The Hindu Business Line : Building on bands to discover price

"The first-ever Islamic sukuk issue by an airline and also the first ever sukuk with a term of seven years, with the principal proceeds being paid on maturity," www.strategiy.com reports about Emirates netting $824 million through a book building exercise. The French government plans to sell at least 152 million shares in France Telecom, the country's largest phone operator, through a so-called accelerated book building, informs www.bloomberg.com. Recently SKF India brought to an end the reverse book building process to de-list itself after the discovered price came in at Rs 295, against the company's maximum offer of Rs 153, notes www.moneycontrol.com. "Reverse book-building is a difficult and costly affair," conceded M. Damodaran, Chairman, Securities Exchange Board of India (SEBI), a few weeks ago. But first, what is book building?

The Oxford Dictionary of Business jumps from `bonus shares' to `book-keeping' and then on to `book of primary entry' without devoting an entry for book building. www.investopedia.com explains the phrase as "the process by which an underwriter attempts to determine at what price to offer an initial public offering (IPO) based on demand from institutional investors".

An underwriter `builds a book' by accepting orders from fund managers, indicating the number of shares they desire and the price they are willing to pay, elaborates Investopedia, deriving the meaning of the phrase.

Please remember that a bookmaker is not the same as a book builder. The former, a.k.a. bookie, takes bets and pays out money to people who win,.

SEBI Guidelines define `book building' as a process undertaken by which a demand for the securities proposed to be issued by a body corporate is elicited and built up and the price for such securities is assessed for the determination of the quantum of such securities to be issued by means of a notice, circular, advertisement, document or information memoranda or offer document.

In layman's terms, when shares are issued through the book-building route, there is no fixed price; only a price band is announced by the company, on the advice of merchant bankers or Book Running Lead Managers (BRLM).

For instance, Provogue's ad speaks of Rs 130-150 band for its public issue of 40 lakh "equity shares of Rs 10 each issued for cash at a price of Rs [*] (including premium of Rs [*]) per share aggregating Rs [*] lakh".

Once the answer to the first asterisk is `discovered' through book building, you can fill up the other unknowns. Top of the band is called cap and the bottom, floor. Till the offer closes, the company receives bids from institutional investors and the public, each mentioning the number of shares and a price within the band. "After evaluating the bid prices, the company will accept the lowest price that will allow it to dispose the entire block of shares. That is called the cut-off price," explains Sulagna Chakravarty on http://in.rediff.com.

`Cut-off' price is arrived at on the lines of Dutch auction, explains an FAQ on http://investor.sebi.gov.in, assuming that you know such an auction is where the auctioneer starts by calling a very high price and reduces it until a bid is received. Thus, `discovery' takes place after the bids are processed; and you're successful as a bidder if the price you mentioned was at or above cut-off price.

Companies explain the process through an illustration in the red herring prospectus. If you see Jet Airways' document of February 8, there is an example of five bids for an offer size of 1,800 equity shares within a price band of Rs 20-24. There have been cases where companies have benignly finalised a price below the cut-off.

There is reservation in book building. Retail individual investors (RIIs), non-institutional investors (NIIs) and qualified institutional buyers (QIBs) share the pie in the ratio of 35: 15: 50 respectively. RII is one who applies/bids for securities of/for a value of not more than Rs 1 lakh.

Thankfully, investors can change their bids till the issue closes. And one can track on the BSE and the NSE sites for what's happening because they display the data regarding the bids obtained.

For those who are trawling the Net for more, there is Prafull Rai's `Demystifying book building' on www.indiainfoline.com, useful though dated. "Kotak Mahindra pioneered the concept of book built equity offerings in India for Hughes Software Systems Limited which was immediately followed by HCL Technologies with a Rs 823 crore book built offering," is a claim on www.kmcc.co.in that you can check out. `Investment Banking — User's Guide' on www.kontikicapital.com takes you through a comparison of the US and the UK/Australian models.

To the research-minded, here are a few leads. In Global Integration in Primary Equity Markets: The Role of US Banks and US Investors William J. Wilhelm, Jr., et al note that book building is becoming increasingly popular outside the US and typically costs twice as much as a fixed-price offer (http://gates.comm.virginia.edu).

Ensuring a successful book-building effort generally requires use of discriminatory tactics that draw criticism from investors and regulators alike, argued the author in an earlier paper titled, `Initial Public Offerings: Going by the Book'.

The initial impetus for the spread of book building was the wave of privatisations, which were first made fashionable by Margaret Thatcher of the UK, opines Ann E. Sherman in `Global Trends in IPO Methods: Book Building vs. Auctions' on www.gsb.stanford.edu. A 2004 research paper titled `Quid Pro Quo in IPOs: Why book-building is dominating auctions?' by François Degeorge et al shows that "in the French market, where the frequency of book-building and auctions was about equal in the 1990s, the ostensible advantages to the issuer using book-building were advertising-related quid pro quo benefits". The paper, however, concludes that underwriters using the book-building procedure have convinced issuers of the questionable value of advertising and promotion of their shares.

Which can make one wonder if Pete Dye's question — "Golf is not a fair game, so why build a course fair?" — may well apply to book building too?

ZeroBase@TheHindu.co.in

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