Undersubscribed IPO: Meaning, SEBI Rules, and Investor Impact

An Initial Public Offering (IPO) is the process through which a company raises capital by offering its shares to the public for the first time. During this process, investors subscribe by bidding for shares within a set price band. Based on demand, an IPO can be oversubscribed (wherein demand exceeds supply), fully subscribed (wherein demand matches supply), or undersubscribed (where demand falls short of supply). Subscription level indicates investor interest and market sentiment.

What Is Undersubscription?

Undersubscription occurs when an IPO receives fewer bids than the number of shares offered by the company. In simple terms, demand from investors is lower than the supply of shares available. When undersubscription happens, investors who applied usually receive their full allotment since shares remain unclaimed. However, if the subscription level falls below the Securities and Exchange Board of India’s mandatory 90% threshold, the IPO fails, and companies must refund the money to applicants.

What Happens in Case of Undersubscription

• Price adjustment: If investor demand is low, the issuing company may reduce the IPO price to attract more subscribers, even if it means raising less capital than initially expected.

• Underwriters’ obligation: Companies often sign agreements with underwriters before the IPO. In case of undersubscription, underwriters are required to purchase the unsold shares, ensuring the issue goes through.

• Role of underwriters: Typically investment banks, underwriters not only backstop unsold shares but also help the company determine appropriate IPO valuation and market the issue to potential investors.

• Market expectations: Despite undersubscription, companies often remain optimistic, as listing day prices are influenced by broader market conditions and investor sentiment.

Reasons for Undersubscription

Undersubscription in an IPO generally reflects weak investor demand, which can stem from several factors. A common reason is lack of awareness about the issue. If the IPO is not marketed effectively, many potential investors may not even know it exists. Another critical factor is high pricing. If the price band is set above what investors consider fair based on the company’s fundamentals, participation tends to drop.

Poor marketing efforts also play a role, as inadequate communication about the company’s strengths, growth potential, and prospects fails to generate excitement. Broader market conditions heavily influence subscription levels too; bearish or uncertain markets discourage investors from taking fresh positions.

Finally, investors usually avoid IPOs if they detect problems or irregularities in the company’s financials, governance, or reputation, as such concerns create doubts about long-term value and stability.

Minimum Subscription of 90%

According to SEBI, every company needs a minimum subscription of 90% of the issued amount on the date of closure.

In the event of this not happening, the company refunds the entire subscription amount it received. There is no loss to the investors as the money they invested will be returned to them. The issuing company will not receive any money though.

Although there is no profit or loss made, the confidence enjoyed by the company in the market will suffer a blow.

How to Avoid Undersubscribed IPOs

First, check the grade assigned by SEBI to the company floating an IPO. The grading is done on a 5-point scale. The grade will be high if the company’s financial condition is in good stead and compares well to its competitors in the market.

Second, it is always advisable to go through the company’s red herring prospectus in detail. The document, which is uploaded on SEBI’s website, provides a range of information about the company’s financials, future plans, among other information.

Allotment of Shares

Since demand for IPO shares is lesser than the shares supplied, every bidder receives the full allotment. Say, an investor had bid for 10 lots of shares. If the IPO is undersubscribed, they would get all the lots they had applied for.

As mentioned earlier in the piece, in case the IPO is undersubscribed below 90%, the shares are forfeited and the money is refunded.

The taint of undersubscription can affect any company. For instance, Google, one of the technology giants, has also faced this issue in the past. Back in 2008, Google were compelled to slash the share price from the original $108-135 a share to $85-95 per share. In the end, it fixed the price at $85 per share due to low demand.

Does Undersubscription Lead to Losses After Listing?

Listing gains can be described as the difference between the allotment price at the time of the IPO and the stock price on the opening day at the stock exchange. If the opening day’s stock price is higher, the difference is known as listing gain.

Usually, oversubscribed IPOs tend to make gains on the opening day at the stock exchange. Undersubscribed IPOs, meanwhile, rarely record listing gains. But that’s not to say the stock is condemned to underperform throughout. These stocks can bounce back over time due to better confidence in the market, healthy financial state, and conducive market conditions.

A Few Cases of Undersubscription

The ICICI Securities IPO in 2018 was undersubscribed as many investors felt that the IPO valuation was far too high. ICICI fell short of more than Rs 50 crore — it had expected to raise more than Rs 4,000 crores.

In the same week, HAL (Hindustan Aeronautics Ltd) was subscribed at only 50% during the third day of its IPO. But when LIC decided to invest, the percentage of the subscription rocketed to 99%.

Conclusion

Undersubscription signals weak investor confidence and can impact a company’s reputation and capital raising. While investors face no direct loss, it is always better to avoid getting sucked into the hype that surrounds few IPOs. Even the best of them can tank. Therefore, careful research into fundamentals, valuation, and market conditions remains essential before committing funds to any IPO.