Over 90% of the public issues now use the book-building process to arrive at a market-driven “best price” for the shares they offer for subscription. The apparent justification to prefer this route over the fixed price route is that it allows for “price discovery”. Buyers, not the seller, decide the price of the share. That is the objective or the assumption. In reality, no price discovery happens—definitely not through the retail investors. Instead of a fixed price, book-built issues have a narrow price band, within which investors “discover” the price. Worse, this price band too is fixed during pre-issue consultations with big investors.
The primary reason for the unanimous preference of book-building is the liberty to make allotments to chosen big investors—as much as 50% of an issue gets allotted to institutional investors (termed as qualified institutional buyers, or QIBs). This element of discretion doesn’t exist in fixed-price issues, where the entire allocation is made on an anonymous basis. Sure, it is legal for an issuer to prefer one investor over another, but then the route should be private placement or preferential issue, and be subjected to the regulations that come with these routes, including a lock-in. In its current form, book-built issues assure subscription from QIBs, something not possible in a fixed-price issue.
The craze for book-building has strangely caught even listed companies for follow-on public issues whose share price is already “discovered” in the secondary market. It’s absurd to discover the price of a stock in two different markets simultaneously. But importantly, since such issues have to be offered at below market price, one big question emerges—does book-building actually help discover price? This raises another question: if book-building is truly an instrument of price discovery, then why such heavy oversubscriptions, why such huge listing gains?
It’s most illogical to use book-building for the retail segment, which cannot, and does not, discover the price. For lack of resources and understanding, 97% of retail participation comes at the cut-off price. If retail is going to use only the cut-off, why have book-building for them? QIBs and retail are entirely different classes of investors. It makes little sense to have a common book for both. Even in the case QIBs, I don’t think a real price discovery takes place, as bids are made within a price band.
To me book-building is about analysing fundamentals and prospects and arriving at a price one is willing to pay. In the present system, neither retail nor institutions discover the price. One can understand the QIBs attempting to discover price, but why bring small investors into book-building? The paltry quota for small investors leads to most applications being rejected or miniscule allotments being made. This, coupled with the oversubscription hype, creates a huge post-listing demand. It results in zooming prices, and QIBs make big gains exiting the IPO. My advice: small investors must realise that a good company at a bad price is a bad investment. Just as you do not buy every scrip in the secondary market, you should not chase every IPO.
(By Prithvi Haldea, Managing Director, Prime Database)