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Determination of IPO price through Price

Discovery Process
(Book Building Floatation Method)

By
Mahmood Osman Imam Ph.D.
Professor and Former Chairman
Department of Finance
University of Dhaka

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IPO in Primary Market New Issue Management

Initial Public Offering:


Initial Public Offering means first offering of security by
an issuer to the general public.

It is an unseasoned new issue in terms of first time offering


of shares by a specific firm to the public.

Undertaking an IPO moves the firm from the private to the


public domain.

Repeat Public Offering:


It is a seasoned new issue by a listed firm to the public
again.

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IPO in Primary Market New Issue Management

IPO Rationale:
mechanism for assisting the firms initial shareholders in
diversifying their holdings.
assist managers (often the firms founder[s]) in procuring the
necessary funding for undertaking new projects.

The IPO enables these individuals to sell a portion of their


holdings in the firm and utilize the funds generated from the
sale of stock to diversify their investment risk (Rock, 1986).
Both goals can be simultaneously achieved.
Arkebauer (1991) found that the need to generate funds to
pursue new projects dominated portfolio diversification.
For many entrepreneurial ventures, an IPO enables firm
management to pursue growth opportunities that would
otherwise be impossible to fund.

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IPO in Primary Market New Issue Management
Why do companies go public (list)?
At some point in time, in the life cycle of a firm's external financing for
growth, privately-held firms generally find it desirable to "go public" by
selling stock to a large number of diversified investors.
Possible incentives for going pubic:

First, it enables a firm to raise new equity funds for expansion and future
investment.

Second, it may enable the original owners of the firm to realize part of their
investment, and thus can serve as an important exit route for the
entrepreneur or venture capitalists.

Third, it provides a mechanism for assisting the firms initial shareholders in


diversifying their holdings.

Fourth, once the stock is traded, this enhanced liquidity allows the firm to
raise additional capital via secondary issues..

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IPO in Primary Market New Issue Management
Advantages of Listing or Going Public
The best way to raise fund for your company
Liquidity
Enhancement of efficiency
Outreach to investors for future finance need
Tax Benefit
Enhanced Reputation
Disadvantages of Listing or Going Public
There are costs associated with listing or going public, too. These are:
Ongoing costs of compliance associated with the need to supply
information on a regular basis to investors and regulators for publicly-traded
firms.
Furthermore, there are substantial one-time costsnamely,
Direct costs that comprise costs of legal, auditing & underwriting fees
etc., and
Indirect cost, if the shares are sold for less than investors would be
willing to pay (i.e. underpricing).
These direct and indirect costs affect the cost of capital for firms going
public

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IPO New Issue Management
IPO Process:
Upon deciding to undertake an IPO, firm management must
first secure the services of a issue-manager (& lead
underwriter as well).
The issue-manager assist firms managers in preparing the
extensive paperwork involved in complying with SEC
guidelines, including the registration statement, of which the
prospectus is a part.
Prospectus/IM is these materials that serve as the primary
marketing tool for the firms securities.
The IPO marketing process is punctuated by what is called a
road show.
These presentations focus on the firms operations, products
and services, and management.
The road show is designed to gauge the anticipated demand
for the firms stock and serves as a key input in the merchant
bankers final determination of the price at which the firms
stock will initially trade.

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IPO New Issue Management
IPO Process:
Upon completion of the road shows, and just prior to the
actual first day of trading, firm managers and the
underwriters shepherding the process will set the initial
offering price.

This is a critical decision point for firm management because


once the price has been set, shares cannot be offered to the
initial investors at a higher price the first day of trading
regardless of the level of demand (Gordon & Jin, 1993).

It is this initial stock price that forms the basis for


underpricing given that underpricing represents the
difference between the initial stock price set by IPO firm
managers and the underwriters, and the price of the stock at
the close of the first day of trading.

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IPO New Issue Management
IPO Mechanism in Bangladesh:
The Securities and Exchange Commission (Issue of Capital) Rules,
2001 requires that a company intending to raise capital in Bangladesh
shall first make an application to the Securities and Exchange
Commission for consent.

Firms file registration statements that will include preliminary


prospectus that specify information about the firm, the securities
being offered for sale, and the expected use of proceeds. The audited
financial statements of the issuer (not older than 120 days at the time
of submission to the Commission) must also be submitted along with
the application, prospectus/red-herring prospectus/IM.

After receiving the application, the exchange(s) shall submit its


primary recommendation to the Commission along with checklist,
within 20 days, after due examination of public offer documents.

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IPO - New Issue Management
IPO Mechanism in Bangladesh:

Commission finds that the application does not fulfill all the requirements, it
may, within thirty days of receipt of application, direct the applicant to
comply with the requirements within such time as the Commission may
determine, and

On fulfillment of such requirements, the Commission shall accord the


consent as prayed for within thirty days of such fulfillment.

The commission, after the examination of the information, documents,


recommendation of the exchanges and considering all the factors, shall
take decision to approve or reject the application for public offer.

Once the staff declares registration statements effective, firms are free to
price and sell securities, and they typically access the market as soon as
possible thereafter.

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IPO PROCESS
Advisor
Selection

Valuation of
Assets and
Restructuring

Selection of
Merchant Bank
to the Issue/

Underwriters

Draft
Prospectus

Application
Submission

Consent
from SEC

Figure1: Phases Prior to Attaining the Consent from SEC


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Submission of
Prospectus
IPO PROCESS

Announcement
for the investor

Provide full
Prospectus

Application
for Listing

Subscription
Period

Transaction
rate for NRB
subscription

Applying to
Stock Exchanges
for Listing

Consent of
Listing

Figure 2: Phases after Procurement of the Consent from SEC 11


IPO Floatation Methods
IPO and Floatation Methods:
Fixed Price Method
Book Building Method (Two Stage Fixed Price Method)
Auction Methods (Price Driven Methods)
Sealed-bid Auction
Continuous-bid Auction
Private Placement

Requirements to an issue of capital through public offering in BD:


Consent for public offer may be made on any of the following methods:
Fixed Price Method, when offered at par value; or
Book-building method , when offered above par value.

General Requirements: Issuer offers an amount at least equivalent to 10% of its paid up
capital (incl. intended offer) subject to the minimum of Tk. 15 crore at par value.
It has minimum existing paid-up capital of Tk. 15 crore;
The issue manager is in no way connected with the issuer and does not hold any of its
securities;
It has got its latest financial statements audited by the panel auditors as declared by the
commission;
It has been regular in holding AGM.

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IPO Floatation Methods
Fixed Price Method (FPM):
In a fixed price method, shares are offered for sale at pre-determined price
set by the issue manager on behalf of the issuer.
Under BSEC (Public Issue) Rule, 2015, Sec. 2(g) states that fixed price
method means the process by which an issuer offers its securities at par
value.
Additional Requirements for FPM:
If it has been in commercial operation at least for immediate last 3
(three) years, it has positive net profit after tax and net operating cash
flow at least for immediate preceding 2 (two) financial years; if it has
been in commercial operation for a period of less than 3 (three) years, it
has positive net profit after tax and net operating cash flow at least for
the latest financial year; if it has not started its commercial operation or
not completed any financial period yet, it has positive projected net
profit after tax and net operating cash flow; and
At least 35% of the issue has been underwritten on a firm commitment
basis by the underwriter(s);

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IPO Floatation Methods
Book Building Method
Under BSEC (Public Issue) Rule, 2015, Sec. 2(b) states that book-building method
means the process by which an issuer attempts to determine the price to offer its
securities based on demand from the eligible investors.

Additional requirements for BBM or Prerequisites of an issuer for becoming


eligible for application for public offering under BBM:
An issuer may determine issue price of its security being offered following book-building
method (i.e. price discovery process) subject to compliance with the following, namely:
The issuer-
has been in commercial operation at least for immediate last 3 (three) years;
has made positive net profit after tax at least for immediate preceding 2 (two)
financial years;
has net operating cash flow at least for immediate preceding 2 (two) financial years;
Has appointed separate person as issue manager and registrar to the issue for
managing the issue;
The issuer/issue has been rated by a credit rating company registered with the
Commission;
At least 35% of the issue has been underwritten on a firm commitment basis by the
underwriter(s).

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IPO Floatation Methods
Process for Book Building Method
Conducting Road Show and Submission of Application:
Issuer/issue manager shall send invitation to the eligible institutional investors (EI) to
the road show;
The invitation letter shall accompany a red-herring prospectus containing all relevant
information covering the proposed size of the issue and at least 3 (three) years
audited financial statements and valuation report, prepared by the issue manager
without mentioning any indicative price, as per internationally accepted valuation
methods.
The red-herring prospectus shall be prepared without mentioning the issue price or
number of securities to be offered;
Eligible investors shall submit their comments and observations, if any, to the issuer
or issue manager within 03(three) working days of the road show;
After completion of the road show, the red-herring prospectus shall be finalized on
the basis of comments and observations of the EIs participated in the road show. The
valuation report as finalized must be included in the red-herring prospectus including
detail about the qualitative, quantitative factors and methods of valuation;
The application along with the red-herring prospectus and required documents shall
be simultaneously submitted to the Commission and the exchanges as per rule
4(1)(a).
Consent for bidding to determine the cut-off price.

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IPO Floatation Methods
Process for Book Building Method
Determination of the cut-off price:
(i) Eligible investors shall participate in the electronic bidding process and submit their
intended quantity and price:
provided that any connected person on related party of the issuer shall not be eligible
to participate in the bidding process;
(ii) No eligible investor shall quote for more than 10% (ten percent) of the total amount
offered to the eligible investors;
(iii) Eligible investors bidding shall be opened for 72 (seventy two) hours round the clock;
(iv) The bidding will be conducted through an uniform and integrated automated system of
the exchanges, especially developed for book building process;
(v) The value of bid at different prices will be displayed on the screen without identifying
the bidders;
(vi) The bidders shall deposit at least 20% (twenty percent) of the bid amount in advance
in the designated bank account maintained by the exchange conducting the bidding;
(vii) The bidders can revise their bids for once, within the bidding period, up to 20%
variation of their first bid price;
(viii) After completion of the bidding period, the cut-off price will be determined at nearest
integer of the lowest bid price at which the total securities offered to eligible investors
would be exhausted;

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IPO Floatation Methods
Process for Book Building Method
Determination of the cut-off price:
(ix) All the eligible investors participating in the bidding shall be offered to subscribe the
securities at the cut-off price. It is mandatory for EIs bidding at or above the cutoff price to
subscribe up to their intended quantity but optional for EIs bidding below the cut-off price;
(x) The eligible investors shall be allotted securities on prorata basis within their category-
wise quota at the cut-off price. The category-wise quota shall be determined on the basis
of distributing the total securities reserved for other eligible investors equally to each of the
category of eligible investors participating in the bidding, except mutual funds. Mutual
funds shall be allotted securities reserved for them on pro-rata basis;
(xi) The securities shall be offered to general public for subscription at an issue price to be
fixed at 10% discount (at nearest integer) from the cut-off price;
(xii) The issuer and the issue manager shall prepare the draft prospectus including the
status of bidding, cut-off price, list of eligible investors with number of securities subscribed
for, price and number of securities for offering to the general public and submit with
relevant documents, simultaneously to the Commission and the exchanges within 5 (five)
working days from the closing day of bidding.
Subscription by the eligible investors:
(i) After examination of the draft prospectus and relevant documents, the Commission, if satisfied, shall
issue consent for raising of capital from the general public and approve the prospectus;
(ii) The balance amount of subscription shall be paid by the eligible investors prior to the date of opening
of subscription to the general public:

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IPO BB Floatation Methods
Book Building Method
The price discovery process through bidding
-- English Auction
-Truthful revelation Process

Distribution mechanism for issuance of security


Issue Method EII Quota General Public
MFs Other EIs NRB Others
Fixed Price 10% 40% 10% 40%
Book Building 10% 50% 10% 30%

provided that in case of under-subscription in any category by up to 35% in an


initial public offer, the unsubscribed portion of securities shall be taken up by the
underwriter(s):
further provided that in case of under-subscription in any of categories above
35%, an initial public offer shall be considered as cancelled.

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IPO BB Floatation Methods
Book Building Method
Lock-in --- 25% of the shares allotted to eligible investors, for 03 (three)
months and other 25% of the shares allotted to them, for 06 (six) months;
Others:
All shares held, at the time of according consent to the public offer, by
sponsors, directors and shareholders holding 5% or more shares, other
than alternative investment funds, for 03(three) years;
(2) All shares allotted, before 02(two) years of according consent to the
public offer, to any person, other than alternative investment funds, for
03(three) years;
In case any existing sponsor or director of the issuer transfers any share to
any person, other than existing shareholders, within preceding 12 (twelve)
months of submitting an application for raising of capital or initial public
offer (IPO), all shares held by those transferee shareholders, for 03(three)
years;

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IPO Floatation Methods
Book Building Method (Prior to Public Issue Rule 2015)
EIIs who support the indicative price should participate in the electronic
bidding process, at least with their intended quantity and indicative price.

However, as long as the total intended quantity by the EIIs, who support the
indicative price, does not reach 10% of the total issue size, the indicative
price shall not be treated as discovered.

Rationale for the indicative price must be included in the prospectus.

The indicative price shall be the basis for formal price building with an
upward and downward band of 20% (twenty percent) of indicative price
within which eligible institutional investors shall bid for the allocated amount
of security;

No institutional investor shall be allowed to quote for more than 5% (five


percent) of the total security offered for sale, subject to maximum of 5 (five)
bids.

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IPO Floatation Methods
Book Building Method
The institutional bidders will be allotted security on pro-rata basis at the
weighted average price of the bids that would clear the total number of
securities being issued to them.

General investors, which include mutual funds and NRBs, shall buy at
the cut-off price.

The Company and The Issue Manger shall submit the status of bidding
and the Cut Off price along with the final draft prospectus,
simultaneously to the Commission and the stock exchanges within 5
working days from the closing day of the bidding.

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IPO Floatation Methods
Book Building Method
The price discovery process through bidding
-- Modified English Auction
-Truthful revelation Process

Distribution mechanism for issuance of security

Issue Size in EII Quota MF Portion NRB Public


Face Value Portion Portion
30 50 cr. 40% 15% 10% 35% or
balance amt
Over 50 100 cr 50% 15% 10% 25% or
balance amt.
Over 100 cr. 60% 15% 10% 15% or
balance amt
Lock-in --- lock-in of 4 (four) months from the first trading day to EIIs

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IPO Floatation Methods
Fixed price Method:
It the offer price is higher than the par value justification of
the premium should be mentioned in the prospectus with
reference to the following as per sub-clause 16 of rule 8 of
Public Issue Rule, 2006:
net asset value per share at historical or current cost;
earning based value per share calculated on the basis of
weighted average of net profit after tax for immediately
preceding five years;
projected earnings per share for the next three
accounting year as per the issuers own assessment duly
certified by the auditor of the issuer;
average market price per share of similar stock for the
last one year immediately prior to the offer for common
stocks.
All other factors with justification which have been taken
into account by the issuer for fixing the premium.
If the issue is oversubscribed then rationing occurs.

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IPO New Issue Management

Underwriting the IPO:


At least 50% of the IPO size need to be underwritten.

Firm Commitment Vs. Best Effort.

In firm commitment in US, IB/underwriter(s) buys the


securities less than the offering price and accepts the risk of
not being able to sell them. In other words, underwriter
advances money against underwriting shares and sale
proceeds of these to public are then adjusted with their
advances.
In firm commitment in Bangladesh, underwriters provide a
form of guarantee that if any share remains
undersubscribed, then unsold shares would be undertaken.

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IPO New Issue Management

Price Stabilization:
Price stabilization support is provided by the underwriters in
US in the one month aftermarket. If the price will tend to go
below the subscription price, underwriter support price
pegging at the issue price.

Merchant banks, being the underwriters, in Bangladesh


could not afford to provide this sort of support.

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Bangladesh Securities Market
in 2010 and 2014 at a glance
Market Indicators End of 2009 End of 2010 End of 2014
Number of BO Accounts 1.78 million 3.3 million 3.02 million
DGEN/DSEx 4535.53 8290.41 4,864.96
Average Daily Turnover Tk. 6.04 billion Tk. 16.43 billion Tk. 4.99 billion
Total Market Capitalization Tk. 1903 billion Tk. 3508 billion Tk. 3259 billion
Number of IPOs 9 companies 11 companies 20 companies
Amount of Offerings Tk. 6.03 billion Tk. 23.55 billion Tk. 13.14 billion
Number of Companies offering RS 6 companies 22 companies 14 companies

Amount of Right Offerings Tk. 1.44 billion Tk. 24.72 billion Tk. 20.63 billion
Number of Listed Mutual Funds 7 12 41
Average Market P/E Ratio 25.58 30.50 17.77
Number of Brokerage 388 624 620
Branches/TREC holders
Number of Listed Securities 415 445 546
Number of Companies 279

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Fund Raising through Equity Market

Companies raise money from the primary market


through IPO and Right offer
In the last 9 years, on an average 15 new
companies got listed through IPO each year in
Bangladesh market.
As of May 2015, in total 324 companies are listed
(including 41 mutual funds) in DSE
During last 9 years, average yearly capital raised
through IPO and Right Issue are BDT 14956.54 mn
and 7825.31mn respectively.

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Fund Raising through Equity Market
Year No of new IPO IPO Issue Size (BDT Mn) Year Right offer (BDT Mn)
2006 7 3727 2006 1673.62
2007 14 10057 2007 598.79
2008 12 8270 2008 2112.32
2009 18 19047 2009 2439.87
2010 18 28653 2010 17601.14
2011 14 16899 2011 18589.51
2012 17 18175 2012 4979.09
2013 12 16640 2013 1803.04
2014 20 13141 2014 20630.45
Total 132 134608.86

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Critical Issues
The issue manager and issuer are held accountable primarily
for pricing the issue and secondarily the regulator as it
approves the vetting of the prospectus.

The short run price performance of IPOs that came into public
during 1991 to 2007 suggests that new issues are on average
underpriced.
Overshooting behavior does exist in the stock market in
Bangladesh.

It draws the attention for exerted role of external auditor in


discharging due diligence in ensuring earnings quality, revaluation
of assets, while certifying financial statements and furnishing full,
proper and sufficient disclosures for IPO firms

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THANK YOU ALL

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