The Hindu : Book-building: An efficient aid in mega public issues

Online edition of India's National Newspaper
Monday, Mar 22, 2004

Business

Business

Book-building: An efficient aid in mega public issues

Book-building is the most practical mechanism for quick and efficient management of mega issues.

THE TERMS `book-building,' `price band,' `floor price' and `book runner are very much in the news these days, in the context of the high profile disinvestment in six public sector undertakings. Book-building is the most practical mechanism for the quick and efficient management of mega issues (including offers of sale).

The SEBI (Disclosure and Investor Protection) Guidelines, 2000, define the term `book-building' in a rather complex language 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 determination of the quantum of such securities to be issued by means of a notice, circular, advertisement, document or information memoranda or offer document.''

Interestingly the term used is body corporate, in place of the usual company. The guidelines do not define the term `body corporate' but the Companies Act, 1956 (the Act) explains that body corporates or corporations include a company incorporated outside India. This is as it should be because it will also enable companies incorporated outside India but having shares in companies registered in India to divest through the book-building route. According to the Securities and Exchange Board of India, "the facility of book-building in the capital issuance process would provide the issuer and lead merchant banker the flexibility of price and demand discovery.''

In simple terms, book-building is a mechanism by which the issue price is discovered on the basis of bids received from syndicate members/brokers and not by the issuers/merchant bankers. However, it is felt that this system will be more suited for companies that are in existence for some time as past financial data are available for analysis and there will be awareness of the company, etc. (Suresh Krishna, Chartered Secretary, April 2002).

Malegham panel's

recommendations

The introduction of book-building in India in 1995 followed the recommendation of an expert committee appointed by SEBI under Y. H. Malegam "to review the (then) existing disclosure requirements in offer documents,'' two of the terms of reference being "the basis of pricing the issue'' and "whether substantial reduction was possible in the time taken for processing applications by SEBI.'' The committee recommended and SEBI accepted in November 1995 that the book-building route should be open to issuer companies, subject to certain terms and conditions. Some of the important terms and conditions were:

(a) The option should be available only to issues exceeding Rs. 100 crores;

(b) The issuer companies could either reserve the securities for firm allotment or avail themselves of the book-building process'

(d) A book runner to be nominated from among the lead market bankers charged with specific responsibilities and the name submitted to SEB;I and

(e) The requirement of 25 per cent of the securities to be offered to the public will be applicable.

There have been several amendments/revisions to the above guidelines; the first one in December 1996 made available the option of book-building to all body corporates which were otherwise eligible to make an issue of capital to the public, and in case of undersubscription, the spill-over from the public portion could be permitted to the placement area and vice-versa. In 1997, the restriction of the facility to 75 per cent of the issue was thought to severely constrain the benefits arising out of price and demand discovery, and the facility was extended to 100 per cent of the issue, available only if the issue amount was Rs.100 crores and above, compulsorily offering an additional 10 per cent of the issue size to the public through prospectus, and reserving at least 15 per cent of the issue size to individual investors applying up to ten tradable lots. Further, audited financial ratios had to be disclosed, namely, EPS for last three years, P/E, average return on net worth in last three years and net asset value based on last balance sheet.

However, there were no takers for the 100 per cent book-building facility. Based on suggestions made by leading merchant bankers, the following amendments were made to the guidelines in 1999: (i) the issuer may be allowed to disclose either the issue size or the number of securities to be offered to the public; (ii) allotment should be in demat mode only; and (iii) reservation of 15 per cent of issue amount for individual investors need not be made. This could be offered to the public at a fixed price. Some of the earliest mega issues through the book-building route were those of Larsen & Toubro, ICICI and Tisco.

SEBI guidelines

In January 2000, SEBI came out with a compendium of guidelines, circulars and instructions to merchant bankers relating to issue of capital, including those on the book-building mechanism. The compendium includes a model timeframe for book-building: "After the price has been determined on the basis of bidding, statutory public advertisements for a continuous three days containing, inter alia, the price as well as a table showing the number of securities and the amount payable by an investor, based on the price determined, shall be issued and the interval between the advertisement and issue opening date should be a minimum five days.''

The draft prospectus to be circulated has to indicate the price band within which the securities are being offered for subscription. The bids have to be within the price bands. Bidding is permissible only if an electronically-linked transparent facility is used. An issue company can also fix a minimum bid size. An initial bid can be changed before the final rate is determined.

Two of the recent mega issues, one by Petronet LNG and the other by Biocon, were both through the 100 per cent book-building route. Prospective bidders were advised to read the red herring prospectus carefully. According to the Act, a red herring prospectus means a prospectus that does not have complete particulars on the price of securities offered and the quantum of securities offered. The Concise Oxford Dictionary gives the meaning of `red herring' as a misleading clue or distraction, so named from the practice of using the scent of red herring (a silvery fish) in training hounds.

The 2000 Amendment to the Act gave legal cloak to the book-building route by allowing circulation of the information memorandum and the red herring prospectus. According to the Act, information the memorandum denotes a process undertaken prior to the filing of a prospectus by which a demand for the securities proposed to be issued by a company is elicited, and the price and the terms of the issue of such securities are assessed by means of a notice, circular, advertisement or document. Incidentally the working group on the comprehensive Companies Bill, 1997 (since lapsed) had advocated introduction of book-building. It defined the term as "an international practice that refers to collecting orders from investment bankers and large investors based on an indicative price range. In capital markets, with sufficient width and depth, such a pre-issue exercise often allows the issue to get a better idea of the demand and the final offer price of an intended public offer.''

Application in delisting

Interestingly, SEBI has made it compulsory for promoters of companies desiring to delist to determine the exit price for delisting in accordance with the book building process. The final offer price is to be determined as the price at which the maximum number of shares has been offered. The acquirer shall have the option to accept the price. If the price is accepted, the acquirer shall be required to accept all offers up to and including the final price but may not have to accept higher priced offers. SEBI has given the following illustration:

If the offer is accepted, the acquirer has to accept offers up to and including the final price, that is,240 shares at the final price of Rs. 130.

S. Balakrishnan

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