right team is essential before going for an IPO. Apart from the Chief
Executive Officer (CEO) or the Chairman, the main members are the Chief Financial
Officer (CFO), Chief Operating Officer (COO), the Company Secretary, the auditors,
professional merchant bankers, and the Chief Information Officer (CIO) in the current
age of information and legal advisors.
It is very important for the board of directors involved in the venture to have a
progressive outlook. Only an intelligent team can contribute to the success of the
venture.
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Zeroing in on the right CFO is crucial. Experts in the field opine that the CFO should
be a veteran with not just a sound financial knowledge of the market and the trend of
IPO. The CFO required when the company is at its growth stage is different from the
CFO needed for an IPO, where he should have good networking and market contacts.
A merchant banker works out the logistics of the company, but it is the CFO who
actually markets the IPO.
Team building and the professional team that you bring in is very important. You
should be very careful not only about land and equipment but also while deploying
money and manpower.
Apart from the CFO and the Company Secretary, choosing appropriate auditors makes
a world of difference. Unlike other members of the team, the auditor has the
additional job of assessing whether the entire accounting system is in order, is
transparent and analysing whether the numbers and projections as shown in the Excel
sheet are realistic and practical. If you have a good auditor, half your battle is won. In
fact, one should employ auditors at least one or two years before the IPO is launched.
When the company goes public, it must make a note of disclosures about the company
operations and past records. It can't afford to make any observations which are
incorrect or not backed by strong evidence. You should have a team who can
strategise and can plan the inflow and outflow of resources and money.
3. Definite Goals and Purposes
A company should be focused and clear about the purpose of the IPO. Usually, the
purpose behind making an IPO is to accumulate funds and finances for expansion and
investments and above all woo the investors and consolidate as a brand. This requires
a purely corporate structure.
Currently, there are stringent SEBI guidelines to be followed before any company
goes public. Keeping this in mind, the valuations which the company wishes to
command will depend on the future goals and projects of the company, and the
Page 29 of 64

management team. Unless the management is fully sure of the ultimate goals, the
company will not be able to come up with a high valuation for the proposed issue of
shares.
4. Choosing the Right Merchant Bankers
The primary role of a merchant banker should be to act as a bridge between the
organisation and the investors. Firstly, the merchant banker should have a brand
image in the market.
A merchant banker should have the capability and the experience to handle a largescale IPO. And they should be able to reach a larger mass of people because investors
today are just not located in the metros but also in tier-II and tier-III cities."
Simultaneously, they also chalk out the risk management strategies for the company
since risks and ventures are two sides of the same coin. Hence a company should
choose such a merchant banker who is just not professional but who understands the
logistics and mechanics of the industry.
Apart from being a link between the organisation and the investors, a banker also has
to generate interest and build up the confidence of the investors.
5. Capital Restructuring
Companies should decide on the ways to deploy their capital, namely capital
restructuring. Companies should be clear about the debt and equity ratio. This boils
down to setting the ideal Debt-Equity Ratio (DER), which can vary from 1:1 to 2:2.
"You have to work out your ratio according to the cash and the growth rate, so that
they can accordingly structure their profits.
In capital restructuring, you have to be sure of the DER maintained, what are the
facilities you are planning to set up and what is the land value you are going to
purchase. The way you are going to deploy your capital is also very important. You
have to be very careful while deploying the resources and forecast the profit you will
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incur in three-four years' time."

6. Creating Investor Interest
Confidence building and generating investor interest should be on the priority list for
a company. A Company must project an image of transparency and good governance
to the investors. Infosys should be the role model for all companies going in for an
IPO. Many of the experts agree that IT giant Infosys is a role model because their
balance sheet is very clear, they value their managers as assets and year after year they
expand rapidly. A company is accountable to its investors, which is why when they go
public they have to disclose company projectionspast, present and future prospects.
This is where the team of advisors, consultants and legal experts comes into the
picture. IPO is all about building investors' confidence so we over perform to hike up
investor confidence. If you raise the expectations and do not meet them, then
investors will not excuse you for the next two-three years. Infosys, for instance,
follows this strategy and gets higher multiples because they understate their plans.
The projections given to the public should be realistic. The excel sheet might project
rosy details of growth, but if they do not live up to the expectations then public
confidence is sure to plummet to the lowest level.
7. Media Campaigns
A few years ago, marketing and media campaigns were considered a luxury, but today
they are absolutely necessary. They contribute to the relative success of an IPO
venture. The campaigns can be in the form of road shows and extensive investor
meetings. They are required because the investors need to be made aware of the
company and its past performances and any important projects undertaken/completed.
During the campaigns, various facets related to company performance, the need to
raise money and future plans are disclosed, information that investors seek. A
successful media campaign ensures complete participation in the IPO by one and all.

CHAPTER 12: PRICING OF AN IPO

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The pricing of an IPO is a very critical aspect and has a direct impact on the success or failure
of the IPO issue. There are many factors that need to be considered while pricing an IPO and
an attempt should be made to reach an IPO price that is low enough to generate interest in the
market and at the same time, it should be high enough to raise sufficient capital for the
company.
The process for determining an optimal price for the IPO involves the underwriters arranging
share purchase commitments from leading institutional investors.
12.1 Process
Once the final prospectus is printed and distributed to investors, company management meets
with their investment bank to choose the final offering price and size. The investment bank
tries to fix an appropriate price for the IPO depending upon the demand expected and the
capital requirements of the company.
The pricing of an IPO is a delicate balancing act as the investment firms try to strike a
balance between the company and the investors. The lead underwriter has the responsibility
to ensure smooth trading of the companys stock. The underwriter is legally allowed to
support the price of a newly issued stock by either buying them in the market or by selling
them short.
12.2 IPO Pricing Differences
It is generally noted, that there is a large difference between the price at the time of issue of
an Initial Public Offering (IPO) and the price when they start trading in the secondary market.
These pricing disparities occur mostly when an IPO is considered hot, or in other words,
when it appeals to a large number of investors. An IPO is hot when the demand for it far
exceeds the supply.
This imbalance between demand and supply causes a dramatic rise in the price of each share
in the first day itself, during the early hours of trading.

12.3 Underpricing
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The pricing of an IPO at less than its market value is referred to as Underpricing. In other
words, it is the difference between the offer price and the price of the first trade.
Historically, IPOs have always been underpriced. Underpriced IPO helps to generate
additional interest in the stock when it first becomes publicly traded. This might result in
significant gains for investors who have been allocated shares at the offering price. However,
underpricing also results in loss of significant amount of capital that could have been raised
had the shares been offered at the higher price.

12.4 Overpricing
The pricing of an IPO at more than its market value is referred to as Overpricing. Even
overpricing of shares is not as healthy option. If the stock is offered at a higher price than
what the market is willing to pay, then it is likely to become difficult for the underwriters to
fulfil their commitment to sell shares. Furthermore, even if the underwriters are successful in
selling all the issued shares and the stock falls in value on the first day itself of trading, then it
is likely to lose its marketability and hence, even more of its value.

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CHAPTER 13: STEPS TO GO PUBLIC

Approval of BOD: Approval of BOD is required for raising capital from the public.

Appointment of lead managers: The lead manager is the merchant banker who orchestrates
the issue in consultation of the company.

Appointment of other intermediaries:

-

Co-managers and advisors

Underwriters

Bankers

Brokers and principal brokers

Registrars

Filing the prospectus with SEBI: The prospectus or the offer document communicates
information about the company and the proposed security issue to the investing public. All
the companies seeking to make a public issue have to file their offer document with SEBI. If
SEBI or public does not communicate its observations within 21 days from the filing of the
offer document, the company can proceed with its public issue.

Filing of the prospectus with the registrar of the companies: Once the prospectus have
been approved by the concerned stock exchanges and the consent obtained from the bankers,
auditors, registrar, underwriters and others, the prospectus signed by the directors, must be
filed with the registrar of companies, with the required documents as per the companies act
1956.
Printing and dispatch of prospectus: After the prospectus is filed with the registrar of
companies, the company should print the prospectus. The quantity in which prospectus is
printed should be sufficient to meet requirements. They should be send to the stock

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exchanges and brokers so they receive them atleast 21 days before the first announcement is
made in the news papers.

Filing of initial listing application: Within 10 days of filing the prospectus, the initial listing
application must be made to the concerned stock exchanges with the listing fees.

Promotion of the issue: The promotional campaign typically commences with the filing of
the prospectus with the registrar of the companies and ends with the release of the statutory
announcement of the issue.

Statutory announcement: The issue must be made after seeking approval of the stock
exchange. This must be published atleast 10 days before the opening of the subscription list.

Collections of applications: The Statutory announcement specifies when the subscription

would open, when it would close, and the banks where the applications can be made. During
the period the subscription is kept open, the bankers will collect the applications on behalf of
the company.

Processing of applications: Scrutinizing of the applications is done.

Establishing the liability of the underwriters: If the issue is undersubscribed, the liability
of the underwriters has to be established.

Allotment of shares: Proportionate system of allotment is to be followed.

Listing of the issue: The detail listing application should be submitted to the concerned stock
exchange along with the listing agreement and the listing fee. The allotment formalities
should be completed within 30 days.

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CHAPTER 14: BOOK BUILDING PROCESS

The company does not come out with a fixed price for its shares; instead, it indicates a price
band that mentions the lowest (referred to as the floor) and the highest (the cap) prices at
which a share can be sold.

Bids are then invited for the shares. Each investor states how many shares s/he wants and
what s/he is willing to pay for those shares (depending on the price band). The actual price is
then discovered based on these bids. As we continue with the series, we will explain the
process in detail.

According to the book building process, three classes of investors can bid for the shares:
1. Qualified Institutional Buyers: Mutual funds and Foreign Institutional Investors.
2. Retail investors: Anyone who bids for shares under Rs 1,00,000/- is a retail investor.
3. High net worth individuals and employees of the company.

Allotment is the process whereby those who apply are given (allotted) shares. The bids are
first allotted to the different categories and the over-subscription (more shares applied for
than shares available) in each category is determined. Retail investors and high net worth
individuals get allotments on a proportional basis.
Example 1:
Assuming you are a retail investor and have applied for 200 shares in the issue, and the issue
is over-subscribed five times in the retail category, you qualify to get 40 shares (200
shares/5). Sometimes, the over-subscription is huge or the issue is priced so high that you
can't really bid for too many shares before the Rs 1,00,000/- limit is reached. In such cases,
allotments are made on the basis of a lottery.
Example 2:
Say, a retail investor has applied for five shares in an issue, and the retail category has been
over-subscribed 10 times. The investor is entitled to half a share. Since that isn't possible, it
may then be decided that every 1 in 2 retail investors will get allotment. The investors are
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then selected by lottery and the issue allotted on a proportional basis. That is why there is no
way you can be sure of getting an allotment.
Book Building is basically a capital issuance process used in Initial Public Offer (IPO) which
aids price and demand discovery. It is a process used for marketing a public offer of equity
shares of a company. It is a mechanism where, during the period for which the book for the
IPO is open, bids are collected from investors at various prices, which are above or equal to
the floor price. The process aims at tapping both wholesale and retail investors. The
offer/issue price is then determined after the bid closing date based on certain evaluation
criteria.

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14.1 The Process

The Issuer who is planning an IPO nominates a lead merchant banker as a 'book
runner'.
The Issuer specifies the number of securities to be issued and the price band for
orders.
The Issuer also appoints syndicate members with whom orders can be placed by the
investors.
Investors place their order with a syndicate member who inputs the orders into the
'electronic book'. This process is called 'bidding' and is similar to open auction.
A Book should remain open for a minimum of 5 days.
Bids cannot be entered less than the floor price.
Bids can be revised by the bidder before the issue closes.
On the close of the book building period the 'book runner evaluates the bids on the
basis of the evaluation criteria which may include Price Aggression
Investor quality
Earliness of bids, etc.
The book runner the company concludes the final price at which it is willing to issue
the stock and allocation of securities.
Generally, the numbers of shares are fixed; the issue size gets frozen based on the
price per share discovered through the book building process.
Allocation of securities is made to the successful bidders.
Book Building is a good concept and represents a capital market which is in the
process of maturing.

Book-building is all about letting the company know the price at which you are willing to buy
the stock and getting an allotment at a price that a majority of the investors are willing to pay.
The price discovery is made depending on the demand for the stock.

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The price that you can suggest is subject to a certain minimum price level, called the floor
price. For instance, the floor price fixed for the Maruti's initial public offering was Rs 115,
which means that the price you are willing to pay should be at or above Rs 115.
In some cases, as in Biocon, the price band (minimum and maximum price) at which you can
apply is specified. A price band of Rs 270 to Rs 315 means that you can apply at a floor price
of Rs 270 and a ceiling of Rs 315.
If you are not still very comfortable fixing a price, do not worry. You, as a retail investor,
have the option of applying at the cut-off price. That is, you can just agree to pick up the
shares at the final price fixed. This way, you do not run the risk of not getting an allotment
because you have bid at a lower price. If you bid at the cut-off price and the price is revised
upwards, then the managers to the offer may reduce the number of shares allotted to keep it
within the payment already made. You can get the application forms from the nearest offices
of the lead managers to the offer or from the corporate or the registered office of the
company.

14.2 How is the price fixed?

All the applications received till the last date are analysed and a final offer price, known as
the cut-off price is arrived at. The final price is the equilibrium price or the highest price at
which all the shares on offer can be sold smoothly.
If your price is less than the final price, you will not get allotment. If your price is higher than
the final price, the amount in excess of the final price is refunded if you get allotment. If you
do not get allotment, you should get your full refund of your money in 15 days after the final
allotment is made. If you do not get your money or allotment in a month's time, you can
demand interest at 15 per cent per annum on the money due.
14.3 How are shares allocated?

As per regulations, at least 25 per cent of the shares on offer should be set aside for
retail investors. Fifty per cent of the offer is for qualified institutional investors. Qualified
Institutional Bidders (QIB) are specified under the regulation and allotment to this class is
made at the discretion of the company based on certain criteria.
Page 39 of 64

QIBs can be mutual funds, foreign institutional investors, banks or insurance

companies. If any of these categories is under-subscribed, say, the retail portion is not
adequately subscribed, then that portion can be allocated among the other two categories
at the discretion of the management. For instance, in an offer for two lakh shares, around
50,000 shares (or generally 25 per cent of the offer) are reserved for retail investors. But
if the bids from this category are received are only for 40,000 shares, then 10,000 shares
can be allocated either to the QIBs or non-institutional investors.

The allotment of shares is made on a pro-rata basis. Consider this illustration: An

offer is made for two lakh shares and is oversubscribed by times times, that is, bids are
received for six lakh shares. The minimum allotment is 100 shares. 1,500 applicants have
applied for 100 shares each; and 200 applicants have bid for 500 shares each. The shares
would be allotted in the following manner:

Shares are segregated into various categories depending on the number of shares
applied for. In the above illustration, all investors who applied for 100 shares will fall in
category A and those for 500 shares in category B and so on.

The total number of shares to be allotted in category A will be 50,000

(100*1500*1/3). That is, the number of shares applied for (100)* number of applications
received (1500)* oversubscription ratio (1/3). Category B will be allotted 33,300 shares in
a similar manner.

Shares allotted to each applicant in category A should be 33 shares (100*1/3). That is,
shares applied by each applicant in the category multiplied by the oversubscription ratio.
As, the minimum allotment lot is 100 shares, it is rounded off to the nearest minimum lot.
Therefore, 500 applicants will get 100 shares each in category A total shares allotted to
the category (50,000) divided by the minimum lot size (100).

In category B, each applicant should be allotted 167 shares (500/3). But it is rounded
off to 200 shares each. Therefore, 167 applicants out of 200 (33300/200) would get an
allotment of 200 shares each in category B.
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The final allotment is made by drawing a lot from each category. If you are lucky you
may get allotment in the final draw.

The shares are listed and trading commences within seven working days of
finalisation of the basis of allotment. You can check the daily status of the bids received,
the price bid for and the response form various categories in the Web sites of stock
exchanges. This will give you an idea of the demand for the stock and a chance to change
your mind. After seeing the response, if you feel you have bid at a higher or a lower price,
you can always change the bid price and submit a revision form.

The traditional method of doing IPOs is the fixed price offering. Here, the issuer and
the merchant banker agree on an "issue price" - e.g. Rs.100. Then one have the choice of
filling in an application form at this price and subscribing to the issue. Extensive research
has revealed that the fixed price offering is a poor way of doing IPOs. Fixed price
offerings, all over the world, suffer from `IPO underpricing'. In India, on average, the
fixed-price seems to be around 50% below the price at first listing; i.e. the issuer obtains
50% lower issue proceeds as compared to what might have been the case. This average
masks a steady stream of dubious IPOs who get an issue price which is much higher than
the price at first listing. Hence fixed price offerings are weak in two directions: dubious
issues get overpriced and good issues get underpriced, with a prevalence of underpricing
on average.

What is needed is a way to engage in serious price discovery in setting the price at the IPO.
No issuer knows the true price of his shares; no merchant banker knows the true price of the
shares; it is only the market that knows this price. In that case, can we just ask the market to
pick the price at the IPO?
Imagine a process where an issuer only releases a prospectus, announces the number of
shares that are up for sale, with no price indicated. People from all over India would bid to
buy shares in prices and quantities that they think fit. This would yield a price. Such a
procedure should innately obtain an issue price which is very close to the price at first listing
the hallmark of a healthy IPO market.
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In India, there had been issue from Hughes Software Solutions which was a milestone in our
growth from fixed price offerings to true price discovery IPOs. While the HSS issue has
many positive and fascinating features, the design adopted was still riddled with flaws, and
we can do much better.

14.4 Documents Required:

A company coming out with a public issue has to come out with an Offer Document/
Prospectus.

An offer document is the document that contains all the information you need about the
company. It will tell you why the company is coming is out with a public issue, its
financials and how the issue will be priced.

The Draft Offer Document is the offer document in the draft stage. Any company making
a public issue is required to file the draft offer document with the Securities and Exchange
Board of India, the market regulator.

If SEBI demands any changes, they have to be made. Once the changes are made, it is
filed with the Registrar of Companies or the Stock Exchange. It must be filed with SEBI
at least 21 days before the company files it with the ROC/ Stock Exchange. During this
period, you can check it out on the SEBI Web site.

Red Herring Prospectus is just like the above, except that it will have all the information
as a draft offer document; it will, however, not have the details of the price or the number
of shares being offered or the amount of issue. That is because the Red Herring
Prospectus is used in book building issues only, where the details of the final price are
known only after bidding is concluded.

Players:

Co-managers and advisors

Underwriters

Lead managers
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Bankers

Brokers and principal brokers

Registrars

Stock exchanges.

Page 43 of 64

CHAPTER 15: CASE STUDY HDIL IPO VALUATION

Housing Development and Infrastructure Ltd is a part of the Wadhawan Group (formerly
known as the Dheeraj Group), which has been involved in real estate development in the
Mumbai Metropolitan Region for almost three decades.
Since 1996, HDIL has been satisfying the diverse needs of scores of home seekers in Mumbai
Metropolitan region. Their business focuses on real estate development, including
construction and development of residential projects, commercial, retail and slum
rehabilitation projects.
A sincere study of the market and a strong feeling to meet the needs of the lower and the
middle income group prompted HDIL to help these people tide over difficult times and
harrowing experiences of buying a home.
HDIL had acted pro-actively in identifying the intricate needs of its residents and offered
them just what they needed. It provided and still provides all services under one roof through
tie-ups with banks and HDFCs.
With numerous projects to its credit and lakhs of happy and satisfied home buyers, HDIL has
carved a niche for itself in the real estate industry and has made its mark in the hearts of
millions of people.
HDILs Board of Directors
In tune with its efforts to evolve into a professionally managed Corporate Structure, HDIL
has broaden its Board composition by inducting people of high standing from the banking
industry, legal and the audit profession as Independent Directors. The Company now has an
ideal mix of Executive and Independent Directors, which gives it an advantage of expertise of
various fields in effective management and consistent growth.
Mission
HDIL is committed to creating microstructures, mega structures and infrastructure for the
nation and creating value for our customers, investors, employees & society at large.
Their mission is to be an icon in Infrastructure & Real Estate Development, defining
Page 44 of 64

QUALITY Conforming to standards

MARKMANSHIP Par Excellence

CUSTOMER SATISFACTION Their Motto to deliver the best at all time

Finance
Finance for buying flats in any of the HDIL projects can be obtained through any one of the
following Housing Finance Companies:

HDFC
LIC
GIC
Dewan Housing Finance Corporation Limited
VYSYA Bank Housing Finance

HDIL IPO - opened for subscription on 28 June, 2007 and closed on July 03, 2007.
About the Company
Since 1978, HDIL has been satisfying the diverse needs of scores of home seekers in
Mumbai, the commercial capital of India and Bangalore. It was not just the intention of doing
business by being responsible for marketing affordable homes; the very inclination was to
give the best to the home seeker fraternity at large.

Issue Details
Issue of Equity Shares# 30,000,000 Equity Shares of which
Employee Reservation Portion# 600,000 Equity Shares
Net Issue# 29,400,000 Equity Shares Of which:
Qualified Institutional Buyers (QIBs) Portion At least 17,640,000 Equity Shares* of which
Available for Mutual Funds only 882,000 Equity Shares*
Balance of QIB Portion (available for QIBs including Mutual Funds) : 16,758,000 Equity
Shares*
Non-Institutional Portion 2,940,000 Equity Shares*
Retail Portion 8,820,000 Equity Shares*
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Green Shoe Option Portion1 Up to 4,500,000 Equity Shares

The Issue and Green Shoe Option Portion Up to 34,500,000 Equity Shares
Pre and post-Issue Equity Shares
Equity Shares outstanding prior to the Issue : 180,000,000 Equity Shares
Equity Shares outstanding after the Issue (excluding the exercise of the Green Shoe Option) :
210,000,000 Equity Shares
Equity Shares outstanding after the Issue (including the exercise of the Green Shoe Option in
full) : 214,500,000 Equity Shares
IPO Valuation DCF Analysis
Introduction
In simple terms, discounted cash flow tries to work out the value of a company today, based
on projections of how much money it's going to make in the future. DCF analysis says that a
company is worth all of the cash that it could make available to investors in the future. It is
described as "discounted" cash flow because cash in the future is worth less than cash today.
For example, let's say someone asked you to choose between receiving Rs100 today and
receiving Rs100 in a year. Chances are you would take the money today, knowing that you
could invest that Rs100 now and have more than Rs100 in a year's time. If you turn that
thinking on its head, you are saying that the amount that you'd have in one year is worth
Rs100 today - or the discounted value is Rs100. Make the same calculation for all the cash
you expect a company to produce in the future and you have a good measure of the
companys revenue. There are several tried and true approaches to discounted cash flow
analysis; we will use the free cash flow to firm approach commonly used by Street analysts to
determine the "fair value" of companies.

The Forecast Period

The table below shows good guidelines to use when determining a company's excess return
period/forecast period:

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Excess
Period

Company Competitive Position

Slow-growing

company;

Return/Forecast

operates

in

highly competitive, low margin industry

1 year

Solid company; operates with advantage

such

as

strong

marketing

channels,

recognizable brand name, or regulatory

5 years

advantage
Outstanding growth company; operates
with very high barriers to entry, dominant 10 years
market position or prospects

How far in the future should we forecast? Let's assume that the company is keeping itself
busy meeting the demand for its Infrastructure development. Thanks to strong marketing
channels and upgraded technology and HDIL has been satisfying the diverse needs of scores
of home seekers in Mumbai Metropolitan region. Their business focuses on real estate
development, including construction and development of residential projects, commercial,
retail and slum rehabilitation projects. There is enough demand for Infrastructure
development to maintain five years of strong growth, but after that the market will be
saturated as new competitors enter the market. So, from the above table, we will project cash
flows for the next five years of business.
Growth Rate
HDIL is expected to grow at to have CAGR of 42 % (Source: Emkay Research). We take
fixed growth rate of 42% for DCF valuation for coming 5 years.
Reinvestment Rate
If we relax the assumption that the only source of equity is retained earnings, the growth in
net income can be different from the growth in earnings per share. Intuitively, note that a firm
can grow net income significantly by issuing new equity to fund new projects while earnings
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per share stagnate. To derive the relationship between net income growth and fundamentals,
we need a measure of how investment that goes beyond retained earnings. One way to obtain
such a measure is to estimate directly how much equity the firm reinvests back into its
businesses in the form of net capital expenditures and investments in working capital.
Equity Reinvestment Rate = Growth Rate / ROE
= 42/76
= 55.26 %
Forecasting Free Cash Flows
Free cash flow is the cash that flows through a company in the course of a quarter or a year
once all cash expenses have been taken out. Free cash flow represents the actual amount of
cash that a company has left from its operations that could be used to pursue opportunities
that enhance shareholder value - for example, developing new products, paying dividends to
investors or doing share buybacks.
Free cash flow

= EBIT (1-tax) [EBIT (1-tax) Reinvestment Rate]

EBIT (1-tax) nth year = EBIT (1-tax) n-1 year (1 + growth rate)
Rs in mn
Current
Year

2008

2009

2010

2011

2012

Expected Growth Rate

42%

42%

42%

42%

42%

EBIT (1-tax)

6181

8777

12463

17698

25131

35686

Equity
Rate

55.26% 55.26% 55.26% 55.26% 55.26%

22185

FCFE

Reinvestment
30394

41639

57046

78153

A wide variety of methods can be used to determine discount rates, but in most cases, these
calculations resemble art more than science. Still, it is better to be generally correct than
precisely incorrect, so it is worth your while to use a rigorous method to estimate the
discount rate. A good strategy is to apply the concepts of the weighted average cost of
capital (WACC). The WACC is essentially a blend of the cost of equity and the after-tax
cost of debt.

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Cost of Equity (Re)

Unlike debt, which the company must pay at a set rate of interest, equity does not have a
concrete price that the company must pay. But that doesn't mean that there is no cost of
equity. Equity shareholders expect to obtain a certain return on their equity investment in a
company. From the company's perspective, the equity holders' required rate of return is a
cost, because if the company does not deliver this expected return, shareholders will simply
sell their shares, causing the price to drop. Therefore, the cost of equity is basically what it
costs the company to maintain a share price that is satisfactory (at least in theory) to
investors. The most commonly accepted method for calculating cost of equity comes from the
Nobel Prize-winning capital asset pricing model (CAPM), where:
Cost of Equity = RF + Beta (Rm-Rf)

Rf - Risk-Free Rate - This is the amount obtained from investing in securities considered free
from credit risk, such as government bonds from developed countries. The interest rate of
government bonds is frequently used as a proxy for the risk-free rate.
- Beta - This measures how much a company's share price moves against the market as a
whole. A beta of one, for instance, indicates that the company moves in line with the market.
If the beta is in excess of one, the share is exaggerating the market's movements; less than
one means the share is more stable. We take Beta of comparable firm i.e Unitech which is
having beta of 1.1
(Rm Rf) Equity Market Risk Premium - The equity market risk premium (EMRP)
represents the returns investors expect, over and above the risk-free rate, to compensate them
for taking extra risk by investing in the stock market. In other words, it is the difference
between the risk-free rate and the market rate.
Cost of Debt (Rd)
As companies benefit from the tax deductions available on interest paid, the net cost of
the debt is actually the interest paid less the tax savings resulting from the taxdeductible interest payment. Therefore, the after-tax cost of debt is Rd (1 corporate tax rate).

Page 49 of 64

Weighted Average Cost Of Capital (WACC):

The WACC is the weighted average of the cost of equity and the cost of debt based on the
proportion of debt and equity in the company's capital structure. The proportion of debt is
represented by D/V, a ratio comparing the company's debt to the company's total value
(equity + debt). The proportion of equity is represented by E/V, a ratio comparing the
company's equity to the company's total value (equity + debt). The WACC is represented by
the following formula:
WACC

=
=

Cost of Equity + Cost of Debt

E/V x Re + Rd x (1 - corporate tax rate) x D/V.

E/V

0.66

Rf

7.44

Corporate tax

30%

Beta

1.1

D/V

0.34

Rm

13.5

Cost of Debt

Cost of Equity

D/V x (1 - corporate tax rate)

E/V x [Rf + Beta (Rm-Rf)]

0.34 [1-0.30]

0.66 [7.44 + 1.1 x 6]

WACC = Cost of Debt + Cost of Equity = 9.5%

Present Value
The present value of a single or multiple future payments (known as cash flows) is the
nominal amounts of money to change hands at some future date, discounted to account for
the time value of money, and other factors such as investment risk. A given amount of money
is always more valuable sooner than later since this enables one to take advantage of
investment opportunities. Present values are therefore smaller than corresponding future
values.
Page 50 of 64

When future cash flow of the company is divided by the discount rate we get the present
value of that predicted years cash flow.
Present Value n

= Predicted cash flow n / (1+ discount rate)n

Where, n = year
Rs in mn

Free Cash Flow

Discount rate
Present value

2008
3927

2009
5576

2010
7918

2011
11243

2012
15965

1.095
3586

(1.095) (1.095) (1.095)4 (1.095)5

4650
6030
7820
10141

TERMINAL VALUE
Perpetuity Growth Model
The Perpetuity Growth Model accounts for the value of free cash flows that continues into
perpetuity in the future, growing at an assumed constant rate. Here, the projected free cash
flow in the first year beyond the projection horizon (N+1) is used. We have assumed
perpetuity growth rate for HDIL as 6%
Beyond 2012 HDIL is expected to grow at 6% p.a i.e. at its perpetuity rate, hence net income
for the year 2013 will be:
Net income of 2012 (1+ perpetuity growth rate)
=

35686 (1+0.06)

Rs. 37827 mn

Reinvestment rate after 2012 (Terminal Point)

Reinvestment rate = Perpetuity Growth rate / Return on Equity
Here, return on equity is rate at which company expect to get returns on its investments after
terminal point i.e. 2012.
Return on equity will drop to the stable period cost of capital of 9.5%.
Page 51 of 64

Reinvestment rate (terminal point)

Free cash flow

6/9.5

63%

= EBIT (1-tax) [EBIT (1-tax) x Reinvestment Rate]

Therefore,
Free cash flow 2013

37827 [37827 x 52%]

Rs. 13936 mn

Gordon Growth Model:

There are several ways to estimate a terminal value of cash flows, but one well-worn method
is to value the company as a perpetuity using the Gordon Growth Model. The model uses this
formula:
Free cash flow of the year after the terminal year
(Discount Rate Perpetuity Growth Rate)
The formula simplifies the practical problem of projecting cash flows far into the future.
Therefore,
Terminal Value

Present value of
Terminal year

13936 100
9.5 6

Rs 146099 mn

146099 / (1.095)6

Rs. 84754 mn

Calculating Total Enterprise Value

Page 52 of 64

Total Enterprise

Sum of Present value for 5 years + Present valueOf Terminal

Year + Cash Debt
=

32228 + 84754 + 1949 - 3756

Rs. 115175 mn

Fair value

Rs 115175 mn

Number of outstanding shares

214 mn

Fair value of the HDIL per share

Rs 538

SENSITIVITY ANALYSIS
Sensitivity analysis is the investigation of how the projected performance varies along with
changes in the key assumptions on which the projections are based.
The sensitivity analysis of the above DCF model can be done as follows:
Discount Rate

Perpetuity Growth
Rate

9%

9.5%

10%

5.5%

596

592

585

6%

533

538

537

6.5%

469

483

489

HDIL IPO

Particulars
Figures
Issue of Equity shares
30,000,000
Equity Shares outstanding prior to the 180,000,000
Issue
Equity Shares outstanding after the 210,000,000
Issue
Price Band
Issue Price
Listing Price
3 Days High
3 Days Low
Close Price (26th July 2007)
Page 53 of 64

Rs. 430 to Rs.500

Rs. 500
Rs. 538
Rs.634
Rs.535
Rs. 621

DCF Valuation

Rs. 538

NSE Data

Date

Prev Close Open

High

Low

Close

Total Trd
Qty
Turnover in Lacs

24-Jul-07 500

538.6

575.95

535

559.35

28590806 160030.8

25-Jul-07 559.35

549.4

587.4

545.3

580.1

8552244 48465.14

26-Jul-07 580.1

585.6

634.3

585.6

621.4

9125757 55976.88

It can be seen that per share value of the HDIL comes to Rs. 538 and the listing price is
Rs.538. Close Price as of 26th July 2007 is Rs.621. Hence it is buying opportunity of the
investors.

HDIL IPO NEWS TRIVIA

According to CLSA, HDIL IPO had been priced at a 20-30% discount to its
forward NPV. The IPO is good but the only concern here is the fall in retail
demand for property because of high interest rates.
The HDIL IPO had performed pretty well.
It had been subscribed by 6.6 times (oversubscribed 5.6 times).
Retail category has been subscribed by only 1.59 times (oversubscribed by 0.59
times).
Institutional investor category in the HDIL IPO had been subscribed by over 10.13
times (oversubscribed 9.13 times)
The High Net worth Individual category had been subscribed by 1.78 times
(oversubscription ratio: 0.78 times).
Page 54 of 64

Page 55 of 64

CHAPTER 16: PAST ISSUES IN 2010

Sr.
No.

Name of the issue

Date of
Issue

Issue Size (lakh

Price Range
shares)

Issue
Price
(Rs.)

Date of
Listing

Grade assigned

23/03/2010
to
100
26/03/2010

Rs. 135 to
Rs. 145

135

IPO Grade 2

INTRASOFT
2 TECHNOLOGIES
LIMITED

23/03/2010
to
37
26/03/2010

Rs. 137 to
Rs. 145

145.00

12-Apr-2010

IPO Grade 3

SHREE GANESH
3 JEWELLERY HOUSE
LIMITED

19/03/2010
to
142.69831
23/03/2010

Rs.260 to
Rs. 270

260.00

09-Apr-2010 Care IPO Grade 3

17/03/2010
to
54.19
19/03/2010

Rs.290 to
Rs. 310

310.00

06-Apr-2010

IPO Grade 4

Equity Shares
11/03/2010
aggregating to Rs.242 to
to
Rs. 7,000
Rs.258
15/03/2010
million

258.00

30-Mar-2010

CARE IPO Grade 4

and 4 (ind)

11/03/2010
to
106
15/03/2010

Rs. 100 to
Rs. 110

110.00

05-Apr-2010

IPO GRADE 2

10/03/2010
to
3322.432
12/03/2010

Rs.300 to
Rs.350

300

NA

IPO GRADE 3

GOENKA DIAMOND &

JEWELS LIMITED

PERSISTENT SYSTEMS
LIMITED

IL&FS
5 TRANSPORTATION
NETWORKS LIMITED
6

PRADIP OVERSEAS
LIMITED

7 NMDC LIMITED

DQ ENTERTAINMENT
(INTERNATIONAL) LTD

08/03/2010
to
160.48
10/03/2010

Rs. 75 to
Rs. 80

80

UNITED BANK OF
INDIA

23/02/2010
to
500
25/02/2010

Rs. 60 to
Rs. 66

66.00

19/02/2010
to
1717.32
23/02/2010

For
Retail,NIB
& Reserve
category
Floor price
203/- For
QIB
category,
any price
above floor
price

RURAL
ELECTRIFICATION
10
CORPORATION
LIMITED

MAN
18/02/2010
11 INFRACONSTRUCTION
to
56.25
LIMITED
22/02/2010

Rs.243 to
Rs.252

12

TEXMO PIPES &

PRODUCTS LTD

16/02/2010
to
50
19/02/2010

Rs.85 to
Rs.90

13

HATHWAY CABLE &

DATACOM LIMITED

09/02/2010
to
277.5
11/02/2010

Rs.240 to
Rs.265

ARSS
14 INFRASTRUCTURE
PROJECTS LIMITED
15 NTPC Limited

Equity shares
08/02/2010
aggregating
Rs.410 to
to
upto Rs.10300 Rs.450.
11/02/2010
lacs
03/02/2010 4122.7322
to
05/02/2010

For
Retail,NIB
& Reserve
category,
Floor price
201/- .For

Page 56 of 64

18-Mar-2010 IPO Grade 3 & 4

NA

252.00

11-Mar-2010

IPO Grade 3

90

10-Mar-2010

IPO Grade 2

240

IPO Grade 3/5

450.00

03-Mar-2010

IPO Grade 2

NA

QIB
category,
any price
above floor
price.
16

EMMBI POLYARNS
LIMITED

17 D B REALTY LIMITED

01/02/2010
to
95.74
03/02/2010

Rs.40 to
Rs.45.

45.00

24-Feb-2010

IPO Grade 2

468.00

24-Feb-2010

IPO Grade 2

Rs.200 to
Rs. 225

220

23-Feb-2010

IPO Grade 3

Equity Shares
29/01/2010
aggregating to Rs.468 to
to
Rs. 15,000
Rs. 486
02/02/2010
Million

Equity shares
25/01/2010 for cash
18 AQUA LOGISTICS LTD
to
aggregating
02/02/2010 upto Rs.
15,000 lacs
19

SYNCOM HEALTHCARE
LIMITED

27/01/2010
to
75
29/01/2010

Rs. 65 to
Rs. 75

75.00

15-Feb-2010

IPO Grade 2

20

VASCON ENGINEERS
LIMITED

27/01/2010
to
108
29/01/2010

Rs.165 to
Rs. 185

165.00

15-Feb-2010

IPO Grade 3

21

THANGAMAYIL
JEWELLERY LIMITED

27/01/2010
to
14.075
29/01/2010

Rs. 70 To
Rs.75.

75.00

19-Feb-2010

BWR IPO Grade

III

22

JUBILANT
FOODWORKS LIMITED

18/01/2010
to
226.70447
20/01/2010

Rs.135 to
Rs. 145

145.00

23

BIRLA SHLOKA
EDUTECH LIMITED

11/01/2010
to
59.55
13/01/2010

Rs. 45 To
Rs.50.

50

NA

11/01/2010
to
115.03
13/01/2010

Rs. 155 To
Rs.165.

165

03-FEB-2010

IPO GRADE 2/5

INFINITE COMPUTER
24 SOLUTIONS (INDIA)
LIMITED

Page 57 of 64

08-Feb-2010 IPO Grade 3(ind)

CHAPTER 17: IPO GLOSSARY

A
Allocation
This is the amount of stock in an initial public offering (IPO) granted by the
underwriter to an investor.
Aftermarket
Trading in the IPO subsequent to its offering is called the aftermarket.

B
Board of Directors
The composition of the Board of Directors is particularly critical for an IPO.
Typically, a board is composed of inside and outside directors.
Broken IPOs
If an IPO trades below its IPO price in the aftermarket, it is said to be a broken IPO.
C
Calendar
This refers to upcoming IPOs and secondary offerings. Brokerage houses have equity
calendars, bond calendars and municipal calendars.
Clearing Price
The price at which all shares of an IPO can be sold to investors in a Dutch Auction.
Sometimes referred to as the market clearing price.
F
First Day Close
The closing price at the end of the first day of trading reflects not only how well the
lead manager priced and placed the deal, but what the near-term trading is likely to be.
Float
When a company is publicly traded, a distinction is made between the total number of
shares outstanding and the number of shares in circulation, referred to as the float.
The float consists of the company's shares held by the general public.
G
Green Shoe
A typical underwriting agreement allows the underwriters to buy up to an additional
15% of shares at the offering price for a period of several weeks after the offering.
Page 58 of 64

This option is also called the overallotment and is exercised when the IPO is
oversubscribed and trading above its offer price. The term comes from the Green
Shoe Company, which was the first to have this option.
H
Hot Issue
When there is significantly more demand than supply for an IPO it is said to be a hot
issue.
I
Initial Public Offering
This is the event of a company first selling its shares to the public.

Insiders
Management, directors and significant stockholders are regarded as insiders because
they are privy to information about the operations of a company not known to the
general public.
IPO Price
Individual investors often ask why the price at which an IPO starts trading is different
from its offer price. This occurs because the offer price is set by the underwriters
before the stock starts trading. Once the stock starts trading, the price is determined by
actual supply and demand and can be higher or lower.
IPO Research
Prior to the offering, the underwriters involved in the IPO are prohibited from issuing
research or recommendations for forty days. Following the IPO, the underwriter is
allowed to issue a research report
M-N
Market Capitalization
The total market value of a firm. It is defined as the product of the company's stock
price per share and the total number of shares outstanding

Market Value
The market value of a company is determined by multiplying the number of shares
outstanding by the current price of the stock.
O
Offering Price
Page 59 of 64

This is the price at which the IPO is first sold to the public. It is set by the lead
manager, usually after the close of stock market trading the night before the shares are
distributed to IPO buyers. In the case of some foreign IPOs, the pricing occurs over
the weekend.
Oversubscribed
When a deal has more orders than there are shares available it is said to be
oversubscribed.
P
Preliminary Prospectus
This is the offering document printed by the company containing a description of the
business, discussion of strategy, presentation of historical financial statements,
explanation of recent financial results, management and their backgrounds and
ownership.
Proceeds
Companies go public to raise money. The money raised is referred to as proceeds.
R
Red Herring
This is the term of art for the preliminary prospectus. It gets its name from the printed
red disclaimer on the left side of the prospectus.

U-V
Underwriter
This is a brokerage firm that raises money for companies using public equity and debt
markets. Underwriters are financial intermediaries that buy stock or bonds from an
issuer and then sell these securities to the public.
Venture Capital
Funding acquired during the pre-IPO process of raising money for companies. It is
done only by accredited investors.

CHAPTER 18: CONCLUSION

Page 60 of 64

The price of financial assets traded on the market is set by the forces of demand & supply.
Newly issued stocks are no exception to the rule they sell for whatever price a person is
willing to pay for them. The best analysts are experts at evaluating stocks. They figure out
what is the worth of the stock & if the stock is trading at a discount from what they believe it
is worth, they will buy the stock and hold it until they can sell it for a price that is close to or
above, what they believe is a fair price for the stock.
Conversely if a good analyst find a stock trading for more than its worth he moves on to
analyzing another company or short sells the overpriced stock anticipating a market
correction in the share price.
A number of methods can be used to analyze IPO, but because these stock dont have a past
performance, analyzing those using conventional means becomes a bit trickery.
If you are lucky enough to have a good relationship with a broker you may be able to
purchase oversubscribed new issue before other clients. This tends to appreciate considerably
in price as soon as they become available on the market because demand for this issue is
higher than supply. The prices if oversubscribed IPOs tends to increase until supply and
demand come into equilibrium. If you are an investor who does not get the first right to buy
new issues, there is still an opportunity to make money but it involves doing a substantial
amount of work analyzing the issuing companies.
Here are some points that should be evaluated while looking at new issues:
1) Why the company elected to go public?
2) What the company plans to do with the money raised?
3) What is the competitive landscape in the market for the business?
4) What is the company position in the landscape?
5) What are the company growth prospects?
6) What is the Management like?
7) What level of profitability does the company expect to achieve?
8) What is the business operating & financial history?
Page 61 of 64

9) Management stake & promoter stake in the company?

10) Do they have a history of success in business ventures?
Most recent IPO have resulted in decent listing gains for the investors. The listing gains have
probably initiated a kind of virtuous cycle, tempting investors who have already made money
to return to primary market. There is also a reason to believe that companies are pricing their
issues less aggressively this time, either due to leave something on the table for all investors.
Companies have been quick to take advantage of the investors interest in IPOs and banks,
broking houses, retail outlets, media houses government companies are lining up issues. Even
mutual fund have gone into the act and are tailoring the offer to match current market like
fancy mid-cap funds, dividend yield fund etc. If the government wants to get some money
into its kitty through disinvestment programmes, this is the right time to go for it.

Page 62 of 64

CHAPTER 19: RECOMMENDATIONS

Initial return given by the IPO should not be treated as indication of its success or
failure in the long run.
Investors of the secondary market must take part in the primary markets as it has been
seen that IPO activity in Indian Stock Market has been tremendously growing and
investing in good IPO is one of the safest stock market investment.
Oversubscription alone should not be treated as an indication of success of the issue.
Investors must analyze all the sectors before investing in the IPO, in order to get
maximum returns.
Investors should take into consideration the promoters of the business, the prevailing
market trend & recent IPO performance before investing in an IPO.

Page 63 of 64

BIBLIOGRAPHY
Books & Magazines
Financial Management Prasanna Chandra
The Chartered Accountant Journal of Institute of Chartered Accountant in India
Websites
www.nseindia.com
www.sebi.org.in
www.investopedia.com
www.icai.org
www.hdil.in
www.ipogrades.com
www.crisil.com
www.investorguide.com

Page 64 of 64