What is Initial Public Offer, IPO? And should you invest in an IPO?

IPO is the easy way out to distribute fractions of partnerships in lieu of shareholders money. In IPO, companies allot shares at a price which is way above the face value, and investors lap up those shares by paying the Premium above the face value.

Basically, what is IPO ?

IPO  (Initial Public Offerings ) means offering shares of a private company to the public for the first time. By this route, the company becomes a public limited company with a plethora of QIP (Qualified institutional Partners), Angel investors, Anchors,  HNIs (High Networth Individuals), NBFCs and public shareholders.

But why do the companies go for IPO knowing that their business has to be bared before every investor ? Why IPO !

How will I apply for an IPO, What is Initial Public Offer, IPO ? And should you invest in an IPO ? Initial Public offer, What is Initial Public Offer, IPO, should you invest in an IPO
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You know that any company has to expand for survival. It has to invest in new technologies to remain relevant and afloat. Those days are long gone when Ambassador Mark IV differed from Ambassador Mark III only by some cosmetic changes.
It has to expand in capacity. In this regard note how Interglobe Aviation (Indigo for aam admi) is edging out Spice jet and Jet Airways from the Tier III cities and new Northeast routes owing to its greater fleet size and newer models.
Large corporations invest in a greenfield project. Investing in greenfield projects needs hundreds of crores of capital and it's not easy to find finance for such big projects.
Even when the large corporations find the financer like Softbank or Bank of China or Bank of Japan, sometimes the rates are too high making the break-even difficult.
Long-term loans with lower interest (say for ten years) may not be always available for a project whereas the gestation period for the project to start operation and generate cash flow may be lengthy. For such long gestation period projects, short or medium loans may not be feasible.
Lo and Behold ! Here comes the IPO to their rescue.
IPO is the easy way out to distribute fractions of partnerships in lieu of shareholders money. In IPO, companies allot shares at a price which is way above the face value, and investors lap up those shares by paying the Premium above the face value. This money goes as the shareholder's fund into the company's balance sheet. In return, the investor gets a part of profit (as a dividend) or profit as capital appreciation in those share's price.

A brief on the process of IPO :

For an IPO the company sends "Letter of Approval ", prospectus of the company, as request for approval of the IPO by the exchanges and SEBI. Each exchange has a team of experts who scan the prospectus of the company. They decide whether the company can qualify for the IPO. They examine the background of promoters, financial condition of the enterprise over the last three years etc. If the exchange approves it, the enterprise can only then use the name of that exchange as listing place in the prospectus. The prospectus itself has to be also modified as per directions of the exchange before its placed before QIPs, HNIs and the general public,
Once the company gets the approval , it starts the "bookbinding process". It engages financial institutes like Morgan Stanley, Goldman Sachs, JPMorgan Chase, JM Financial, Kotak Mahindra Bank and other merchant bankers to manage it's IPO.
In the "book binding" method, the company issues a price band with a lower floor price and an upper ceiling. The merchant bankers try to enthuse the investors from various fields to invest in this book building process. For this, it conducts road shows, places advertisements in all types of media as per SEBI guidelines and prints brochures. During the bookbinding process, the merchant bankers entice the QIPs,Anchor Angel investors and HNIs to place bids within the issuing price range.They bid in different price ranges as per their understanding of the company. But this price has to be within the price band offered by the firm. Volume is the main point here. The price which attracts the maximum bid (volume wise) becomes the issue or cut off price. HNIs, QIPs who bid below the cut off price are returned their bid amount, so are those who bid at the higher end of the band. The merchant bankers who arrange the "syndicate" of private investors to bid during the book building process are called "book runner".
Once book building is completed, the price which is nearest to the highest bid volume is chosen as the issue price. This is the price at which the normal investors have to bid for this IPO.
The bids for the IPO are frequently oversubscribed. This means that there are more numbers of bidders than the total issue. This manifests in two forms. You will be allowed lesser number of shares than you applied for and the opening price on the debut of these in secondary market is likely to be way above the issue price. In other words,, if you are allocated shares in the IPO, you are likely to make a neat profit on the debut, f you sell them at the beginning.
But beware of two facts. The first is that after the initial euphoria, many debutant IPO stocks have slid in the second session or towards the late afternoon. The second fact is that no company can meet up the expectations or the promises it made throughout its lifetime and it will come down at some point in time. No business is immune to adverse events. So, if you are not investors who keep the shares for decades in his demat e locker, sell it when it re Now comes the question that whether aches lofty valuations.

Should you invest in an IPO ?

You should invest in the IPO only when the quality of the incumbent is good.
Remember, by selling the shares, the company gets interest free non-returnable capital. In return, you get a part of the net profit in form of capital appreciation or dividends. But you can only get these when the company is capable of making profits . So, before subscribing the IPO, take  a 360-degree view of the company's business.
Bury yourself in the prospectus of the company into which you will be investing your thousands and lakhs.
Check the order book, quality of orders and the sectors who give the maximum orders.
Are these sectors likely to feel stress in future? In such a case the orders may turn out to be albatross around the neck and become non-paying instead of money spinners.
Look at the addition of new customers in a couple of preceding years. The business you are applying for should grow with time. The revenue should increase with each passing year and so should the net profit.
The rate of revenue increase cannot remain constant and high all the time. But it should be 75% profit and 25% net loss for the preceding years.
Are the products offered by the company a monopoly in it's field?. And more dangerously, is it commanding a hefty premium on valuation for this fact?
Then stay away if the premium is too much. I reiterate this because monopoly doesn't remain forever. When the monopoly ends, the fall is severe and you would most likely get the stock at much lower rates below the issue price. Take airtel for instance.  It commanded a premium for its coverage and true 3G speeds.
Jio came and disrupted the whole business model of Airtel. The premium it commanded eroded rapidly. Now, Airtel has to consolidate its African operation with the Indian ones to airbrush the results.
If the company has too many subsidiaries, stay away. More the subsidiaries, more opaque will be the operation of the conglomerate. You would n't get a whiff of money when a hundred crore of shareholder's capital gets transferred as an interest-free long-term loan to its loss-making subsidiary. See what happened with 8K miles. When such a  news surfaced, a thousand rupees share dropped to rupees fifty.
As its impossible for you (retail investor) to understand the financial parameters stated in the prospectus of the IPO, consult a qualified accounting professional to point out the hits and misses based on the IPO proposing manual.

How will I apply for an IPO ?

To participate in an IPO, PAN card and demat account is a must. As a retail investor, you can apply for a maximum share lot worth 2 lakhs. There will be a minimum bid size known as one lot . You can bid for one lot or higher in multiples of that IPO market lot.
You have to apply via your broker or by ASBA. In ASBA, login in your bank account, you will have an ASBA section, where you will have the convenience of applying for the IPO. If you apply online from here, that amount of money in your savings account will remain blocked in an escrow account in the bank itself.It will get deducted automatically for the number of shares allotted in that IPO. So, there's no need for money transfer to the merchant banker or IPO agent and again returning that in case of non-allotment .
There have been a lot of successful IPOs and lot of unsuccessful ones like Reliance Power in 2008. Do not go only by the rosy future picture painted by the company, but look at its present and preceding financial conditions, promoters track records, proposed business models etc. to understand the quality of conglomerate you will invest in.