A new era in the primary mart

Better option: Auctioning to give greater freedom to share price discovery

As the Indian capital market is evolving with the time it is getting bigger in terms of number of stocks listed, number of of investors, foreign investors, instruments available for investments and the depth and the width of the market. Keeping pace with the change, the main market regulator, Securities and Exchange Board of India (Sebi) is also constantly ammending the rules governing the market.

Ten days ago Sebi took the market reforms to next level by introducing a significant change in the way institutional bidders invest in follow-on public offers (FPOs) by allowing allotments through auctions. 

Of course, it is only an additional method of book building, wherein bidders would be free to bid at any price above the floor price, yet allotment is on a price priority basis and at differential prices. However, retail individual investors, for whom normally 30 per cent of shares are kept, will get shares at the floor price — in effect, they will generally pay less than institutional investors.

Sebi amended the Issue of Capital and Disclosure Requirements (ICDR) Regulations, or Listing Agreement, to allow pure auctions for qualified institutional investors (QIPs) in FPOs. To start with, FPOs are floated by companies who are already listed on bourses but want to raise funds by issuing some more equity shares.

Another major decision made by Sebi Board was allowing stock exchanges to set up a separate SME (small medium enterprises) platform. With this, the regulator ruled out a separate bourse for SME saying it was not necessary and eased the way for listing with a new set of eligibility norms for companies on SME platform.

Other than the pure auction method for FPO, Sebi also took some investor-friendly initiatives which helped in achieving greater transparency too.  One, it made mandatory for companies to disclose their half-yearly balance sheets along with their audited or un-audited results.  Corporate India now discloses only interim results, while the balance sheet goes with the annual report. Then Sebi relaxed the time available to companies for disclosure of limited quarterly results to 45 days from the existing 30 days. It also reduced the time line for disclosure of audited financial results to 60 days from 90 days and decided to provide an option to all listed entities with subsidiaries to submit their consolidated financial statements as per international financial reporting standards (IFRS). 

The regulator also relaxed Fast Track Issues (FTI) requirement like reducing the average market capitalisation of public shareholding of the issuer from Rs 10,000 crore to Rs 5,000 crore, while pegging the annualised trading turnover to free float for companies whose public shareholding is less than 15 per cent of the issued capital.
 
Positive response

Dalal Street circles are happy with the ‘pure auction’ move by Sebi.  Says Prabhudas Liladhar Capital Markets VP-Investment banking Dara Kalyaniwala, : “It is a fantastic idea. The real fun begins now, as those investors who are convinced about a particular issue will invest at a higher price to seek allotment and those not-so-convinced can invest at a lower price.”

Concurs Prime Database MD Prithvi Haldea, saying: “Auction for QIPs is welcome as it would allow risk-taking entities and not just promoters to be part of the price discovery process.”  Besides, he avers: “It gives the company a better price as it is not limited by a band and the institutions get a free hand to buy at any price.  Finally, the retail investors get the shares at the lowest price.”
The intent is to help India Inc raising resources.  Earlier there were huge subscriptions and great demand for an issue, yet the company could not get more money, points out SMC Capitals Equity Head Jagannadham Thunuguntla: “This becomes more relevant in the context of the recently announced divestment plans and FPOs by the government for public sector units.”  Meaning, that when the government chooses to divest part of its selected PSUs, instead of relying on just the market price to figure out what the divestment entails, it can go in for an auction to get the real price.

Most merchant bankers are eager to see how this will work with quite a few PSU FPOs in the pipeline to hit the primary market soon.  The state run Rural Electrification Corporation (REC) has already made an announcement of its FPO, other PSUs to follow include NMDC, MMTC, RCF, Coal India, Engineeers India, National Fertilizers and Neyveli Lignite Corporation, to mention a few.

Benefit to PSUs

The very timing of the Sebi’s move implies that it seeks out to fetch real value for PSU stocks but the policy — needless to say — is for all including private sector. From the time, Sebi introduced a faster and more efficient QIPs, not too many Indian firms have taken FPO route to raise equity but the scene may change now with the government planning to go for phased divestment of its stake in PSUs, point out experts who cite that from 19 issues raising Rs 12,764 crore in 2005, the number of FPOs went down to just one issue raising Rs 23 crore in 2008.  In the calendar year 2009, just one company — Rishabdev Technologies Ltd — raised Rs 22.62 crore through an FPO and in contrast 40 issues have raised a total of Rs 28,434.5 crore in 2009 through QIPs.
Some investment bankers opine that the new norms do not make FPOs attractive as compared to QIPs. In this context, Vantage Corporate Services CEO Rajesh Dedhia, says: “the issuers preference for a particular route to raise capital is a function of how long it takes to raise money and at what valuation.”  On these counts QIPs do score over FPOs, says he adding: “By bringing flexibility in the bidding process, we are not  making FPOs more attractive.”

Some even say the experiment may not significantly change the way fund raisings are done.  “In an FPO, the new mechanism will have a marginal impact as the price band will typically be narrow as the market price will act like cap price,” says Director of Ripple Wave Equity Mehul Savla, adding: “Also, the book will reflect the actual demand for the shares as compared to the proportionate allotment method.  Under the auction method, retail and high networth investors will surrender their choice to play a part in the price discovery as they would be allotted shares at the floor price discovered in the auction.” 

All things considered, the new norms are still significant especially at a time when the government is considering a proposal to eventually increase public holding in all listed companies to 25 per cent, to be achieved via phased reduction of stake over three years through FPOs.  Even though the auction method has not been mandated by Sebi, which only says a company could choose this, or the book-building method, one school of thinking in Dalal Street recommends that the regulator may as well look at applying its new standards of FPOs to IPOs as well.  Haldea of Prime Database, an IPO-tracking firm, says: “Once the pure auction system is implemented, the era of oversubscription in the QIB category will end.”  It is only apparent that Sebi is taking measured steps since the current structure put an end to complaints on IPOs before it was introduced.

On SME listing

Sebi’s announcement of a separate platform for SMEs in bourses with exclusive guidelines were hailed by merchant bankers saying smaller companies were currently getting lost amid the big ticket IPOs in the primary market.  “The SME platform envisaged now by Sebi seems to be on the lines of the AIM — alternative investment market — on the London Stock Exchange and it would be better,” says Kalyaniwala of Prabhudas Leeladhar Capital.  Companies having a paid-up capital between Rs 10 crore and Rs 25 crore qualify as SMEs and they have an option of either being on the SME platform or the main bourses.  A minimum paid-up capital of Rs 10 crore would be needed for listing on the main boards of BSE, NSE.  The move is expected to make fund-raising easier for close to three crore micro, small & medium enterprises in the country that account for 40 per cent of domestic industrial output.  Till now, SMEs have had to depend on either informal finance or expensive loans.

What’s more?  Companies seeking listing on SME platform will be exempt from the eligibility norms applicable to IPOs and FPOs prescribed in ICDR Regulations of 2009.  Sebi Chairman C B Bhave makes it clear saying: “The existing minimum net worth and profitability criteria would not be applicable for SMEs to get listed.”

For an investor, the minimum application size in an SME IPO has been pegged at Rs 1 lakh.  This may not seem like retail investor-friendly move but merchant bankers opine that it allows them to take more informed decisions.  As the chances of manipulation with respect to smaller companies are much higher, Thungutla of SMC Capital points out: “Those investors with the right amount of knowledge and liquidity will be the ones investing in these IPOs.”

Merchant bankers entrusted with the responsibility of market making in SMEs have to ensure the issue is underwritten 100 per cent, in which a minimum of 15 per cent mandated to be compulsorily underwritten by the former itself.  What gladdens them is that the minimum number of investors in an SME issue is restricted to 50 nos. as compared to a minimum of 1000 investors in the regular issue, as of now. 

Haldea of Prime Database says the merchant bankers will have to be highly confident over the financials of a company to associate with it and ensure that they not only price the issue properly but also provide proper valuations.  “They will now be more responsible while pricing the issue,” adds he. Considering other shareholder-friendly initiatives of Sebi ranging from greater disclosure in balance sheet to adoption of IFRS by listed companies, it is hoped that the regulator will follow-on to help investors understand their investment decisions better in the days to come.