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Monday, October 01, 2007

Open auction may decide IPO price

An auction-based method for pricing of initial public offers may replace book-building, with the government aiming to bring in more transparency and efficiency in share sale.

Market regulator SEBI’s primary market advisory committee (PMAC), which has been asked to prepare a paper on various price discovery mechanisms, is examining the issue. While no final decision has been taken, it is possible that SEBI might opt for a method similar to the Dutch auction process used in the Google initial share offer.

The government had discussed the proposal with SEBI after which the panel was entrusted with the task. According to one model being considered by the committee, qualified institutional buyers will be told to bid for shares in an open auction. The lowest bid will then become the fixed price for retail investors.

Generally, in an open auction, investors are asked to indicate the price and number of shares they wish to buy. The issuer then allocates certain shares in a descending order of prices till the amount of shares to be issued is exhausted. The lowest bid price is accepted as the deemed price and all investors pay this price. In case of oversubscription, allocation is done on a pro-rata basis.

Consider a situation where a company wants to sell one million shares. The underwriters rank the demand for shares in descending order of prices till one million shares are reached. If the total demand is for two million shares, then the highest price bids adding up to one million shares is considered. The lowest price becomes the price at which shares will be allocated.

“In an auction method, the issuer gets the right value for shares, institutional investors get shares at a price they want and retail investors can then buy it at the lowest price offered by a qualified institutional buyer,” Prithvi Haldea of Prime Database said.

Open auction has become the preferred way to discover the price in Japan and France, among other countries. In the US, the concept was pioneered by venture capitalist Bill Hambrecht and was used in the Google IPO, although the concept is yet to gain popularity in that country.

The government’s move to look at alternatives to book-building method for price discovery comes against the backdrop of an increase in pre-IPO share placements. In last few years, most companies hitting the capital market have opted for a private placement just ahead of the IPO. In most such deals, while institutional investors managed to bag shares at a lower price, retail investors, who bought shares through the IPO, had to pay a higher price.

Also, there is a strong view that book-building, which was introduced in India in 1999 as an alternative to fixed prices, did not lead to any real price discovery, since a price band is already prescribed. Experts feel underpricing is rampant, as the listing price in case of most IPOs is much higher than the issue price, reports The Economic Times.

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