HOW IS IPO PRICE BAND DECIDED?
WHAT IS IPO PRICE BAND?
Before we dive deep into the understanding of how the price band of an IPO is determined and what are the rationales behind the same, first let us understand the meaning of Price Band to gain a better understanding.
Usually, the term price band refers to the highest and lowest price which the seller decides and lets the buyer bid for the shares during the launch of an IPO. Let us take a very recent example of food delivery platform Zomato IPO where the range i.e. the price band of the IPO was Rs 72 to Rs 76. However, the face value of the share was hardly Rs 1 per share. Just to gain understanding of the zomato IPO, we say the entity wants to issue ten thousand shares and their underwriter banks have decided on a price band of Rs 72 to Rs 76 and investors bid between this range and at the cut offs.
Now let's assume the IPO got oversubscribed and zomato received ids of 16,600 shares against that of 10,000 shares. So as per the Act, the bidding company will only allocate shares for Rs 75 and above. Rest of the investors will get a refund and Rs 75 will be the cutoff price as all shares get allocated on this price mark up.
Determining this bank is a crucial stage in deciding the share price as it enables a company to gain understanding of how much money investors are willing to pay for an ownership stake in their organisation.
HOW IS PRICE BAND DECIDED?
The price band is decided by the entity owners in consultation with investment bankers who are involved with the IPO launch and the factors that they consider in doing so are as follows:
- Company potential to grow in future
- The quality of shares currently being sold in an IPO
- The current market prices of the stocks of identical companies in the same sector
- The management and organisational set up of the private company
- Overall market trend
- Financial effectiveness of company’s business model
- The demand for company’s shares
- And sometimes, any type of positive news like any recent achievements, product offering, success story may also affect the pricing.
As we have taken the Zomato IPO instance, let’s get into fundamentals and financials which the bankers have considered while selecting a price band to assess the suitable issue price for the company's shares. Zomato’s IPO has done pretty well given the entity’s strong growth over the years. They have generated tremendous revenue across all the business verticals over the past months but due to the pandemic they encountered a loss in the financial year 2021.
Nevertheless, the company closed revenue of around Rs 1300 Crs for the first quarter of FY21, higher expenses led to a loss of Rs 684 crores.
Zomato’s revenue rose up sharply by 96% from Rs 1300 crore in FY19 to Rs 2743 crore in FY20. It’s business got slowed down during the coronavirus but it is not only their business that got impacted as well.
And therefore analysts were positive about the company’s future given that it is one of the most dominant players in the food delivery segment along with the rival swiggy. By the end of the FY20, the company offered its delivery services in approx more than 500 cities across the country with more than 2 lacs delivery partners and over 3.6 lacs active restaurants under their network.
HOW IS THE BAND CALCULATED?
A lot of complex calculations, research, quantitative analysis goes behind the calculation of a rational price band that we have discussed earlier. To decide the price band entity go for a book building process. In which the securities are offered to various big processes to assess the demand of the shares in the market and therefore the price is discovered for the shares. The price under the book building process is the price that the share market and accordingly the price for the shares is discovered.
The price under the book building process is the price which is bearable by the market. And generally the same would be more than the price under the fixed pricing method.
LOWER BANK AND UPPER BAND
This year, a lot of IPOs are coming up and a lot have come in the previous year using a book building process, where the price band is decided by entities issuers and their bankers. The highest point is called the upper band and the lowest point is the lower band. On the basis of bidding received from investors, issue price will be decided.
And then the shares will be allocated to only those investors who bid equal and above the price of issue. As in Zomato’s IPO instance, Rs. 72 was the lower band and Rs. 76 was the upper band.