IPO pricing: Towards book building method
Monday, 18 January 2010
Faruq A Siddiqi
Bangladesh capital market has been witnessing an impressive growth since 2007. During this period, daily turnover has increased from about Tk. 300 million to Tk 10 billion. Growth of market capitalisation is just about five hundred per cent. Market capitalisation to GDP ratio has improved from a meagre 7% to more than 25%. Today we are poised for the transformation of the market from a frontier market to an emerging market.
However, the rapidly growing market has created some problems as well. The most serious problem is demand and supply mismatch. Supply of scrip could not keep pace with the growing demand. This often resulted in pushing the price up beyond a reasonable limit and the market had propensity to become risky for inexperienced investors.
Today, there are over two million BO account holders operating in primary and secondary markets. Trading is no more confined to Dhaka and Chittagong. It has extended to many other places. All these positive developments have put pressure on the limited good shares. Therefore, in the interest of stability of the market, the most demanding task is to bring more companies under listing to satisfy the growing appetite of the investors. This has not been happening as fast as it should. More than a third of the present market capitalisation is from the banking sector as the banks are obliged to be listed due to regulatory compulsion. This is nearly complete and there is not much prospect of new supply of shares from this sector. The other prospective area is offloading at least a portion of government-held shares in different companies through the stock market. This has also slowed down and in last more than a year, the government did not offload any share through the stock market. Besides, government-owned companies, eligible for listing, are limited and are likely to dry up in the near future. This brings us to the third option, which should be the most important targeted option - and that is the private sector.
Private sector entrepreneurs are largely reliant on the banking system for funding. There is not much enthusiasm for exploring the possibility of funding their business enterprises from the capital market despite the fact that cost of fund from the capital market is generally more favourable. There is also no liability for repayment of the fund or payment of interest at a fixed interval. In spite of these advantages, not many entrepreneurs are coming forward to the capital market. Why so? This needs to be studied in greater details. But some factors for this reluctance may not be far to seek. To start with, many of our entrepreneurs are not familiar with capital market. They are familiar with the banking system. Most of the time, banks have surplus liquidity and entrepreneurs generally have access to a large number of entrepreneurs who would prefer to keep ownership and management of their business within the family. That may be an important reason for avoiding capital market. There could be another group who want to avoid transparency. Listing with stock market involves more regulatory control. There are requirements for regular financial disclosures which are scrutinised by the regulators and a large number of market intermediaries and investors. Listed companies are also required to comply with securities laws and hold transparent AGMs regularly. These may not be pleasant suggestion to some entrepreneurs. Again, some business houses may have hesitation on corporate governance issue. Listed companies are required to abide by corporate governance guidelines of the SEC. This is not acceptable to some entrepreneurs - especially to first generation businessmen. There is a substantial corporate tax relief for listed companies. Even this generous tax concession has not been successful to allure companies to come to the stock market.
Generally, established and profitable companies complain that IPO pricing policy does not attract good companies. It is true that in some cases, trading price on the very first day of trading was few times higher than the issue price. It is argued that because of this conservative IPO pricing policy, main benefit goes to the traders and not to the companies. The wide difference between market price and issue price is cited as an example of unfair IPO pricing policy that discourages companies with good fundamentals to come to the capital market. Although stock price in a heated market may not always be a reflection of fair price, there could be some truth in this argument. To address this problem, SEC moved towards book building as an alternative method of IPO pricing. After a long deliberation, rules regarding book building method were notified in March, 2009.
Prior to the introduction of book building system, IPO price was determined only under fixed price method. Under this method, when issue price of the ordinary share is higher than the face value premium is required to be justified with reference to certain parameter. These reference points were net asset value per share, earning based value per share, projected earnings per share for the next three years, average market price per share of similar stock and other factors taken into account by the issuer. Clearly, this system is not rigid and there is sufficient scope for the determination of market-based IPO price. However, a company intending to issue IPO is required to obtain prior approval of the SEC. The Commission approves a proposal when it is satisfied on all points including the proposed price of the IPO. Therefore, ultimately IPO price depends on discretionary authority of the Commission. This may not be an acceptable position to an issuer. Besides, in view of rather blurred criteria, judgment of the Commission could be questionable. To be on the safe side, the Commission may also prefer to take a conservative position. In view of these constraints, a market-based method was being considered by the Commission for some time and book building method was the outcome of such deliberation.
Although rules were amended in March, 2009 making provision for the book building method, the Exchanges took some time to make necessary arrangements including updating software for the purpose. This is now in place and price discovery through institutional bidding process took place in case of a company recently. Hopefully this new system of modern market-based pricing policy will attract well-established companies to the capital market.
In order to be eligible under the book building method, the issuer company must have a minimum net worth of Taka 300 million and be in commercial operation for at least three years. The issuer is also required to offer at least 10% shares of paid-up capital or Taka 300 million at face value, whichever is higher. The process will be completed in three stages.
First step of the process is the determination of indicative price. The issuer is required to invite offer for indicative price. Institutional investors approved by the Commission are eligible to participate in the process. Indicative price will be determined on the basis of indication from at least five institutional investors. Price so established shall be the basis for formal price building with an upward and downward band of 20%. Issuer in association with eligible investors shall quote indicative price to the Commission for its consent.
The second step starts with eligible institutional investors taking part in book bidding within the price band. The bidding period will be three to five days and no bidder shall be allowed to bid for more than 10% of the total security offered for sale.
The allotment to institutional investors will be made on the basis of the weighted average price of the bids that would clear the total number of securities set aside for them.
The third step is the allotment process to general investors and starts with the opening of subscription to them. IPO price for the general investors shall be fixed at the cut-off price of institutional bidding. General investors will include Mutual Funds and NRBs also.
Depending on size of the issue, quota for institutional investors will vary from 20% to 50%. As usual, quota for Mutual Funds and NRBs will remain at 10% each. Public portion of the issue will therefore vary from 30% to 60%. Notable features of the method are that IPO price discovery is being made on the basis of market mechanism without intervention by the SEC. The price discovery process is restricted to participation of the institutional investors only. This is likely to ensure mature and responsible bidding on the basis of proper assessment by the professionals. The system also ensures that under no circumstances a general investor pays more than an institutional investor. There is also provision for lock-in of fifteen trading days from the first trading day on the security issued to institutional investors. Presumably, this has been done to ensure that institutional investors do not sell shares in bulk disturbing the market before the price stabilises. However, since a company is required to have a minimum net worth of Taka 300 million to qualify under the system, smaller companies will not have access to the book building method.
It is expected that by ensuring market-based price of the public offer the new policy will encourage bigger and performing companies to come to the capital market. Proper IPO price is likely to open up an alternative source of cheaper funding. Besides, with the growth of economy the banks may not be in a position to offer long-term credit in the future. At that point of time the capital market is likely to grow very fast. The hesitant entrepreneurs may also come to realise that their business cannot grow beyond a point unless they come out of family management and ownership concept and opt for corporate governance by the professionals.
The author is a former Chairman, Securities and Exchnage Commission. He can be reached at e-mail:
faruqasiddiqi@yahoo.com
Bangladesh capital market has been witnessing an impressive growth since 2007. During this period, daily turnover has increased from about Tk. 300 million to Tk 10 billion. Growth of market capitalisation is just about five hundred per cent. Market capitalisation to GDP ratio has improved from a meagre 7% to more than 25%. Today we are poised for the transformation of the market from a frontier market to an emerging market.
However, the rapidly growing market has created some problems as well. The most serious problem is demand and supply mismatch. Supply of scrip could not keep pace with the growing demand. This often resulted in pushing the price up beyond a reasonable limit and the market had propensity to become risky for inexperienced investors.
Today, there are over two million BO account holders operating in primary and secondary markets. Trading is no more confined to Dhaka and Chittagong. It has extended to many other places. All these positive developments have put pressure on the limited good shares. Therefore, in the interest of stability of the market, the most demanding task is to bring more companies under listing to satisfy the growing appetite of the investors. This has not been happening as fast as it should. More than a third of the present market capitalisation is from the banking sector as the banks are obliged to be listed due to regulatory compulsion. This is nearly complete and there is not much prospect of new supply of shares from this sector. The other prospective area is offloading at least a portion of government-held shares in different companies through the stock market. This has also slowed down and in last more than a year, the government did not offload any share through the stock market. Besides, government-owned companies, eligible for listing, are limited and are likely to dry up in the near future. This brings us to the third option, which should be the most important targeted option - and that is the private sector.
Private sector entrepreneurs are largely reliant on the banking system for funding. There is not much enthusiasm for exploring the possibility of funding their business enterprises from the capital market despite the fact that cost of fund from the capital market is generally more favourable. There is also no liability for repayment of the fund or payment of interest at a fixed interval. In spite of these advantages, not many entrepreneurs are coming forward to the capital market. Why so? This needs to be studied in greater details. But some factors for this reluctance may not be far to seek. To start with, many of our entrepreneurs are not familiar with capital market. They are familiar with the banking system. Most of the time, banks have surplus liquidity and entrepreneurs generally have access to a large number of entrepreneurs who would prefer to keep ownership and management of their business within the family. That may be an important reason for avoiding capital market. There could be another group who want to avoid transparency. Listing with stock market involves more regulatory control. There are requirements for regular financial disclosures which are scrutinised by the regulators and a large number of market intermediaries and investors. Listed companies are also required to comply with securities laws and hold transparent AGMs regularly. These may not be pleasant suggestion to some entrepreneurs. Again, some business houses may have hesitation on corporate governance issue. Listed companies are required to abide by corporate governance guidelines of the SEC. This is not acceptable to some entrepreneurs - especially to first generation businessmen. There is a substantial corporate tax relief for listed companies. Even this generous tax concession has not been successful to allure companies to come to the stock market.
Generally, established and profitable companies complain that IPO pricing policy does not attract good companies. It is true that in some cases, trading price on the very first day of trading was few times higher than the issue price. It is argued that because of this conservative IPO pricing policy, main benefit goes to the traders and not to the companies. The wide difference between market price and issue price is cited as an example of unfair IPO pricing policy that discourages companies with good fundamentals to come to the capital market. Although stock price in a heated market may not always be a reflection of fair price, there could be some truth in this argument. To address this problem, SEC moved towards book building as an alternative method of IPO pricing. After a long deliberation, rules regarding book building method were notified in March, 2009.
Prior to the introduction of book building system, IPO price was determined only under fixed price method. Under this method, when issue price of the ordinary share is higher than the face value premium is required to be justified with reference to certain parameter. These reference points were net asset value per share, earning based value per share, projected earnings per share for the next three years, average market price per share of similar stock and other factors taken into account by the issuer. Clearly, this system is not rigid and there is sufficient scope for the determination of market-based IPO price. However, a company intending to issue IPO is required to obtain prior approval of the SEC. The Commission approves a proposal when it is satisfied on all points including the proposed price of the IPO. Therefore, ultimately IPO price depends on discretionary authority of the Commission. This may not be an acceptable position to an issuer. Besides, in view of rather blurred criteria, judgment of the Commission could be questionable. To be on the safe side, the Commission may also prefer to take a conservative position. In view of these constraints, a market-based method was being considered by the Commission for some time and book building method was the outcome of such deliberation.
Although rules were amended in March, 2009 making provision for the book building method, the Exchanges took some time to make necessary arrangements including updating software for the purpose. This is now in place and price discovery through institutional bidding process took place in case of a company recently. Hopefully this new system of modern market-based pricing policy will attract well-established companies to the capital market.
In order to be eligible under the book building method, the issuer company must have a minimum net worth of Taka 300 million and be in commercial operation for at least three years. The issuer is also required to offer at least 10% shares of paid-up capital or Taka 300 million at face value, whichever is higher. The process will be completed in three stages.
First step of the process is the determination of indicative price. The issuer is required to invite offer for indicative price. Institutional investors approved by the Commission are eligible to participate in the process. Indicative price will be determined on the basis of indication from at least five institutional investors. Price so established shall be the basis for formal price building with an upward and downward band of 20%. Issuer in association with eligible investors shall quote indicative price to the Commission for its consent.
The second step starts with eligible institutional investors taking part in book bidding within the price band. The bidding period will be three to five days and no bidder shall be allowed to bid for more than 10% of the total security offered for sale.
The allotment to institutional investors will be made on the basis of the weighted average price of the bids that would clear the total number of securities set aside for them.
The third step is the allotment process to general investors and starts with the opening of subscription to them. IPO price for the general investors shall be fixed at the cut-off price of institutional bidding. General investors will include Mutual Funds and NRBs also.
Depending on size of the issue, quota for institutional investors will vary from 20% to 50%. As usual, quota for Mutual Funds and NRBs will remain at 10% each. Public portion of the issue will therefore vary from 30% to 60%. Notable features of the method are that IPO price discovery is being made on the basis of market mechanism without intervention by the SEC. The price discovery process is restricted to participation of the institutional investors only. This is likely to ensure mature and responsible bidding on the basis of proper assessment by the professionals. The system also ensures that under no circumstances a general investor pays more than an institutional investor. There is also provision for lock-in of fifteen trading days from the first trading day on the security issued to institutional investors. Presumably, this has been done to ensure that institutional investors do not sell shares in bulk disturbing the market before the price stabilises. However, since a company is required to have a minimum net worth of Taka 300 million to qualify under the system, smaller companies will not have access to the book building method.
It is expected that by ensuring market-based price of the public offer the new policy will encourage bigger and performing companies to come to the capital market. Proper IPO price is likely to open up an alternative source of cheaper funding. Besides, with the growth of economy the banks may not be in a position to offer long-term credit in the future. At that point of time the capital market is likely to grow very fast. The hesitant entrepreneurs may also come to realise that their business cannot grow beyond a point unless they come out of family management and ownership concept and opt for corporate governance by the professionals.
The author is a former Chairman, Securities and Exchnage Commission. He can be reached at e-mail:
faruqasiddiqi@yahoo.com