Basics of stock market 5: What happens after the IPO process
Now you got an understanding of how the company comes forwards in filing the IPO process. Once the IPO is live, there are still many challenges the company has to go through to successfully come out of the IPO. Let’s take a look at what these challenges are and learn some terminologies along the way.
Table of contents
Primary market and Secondary market
In simple terms, the primary market is where the securities (shares) are created and the secondary market is where these securities are traded.
Primary market
This is the place where the companies first sell their shares or securities through IPOs. Additional to IPOs, rights issue, bond issue, share buyback is also conducted through primary market. Here the company will be directly involved in the transaction when you buy shares through IPO.
Secondary market
The secondary market is the stock market where the buyers and sellers come to trade. The exchanges act as the secondary markets here. We have 2 main exchanges in India, the National stock exchange (NSE) and the Bombay stock exchange (BSE). Here, while buying shares, the company will not be involved since you are buying shares from another investor who wishes to sell.
Subscription
This refers to the number of people who have subscribed or brought the offering of the IPO when the company first came with its offer. These can be people like you and me or big institutional investors like LIC or banks. In fixed price issues, we can know this count only after the closure of the IPO while in the book building method, we can know after each day of the IPO process. Since the company releases a fixed number of shares for its IPO, we can determine how the IPO performed by comparing how many people brought the shares to the number of shares allotted.
Cut off price
This is the price they fix for the IPO when the shares are allotted using the book building method. Suppose the IPO is allotted with a price band of 120-130 and after the IPO closure the listing price is set to 125. Thus, 125 will be the cut-off price.
So, in terms of fixed price IPO, it will be the fixed price which we will be referring to and in the case of book building method IPO, we will be referring to cut off price.
For people like you and me, often referred to as retail participants, we need to go to our trading terminal (the place where we buy shares) and allot ourselves the required shares of the IPO company which we are going to buy.
There are 2 scenarios that can happen in the case of subscription:
Oversubscription
Sometimes the demand for the shares is higher than the number of shares that are being sold in the IPO. This can happen when a reputed company has come for an IPO. When Zomato came for an IPO in 2021, the IPO was oversubscribed by 38 times. They come for the IPO to raise 719 million but received bids for 27.5 billion. This is mainly because Zomato is the leading online food delivery solution in India and has been in the Indian market for 13 years making a name for itself.
Although this is good in terms of IPO, it has a negative effect on the investors. Now, the bidding will go for a draw and only a few ones will be lucky to get the shares. Suppose I subscribed to Zomato for 100 shares, since it's oversubscribed, the chances of getting the allotment for me is less. Even if I get an allotment, I will be getting a portion of the bidding I asked for. Maybe, I might not get an allotment at all and come back empty-handed. In this case, I would have to buy the shares once it gets listed in the stock market.
Greenshoe option: This is an oversubscription option where the merchant banker agrees to sell an additional 10-15% of the shares if the demand is high. This is called the greenshoe option because, in 1919, the Green Shoe manufacturing company was the first to issue this type of option. This option provides additional price stability to a security issue because the underwriter (merchant banker) can supply and smooth out price fluctuations.
Under subscription
This typically happens when people are less interested to buy the shares and the shares of the company don’t sell-off. This happens when the demand is lower than the supply. If the company came with 100 shares to be sold and could get only 80 shares to be sold in the IPO, this means its undersubscribed.
According to SEBI, every company needs a minimum subscription of 90% of the issued amount on the date of closure. In the event of this not happening, the company refunds the entire subscription amount it received. There is no loss to the investors in this scenario as the money they invested will be refunded. The issuing (IPO company) will not receive any money tough. Although there isn’t any profit or loss made here, the confidence the company has will suffer a blow in the market.
For example, HAL was subscribed at only 50% during the third day of its IPO. But when LIC decided to invest, their percentage subscription skyrocketed to 99%. Even ICICI IPO was undersubscribed as many investors felt that the IPO evaluation was far too high.
Sometimes, when the IPO is undersubscribed, the company reduces the price to accommodate additional investors. Back in 2008, Google was forced to slash the price from the original $108-$135 a share to $85-$95 per share. In the end, they fixed the price at $85 per share due to low demand.
How to subscribe to an IPO?
Retail investors have the option to go to their trading terminal which is provided by the broker you are associated with and give the subscription. You will need to select the correct IPO from the list of IPOs which they are showing and give the required number of lots based on your capital. The number of shares in one lot will be defined on the same page itself.
By this, you will need to allocate your shares in this IPO process. Once you go through the option, you would have to pay the amount through the online portal given on the screen. After your successful purchase of the lot, the allocation will be done on your behalf in the book-building process. The money which you are paying will be blocked under ASBA.
ASBA (Application Supported by Blocked Amount)
ASBA is a process developed by India’s stock market regulator SEBI for applying IPOs. In this process, an IPO applicant’s bank account doesn’t get debited until shares are allotted to them. This is an application containing an authorization to block the application money in the bank account while subscribing to an IPO. There are around 56 banks that support ASBA and since your bank is linked with your trading terminal, they will be guiding you. These banks are also called Self Certified Syndicate Banks (SCSBs).
In this, the SCSB has to accept the application, verify the application, block the fund to the extent of the bid payment amount, upload the details in the web-based bidding system of NSE, unblock once the basis of allotment is finalized, and transfer the amount for allotted shares to the issuer (IPO company).
Listing Gain
The listing day is the day the company starts trading publicly in the stock market. The company officially comes into the secondary market.
Suppose you are buying the IPO allotment and are selling right after the company is getting listed in the stock market, particularly day-1. Usually, when the IPO is oversubscribed, the price at which the stock starts trading will be higher than the allotted price. This difference is the gain you will be getting. This higher price is mostly due to the higher demand for the stock post listing. In this scenario, the trader tries to make a profit by selling these shares and booking a profit.
Suppose if I got shares at a bid price of 200 on the IPO offer. If on listing day, the share of a company opens at 230, or at a 10% upward price than the bid price, the listing gains would be 10%.
Why many investors don’t participate in IPO
There can be many arguments why people don’t participate in an IPO. One reason is that the company and the active banker promote the company’s share for their IPO process. They try to create hype around the stock through various marketing techniques. This allows the company to inflate IPO price, especially if the IPO becomes oversubscribed.
One other reason is, the business owners of the company will be willing to sell their shares only at a favorable price environment. The business can delay and cancel its IPO if the market isn’t favorable. So, if the owner thinks he will get a better price on the IPO next year, he will most probably hold the IPO for next year. This makes it very difficult for the investor to find a bargain for the IPO price.
There is a large information gap between the buyers and the sellers here. Although the DRHP document highlights important details there is a very limited range of historical data at the investor’s disposal making it difficult for the investor to analyze the company. But the owner on the other hand knows insider information, something which the investor is unaware of. This can be a potential risk to the company’s operations or some undisclosed issue with the company’s finances.
Individual investors like you and me find it very difficult to get the IPO allocation. The majority of the IPO shares are generally allocated to large institutions, qualified institutional buyers, or high net worth investors. This makes it very difficult for retail investors to get the allocation.
Conclusion
Now the company is listed in the stock market. You are the lucky few who got the allotment and you are thinking of keeping the shares for the long term. You are super excited to have the shares and look forward to upcoming IPOs as well. Throughout the journey of the IPO, you have been hearing about SEBI. You might be curious about who is this SEBI and what roles does SEBI plays in India, right?
There are quite a number of cases where SEBI rescued companies as well as demolished companies on fraud activities. Even SEBI catches people doing fraud and manipulative activities in the stock market. That is the power SEBI has in India. Let’s understand a bit about SEBI in the next article.
Stay tuned!