Chapter 11: Undersubscribed IPO
- Meaning
- Reasons for undersubscription
- Allotment process
- Past examples of undersubscription
An IPO is termed as undersubscribed when the demand is underwhelming, that is when the number of shares supplied by the company is higher than the demand.
What happens in case of undersubscription
IPO prices are often lowered in such cases in order to ensure the issue is fully subscribed by investors, even if it results in the issuing company not raising the expected capital.
The affected company has another option. Before the IPO process commences, they can get into an agreement with their underwriters stating that the latter would be required to buy unsold shares in case of undersubscrip-tion.
Just to refresh your memory, companies usually hire an investment bank as their underwriters during an IPO pro-cess. Underwriters help companies evaluate the right IPO valuation.
Hope springs eternity and it is no different in the world of IPOs either. Companies always hope that the dark clouds float away eventually and that the IPO price goes up on the offer day. Such scenarios can happen too be-cause IPO share prices are determined by a host of external factors.
Reasons for undersubscription
There are various reasons for an undersubscribed IPO such as lack of awareness of the IPO, high pricing, poor marketing of the IPO and market conditions.
Many investors also stay away if they spot any problems/irregularities with the company.
Minimum subscription of 90%
According to SEBI (Securities and Exchange Board of India), 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 others.
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, she’d get all the lots she 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.
The 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
For instance, the ICICI IPO was undersubscribed recently as many investors felt that the IPO valuation was far too high. ICICI fell short of more than Rs 50 crore — they 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%.
To sum up, it is always better to avoid getting sucked into the hype that surrounds few IPOs. Even the best of them can tank. Therefore, it is always advisable to do one’s own research before investing in an IPO.
What next?
Everybody in the Street advices you to do your own research. But where do you start from? Don't fret, the next chapter answers all these questions.