Getting into an IPO

By Prof. Samie

Global IPO Market

In recent decades, the global IPO market proved to be remarkably resilient. IPO activity weathered the 1987 market crash, the Russian debt implosion, the credit crisis of Long Term Capital Management, the Internet bubble bursting and 9/11. However, 2008s unprecedented financial crisis caused global IPO issuance to come to a near halt in mid-2008. midAfter 93 global IPOs in the first half of 2008, only 26 companies were able to raise over $100 million in the last six months of the year, down an incredible 91% year-overyear-over-year. For the year as a whole, the number of IPOs fell 78% to 120 and total proceeds dropped 69% to $81 billion. However, since then the IPO market has revived in 2009 and 2010.

Global IPO Market

IPO Proceeds (USD bn) for 2010 300 220.5 200 148.4 109 100 80.8 103 265 234.9

0 2004 2005 2006 2007 2008 2009 2010

Source: RenaissanceCapital.com. Reflects deals with gross proceeds of over US$100 million.

Global IPO Market

IPO # of deals
600 500 400 300 200 100 0 2004 2005 2006 2007 2008 2009 2010 257 177 118 345 457 555 480

Source: RenaissanceCapital.com. Reflects deals with gross proceeds of over US$100 million.

Global IPO Market

Proceeds (USD bn) 2004 2005 2006 2007 2008 2009 2010 109 148.4 220.5 265 80.8 103 234.9 # of deals 257 345 457 555 118 177 480 Per deal $m raised 424.1 430.1 482.5 477.5 684.7 581.9 489.4

Watch out for the value raised per deal going up and down.
Source: RenaissanceCapital.com. Reflects deals with gross proceeds of over US$100 million.

Global IPO Market

Largest Global IPOs of 2008
Company Visa China Railway Construction OGX Petroleo e Gas Reliance Power Alinma Bank Ma'aden EDP Renovaveis New World Resources Turk Telekom Zain Source: Renaissance Capital *Based on offer price to 12/31/08 closing prices Dual listing on the Hong Kong & Shanghai exchanges. Market Country United States Hong Kong Brazil India Saudia Arabia Saudia Arabia Portugal United Kingdom Turkey Saudia Arabia Offer Date 3/18/2008 3/6/2008 6/11/2008 1/21/2008 6/2/2008 7/25/2008 6/2/2008 5/2/2008 5/9/2008 3/21/2008 Size (US$bn) $17.86 $5.46 $4.09 $2.96 $2.80 $2.47 $2.44 $2.17 $1.91 $1.87 Industry Financial Capital Goods Energy Energy Financial Materials Energy Energy Communications Communications Return* 19% 8% -53% -73% 11% -47% -37% -80% -24% 6%

Source: RenaissanceCapital.com. Reflects deals with gross proceeds of over US$100 million.

10 Largest Global IPOs ever

Company ABC Bank ICBC Bank NTT Mobile Visa AIA ENEL SpA Date Jul-10 Oct-06 Oct-98 Mar-08 Oct-10 Nov-99 Exchange Hong Kong / Shanghai Hong Kong / Shanghai Tokyo Stock Exchange NYSE Hong Kong NYSE NYSE Tokyo Stock Exchange NYSE Hong Kong / Shanghai Sector Financial Financial Communications Financial Financial Utilities Capital Goods & Services Communications Communications Financial Underwriter Goldman Sachs (Asia) Merrill Lynch Goldman Sachs (Asia) J.P. Morgan Citi Merrill Lynch Morgan Stanley USD MN $19,228 $19,092 $18,099 $17,864 $17,816 $16,452 $15,774

General Motors Nov-10 Nippon Tel Deutsche Telekom Feb-87 Nov-96

Nomura Securities $15,301 Goldman, Sachs & $13,034 Co. Goldman, Sachs & $11,186 Co

Bank of China May-06

Source: RenaissanceCapital.com. Reflects deals with gross proceeds of over US$100 million.

Benefits of going public

Firm has access to a larger supply of capital Firms owners can obtain a market value for their share of ownership (Divestments in India) Firms owners can share risks with other investors Diversification among public investors may also result in lower cost of capital for the firm Some firms may decide to raise equity in order to reduce their amount of debt (Cemex) (Cemex)

Costs of going public

Loss of control for current owners Public firms are subject to more disclosure requirements Information on the firms financial health and business strategy becomes publicly available The firm must face the direct and indirect costs of issuing equity The firm must face the cost of underpricing in IPOs Take Over Target

Types of companies - IPO

A large firm going public to raise funds to use in acquisitions and compensation (e.g., Goldman Sachs, Reliance Power) A spin-off from an already publicly-traded firm (e.g., spinpubliclyAgilent from HP, Kraft from Philip Morris) A young firm seeking funds to expand (e.g., Amazon, Bharti Airtel) Government divestment (NHPC, Oil India)

Public vs. Private Company

Source : Morgan Stanley Dean Witter

Life Before and After IPO

Source : Morgan Stanley Dean Witter

Time Schedule for an IPO US

Source : Morgan Stanley Dean Witter

Time Schedule US Investment Bank

Source : Morgan Stanley Dean Witter

The role of equity research in IPO

Accountable to the investor Perform detailed due diligence on company and its prospects Develop financial model Articulate the story to investors during IPO marketing - Source of independent valuation, Provide institutions with analytical framework, Maintain close communication with institutions throughout marketing process and beyond Provide ongoing support with frequent reports, conference calls, 1-on-1 calls and electronic broadcasts to investment 1-oncommunity Research analysts ranked by investors annually Institutional Investor ranking an important milestone in analysts career

Eligibility for IPO in India

SEBI has laid down eligibility norms for entities planning to enter the primary market through public issues. An unlisted company needs to satisfy following criteria to be eligible for making a public issue:  Net tangible assets of at least Rs 3 crore for three full years  Distributable profits in at least three years  Net worth of at least Rs 1 crore in three years  If change in name, at least 50 per cent of revenue for preceding one year should be from the new activity  The issue size should not exceed five times the prepreissue net worth

Eligibility for IPO in India

SEBI also provides alternate routes to the companies not satisfying any of the above parameters, for accessing the primary market as follows:  Issue shall be made through book-building route, with bookat least 50 per cent to be mandatory allotted to the QIBs.  at least fifteen per cent of the cost of the project is contributed by scheduled commercial banks or public financial institutions, of which not less than ten per cent shall come from the appraisers and the issuer undertakes to allot at least ten per cent.  The minimum post-issue face value capital shall be postRs 10 crore or there shall be a compulsory marketmarketmaking for at least two years.

The main participants in IPO's

The main participants in the IPO process are:  The issuing firm (the firm that goes public)  The IPO underwriters  The IPO marketer (usually the lead manager)  The regulatory agency (SEBI)  The investors The issuing firm and the underwriter are faced with risks during the IPO process and they also may have conflicting interests. The issuer would like to raise as much capital as possible at the lowest cost to the current owners and thus would benefit by selling the shares at a higher price. The issuer must weigh the benefits of a high IPO price against the potential cost of a cold reception by investors

Steps in the IPO process - India

The IPO Process in India could be divided into four major activities:


Approvals and Appointments PrePre-Issue Process Pricing of offer PostPost-Issue Process

Approvals and Appointments

The private company seeks shareholder approval for the IPO. Informal discussions are started with several investment banks about the companys fund raising plan and the possible alternatives available to the company. The Companys management reviews the proposals sent by the investment bankers and appoints a lead manager (LM) and signs a MOU. In case a company hires more than one LM, then the responsibilities of each LM should be clearly defined during the time of appointment.

Approvals and Appointments

In consultation with the LM, the Company hires other agencies such as the registrar, the printer and public relations agency, bankers to the issue. Usually, the Company forms an internal issue team which comprises of the CFO, Company Secretary, Compliance Officer and Support staff. The Compliance Officer directly liaises with SEBI on the laws, rules, regulations and directives issued by SEBI with respect to investor complaints. The Company would also hire outside agencies such as law firms, auditors for the issue.

Pre Issue Process

The issue process begins with the Lead Manager conducting a Due Diligence on the Company and preparing the offer document in compliance with the regulatory requirements. The Lead Manager the issue budget to be spent on the issue which include fees for underwriters and lead managers, registrars, bankers, brokerage, postage, stationary, issue marketing expenses and fees for statutory costs. The board of the company has to approve the issue budget and the draft offer document prepared by the Lead Manager.

Due Diligence Process IB Perspective

Business Overview History, Mission statement/vision, Objectives and key challenges, Operational overview, Management team/organizational chart, Key investment highlights, Strategic position in the industry Industry Overview/Market Opportunity - Industry size/growth rates, Market drivers, Major industry trends (spending, commissions, etc.), Consolidation, Segmentation/target markets, Cyclicality, Regulatory environment Products / Services , Customer Break Down, Suppliers, Growth Strategy and Projections, Acquisitions Ventures, Legal Issues, Retention of Key Employees post - IPO

Pre IPO Issues

Once the draft prospectus is approved, it is filed with SEBI for their observation. SEBI would convey their objections if any within days of filing of the draft prospectus. SEBI would also place the draft prospectus on their website for comments from investors. On filing the offer document with SEBI, the Company enters into a quiet period during which corporate communication and advertisements are regulated. Applications are made at all stock exchanges for listing.

PrePre-IPO Process - Prospectus

An issuer may determine the price of specified securities in consultation with the lead merchant banker (fixed price) or through the book building process. In case of a book built offer, the first prospectus filed with the SEBI is called Draft Red Herring Prospectus that does not specify the issue pricing and therefore the total amount of the issue. Based on investor and SEBI feedback, a Red Herring Prospectus is issued with a price band and the number of share to be issued. After the bidding for the issue is closed, the Company has to file the final offer document with ROC with the final issue price mentioned.

Pricing of Offer SEBI Rules

ISSUE TYPE OFFER PRICE DEMAND PAYMENT RESERVATIONS

Fixed Price Issues

Price at which the securities are offered and would be allotted is made known in advance to the investors

Demand for the securities offered is known only after the closure of the issue

100 % advance payment is required to be made by the investors at the time of application.

50 % of the shares offered are reserved for applications below Rs. 1 lakh and the balance for higher amount applications. 50 % of shares offered are reserved for QIBS, 35 % for small investors and the balance for all other investors.

Book Building Issues

A 20 % price band is offered by the issuer within which investors are allowed to bid and the final price is determined by the issuer only after closure of the bidding.

Demand for the securities offered , and at various prices, is available on a real time basis on the BSE website during the bidding period..

10 % advance payment is required to be made by the QIBs along with the application, while other categories of investors have to pay 100 % advance along with the application.

Pricing an offer

Pricing of Offer
NTPC Power Generating Capacity Capacity Addition in 3-4 years Revenue EBIDTA EBIDTAM Interest Depreciation PBT Tax Adj. PAT Diluted Equity EPS CMP (U/L) P/E (U/L) P/BV (U/L) 30644 MW 10620 MW 41923.73 10397.82 24.80% 2022.9 2364.48 9359.47 1158.17 8201.3 8245.46 9.95 211 21.21 3.03 JP Hydro 300 MW Nil 296.67 245.58 82.78% 81.94 46.97 158.55 15.69 149.88 491 3.05 86 28.2 3.93 NHPC 5175 MW 4622 MW 3678.98 2589.11 70.38% 776.01 656.29 1529.35 167.79 1244.15 12300.7 1.01 36/30 35.6/29.6 2.02/1.74

On P/BV NHPC is cheaper than JP Hydro and NTPC but looks costlier based on P/E. Even near term growth seems to be limited as only 120 MW of power will be commencing operation in FY 10.

Post IPO Issues

The responsibility of finalizing the basis of allotment in a fair and proper manner lies with the executive director of the designated stock exchange along with the post issue lead manager and registrar. The basis of allotment is arrived at as per the prescribed procedure on proportionate basis according to the oversubscription received for the issue. There are other factors which could determine the entitlements in an IPO.

Post IPO Issues

The main task of post issue lead manager is to coordinate the process of collection of subscription figures from the bankers to the issue, processing of applications by the registrar, dispatch of allotment letters and refund orders to all the successful and unsuccessful applicants within the prescribed time, attending to investor grievances and ensuring the listing of the shares on the stock exchange. Trading commences on the day the stock exchange fixes after granting listing permission to the issuer company.

Retail Basis of Allotment Adani Power IPO

Shares Applied 65 130 195 260 325 390 455 520 585 650 715 780 845 975 Ratio 5:13' 3:4' Firm Firm Firm Firm Firm Firm Firm Firm Firm Firm Firm Firm Shares allotted 65 74 98 123 147 172 196 221 245 270 295 319 344 368

Firstly, all retail investors will not get an allotment. The ratio has been fixed at 5:13 for minimum applications, that means, out of 13 applications applied for 65 shares only 5 applications were selected for the allotment. The allotted applicant will get 65 shares. .

Grading of an IPO
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.  IPO grade 1: Poor fundamentals  IPO grade 2: Below-average fundamentals Below IPO grade 3: Average fundamentals  IPO grade 4: Above-average fundamentals Above 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.
Source : SEBI

Grading of an IPO
IPO grading can be done either before filing the draft offer documents with SEBI or thereafter - however, the Prospectus/Red Herring Prospectus, as the case may be, must contain the grade/s given to the IPO and IPO grading is mandatory. The company desirous of making the IPO is required to bear the expenses incurred for grading such IPO. IPO Grading is intended to provide the investor with an informed and objective opinion expressed by a professional rating agency after analyzing factors like business and financial prospects, management quality and corporate governance practices etc.

Source : SEBI

IPO Grading
However, irrespective of the grade obtained by the issuer, the investor needs to make his/her own independent decision regarding investing in any issue after studying the contents of the prospectus including risk factors carefully. The important point to note is that SEBI does not play any role in the assessment made by the grading agency. The grading is intended to be an independent and unbiased opinion of that agency. The grading is intended to be an independent and unbiased opinion of a rating agency and SEBI does not pass any judgment on the quality of the issuer company. Four credit rating agencies are registered with SEBI for this purpose: CARE, ICRA, CRISIL, FITCH.
Source : SEBI

IPO GRADING FIVE STAR SHOW

Rating agency CRSIL announced in June 2011 that the proposed initial share sale of Multi Commodity Exchange of India (MCX) would be given a 5 rating. CRISIL believes that MCX has strong fundamentals, especially reflecting its leadership position in the Indian commodity futures market. According to CRISIL, the grade also reflects MCX's leadership position in the Indian commodity futures market over the past four years it had an 82% share of the overall traded turnover in fiscal year 2010. CRISIL pointed out that the rating also considered the benefits that MCX would derive from amendments to the Forward Contracts (Regulation) Act -- that would allow trading of options and indices as well as participation by institutional investors. This would in turn increase the traded turnover on commodity exchanges.

IPO Grey Market

A `Kostak Rate` is the rate at which one can sell his/her IPO application (in an off market transaction) to someone else even before allotment or listing of the issue.

Company Vaswani Industries Ltd Timbor Home Ltd Birla Pacific Medspa IPO Rushil Decor IPO

Open 29-Apr2011 30-May2011 20-Jun2011 20-Jun2011

Close 03-May2011 02-Jun2011 23-Jun2011 23-Jun2011

Offer Price

Premium ----

Kostak Rate

Rs. 45 - Rs. +- Rs. 4 - 5 49 Rs. 54 - Rs. Rs. 7 - 7.50 63 Rs. 10 - Rs. Rs. 0.75 - 1 11 Rs. 63 - Rs. Rs. 3.50 - 4 72

---Rs. 2100 - 2200 (2 Lac) Rs. 2300 - 2400 (2 Lac)

21-Jun-2011 Warning: Do not subscribe to any IPO's on the basis of grey market price or IPO Forecast. Please check the fundamentals of the company before applying. Use grey market price as an informational tool.

Source : www.greymarket.co.in

What is Flipping ?
The practice of buying initial public offerings at the offering price and then reselling them once trading has begun, usually for a substantial profit. This is more commonly done by institutional investors than retail investors. Flipping is most profitable in a hot IPO market, when the price of an IPO often rises dramatically above the offering price on the first day. Because of flipping, it's a good rule not to buy shares of an IPO if you don't get in on the initial offering. Many IPOs that have big gains on the first day will come back to earth as the institutions take their profits.

CSFB Flipping Case

In January 2002, The Securities and Exchange Commission filed charges against Credit Suisse First Boston Corporation (CSFB), the New York-based Yorkbrokerbroker-dealer and investment bank, for abusive practices relating to the allocation of stock in "hot" initial public offerings (IPOs). The Commission simultaneously announced that CSFB agreed to pay a total of $100 million to resolve the Commission's charges and a related action by NASD Regulation, Inc. (NASDR).

CSFB Flipping Case

The complaint, which will be available on the SEC's website, includes the following allegations: CSFB had control over the allocation of most of the shares in IPOs of hot stocks including Selectica, Gadzooks Networks, and MP3.com In exchange for some of the highly-coveted stock in such highlyhot IPOs, CSFB wrongfully extracted from certain customers a large share of the huge profits those customers made in quickly selling (or flipping) the IPO stock bestowed on them by CSFB. Specifically, CSFB allocated shares of IPOs to more than 100 customers who, in return, funneled between 33 and 65 percent of their IPO profits to CSFB. These customers typically flipped the stock on the day of the IPO, often gaining tremendous profits.

CSFB Flipping Case

Customers then transferred a share of their flipping profits to CSFB by way of excessively high brokerage commissions (ranging from $0.19 per share to $3.15 per share - in contrast to the typical rate of about $0.06 per share). The customers paid these commissions on uneconomic, limitedlimited-risk trades in highly liquid, exchange-traded exchangeshares unrelated to the IPO shares - trades that they effected for the sole purpose of paying IPO flipping profits back to CSFB.

CSFB Flipping Case

The profit-sharing activity was pervasive at CSFB. profitSenior executives who were in managerial and supervisory roles knew of the practices described in the complaint, encouraged many of the practices described in the complaint, directed CSFB employees to urge customers to maintain specified ratios of commissions to IPO profits, and, in some instances, personally engaged in some of the practices described in the complaint. CSFB employees informed the relevant customers, both implicitly and explicitly, that they were expected to pay back to CSFB a portion of profits earned on their IPO flipping in order to continue to receive allocations.

CSFB Flipping Case

Customers who refused to funnel a portion of their profits to CSFB received smaller allocations, and in some instances were denied allocations altogether. The prevalence of CSFB's abusive practices is reflected in numerous e-mail messages and other ecommunications, examples of which are cited in the complaint. The profit-sharing customers received no more than 10 profitpercent of the IPO stock allocated by CSFB in each offering. IPO flipping was so profitable, however, that CSFB wrongfully obtained tens of millions of dollars in IPO profits through this improper conduct.

Two more IPO jargons

Laddering -- or aftermarket tie-in agreements, in which tiean underwriter promotes orders for an IPO at a higher price before trading starts, in an effort to boost the stock. In some cases, these agreements were a prerequisite for getting access to IPO shares at their lower offering price. Spinning -- a practice in which a brokerage firm gives IPO shares to an executive of a company in return for the company's investment banking business. From a regulation point of view, banks would also be prohibited from allocating shares to an executive who already has directed investment banking services toward the firm.

The under pricing of IPOs

The issuer in the IPO is faced with a tradeoff  If the offering price is too high, investors may not purchase the offer and the IPO will not be successful  If the offering price is too low, the firms existing owners will incur a loss given that they sell their shares at a price below their true value. Evidence shows that on the first day of trading of new stocks, the stocks price rises significantly above the issue price. This implies that there is considerable underpricing in IPOs.

Global IPO Under pricing

Country Australia Brazil Canada Indonesia Mexico Norway Taiwan UK US
Source: Jay Ritters web page

Sample size 381 62 500 106 37 68 293 3,042 14,760

Time period 1976-1995 19761979-1990 19791971-1999 19711989-1994 19891987-1990 19871984-1996 19841986-1998 19861959-2000 19591960-2000 1960-

Avg. first-day firstreturn % 12.1 78.5 6.3 15.1 33.0 12.5 31.1 17.5 18.4

Unconventional IPOs
In late 1990s, Travelzoo.com came with an innovative idea to promote the Company well before its IPO. The ambitious Net newbie assigned three free shares to everyone who registers with travelzoo. These new zoo-keepers can earn as many as seven zoomore shares by referring seven new owners. The company had lined up more believers in its IPO than the typically vanilla upstart vacation discount website. When Travelzoo had its initial public offering (IPO) on August 28, 2002, it was priced at $6.50/share. By January 2005 its share price had climbed to $110.62/share.

Unconventional IPOs
OpenIPO is an innovative auction process pioneered by the investment bank WR Hambrecht + Co for distributing stock in an initial public offering to individuals and institutions through an efficient and equitable process. It is a modified Dutch auction process which allows shares of an initial public offering to be allocated in an impartial way. All successful bidders pay the same price per share. Based on an auction system designed by Nobel PrizePrizewinning economist William Vickrey, the OpenIPO auction uses a mathematical model to treat all qualifying bids in an even-handed and impartial way. even-

Unconventional IPOs
WR Hambrecht + Co has used OpenIPO to take a number of companies public including Morningstar, Interactive Brokers Group, Overstock.com, Ravenswood Winery, Clean Energy Fuels, and, most notably, functioned as cocomanager to take Google public in 2004. Many traditional investment banks have balked at the idea of using an auction process, such as OpenIPO to engage in public securities offerings as this new method allows for equal access to the allocation of shares and eliminates the behind the scenes dealings of shares and favorable treatment often found in conventional IPOs. Despite other banks resistance to using this method, however, OpenIPO has been gaining traction in recent years and has been utilized for over 20 public offerings to date.

Should you invest in an IPO?

A study by two university professors a few years back looked at 4,753 IPOs and 3,702 secondary offerings made between 1970 and 1990. In the six months following the offering, IPO firms lost 1.1%, versus a 3.4% gain for matching firms that made secondary offerings. The new issues continued to under perform over the next three years, with the gap narrowing but persisting well into the seventh year following the IPO. Not surprisingly, companies make IPOs when the market is up, when business is going well -- essentially, when they can sell shares at the highest price possible.