All you wanted to know about

The book-built initial public offer (IPO) of Wonderla Holidays has created a splash, jolting the primary market awake. The ₹180- crore offer was over-subscribed by 37 times, with HNIs (high net worth investors) in particular falling over one another to ride with the theme park operator.

Whoa, wait! Why should Wonderla auction its shares, invite bids and all this, if it’s so popular with investors? Can’t it simply fix the price at which it will sell shares to the public? No, it can’t, as per the Securities Exchange Board of India (SEBI’s) rules, which require certain issuers to go public only through the ‘book-building’ route.

Book-building is an auction process by which an unlisted company sells shares to the public. Any company seeking an IPO needs to meet three criteria. It should have had ₹1 crore in net worth and paid out dividends for three out of the last five years. It should also raise not more than five times its net worth.

Now, many start-ups seeking to go public find that they cannot meet these criteria, mainly the one about dividends. SEBI allows such companies with a limited financial track record, to raise money through a book-built offer. In book-building, the company invites bids from the public on how it would like to value the business. The firm opens its ‘book’, putting a certain number of shares on the block, sets a ‘price band’ and invites investors to bid. If the offer receives enough bids within the price band, the IPO is concluded.

Why is it important?

SEBI rules don’t stop simply with saying who should make a book-built offer. They also specify who may bid in the offer. Thus, 60 per cent of the shares sold in any book-built offer have to be reserved for institutional investors. Another 35 per cent is to be reserved for small individual investors (up to ₹2 lakh), and the remaining 15 per cent for HNIs.

A company making a book-built offer lives and dies by the response of institutional investors. If big investors find the business suspect or the offer price fanciful, they would simply keep away. This would be the cue for small investors also to give the IPO a wide berth.

By relying heavily on institutional investors, book-building was supposed to make primary markets safer for the small investor.

With well over half the IPOs in the last decade decimating value for investors, a safety mechanism was certainly needed. But if book-building is so fool-proof, you ask, how did offers such as Reliance Power, Future Capital and MCX sail through? They have all tanked post-offer.

Well, institutional investors aren’t wholly immune to emotions, herd mentality or greed. After all, institutions are run by individuals. In the bull market of 2007, many institutions piled on to book-built offers from firms with hardly any financial record, aiming for a quick gain on listing.

Nor did retail investors always take their cues from the institutions. An entire crop of dubious IPOs with minimal institutional participation sailed through in 2011, thanks to overwhelming support from HNIs, with retail guys following in their wake.

The best-laid plans of regulators often go awry. A retail investor may not have the analytical skills of a big institution, but then, nor does he have its risk appetite. Blindly following in the footsteps of the big guys can result in grief.

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