Module 1 Introduction to Stock Markets

Chapter 14

Supplementary Note

33

IPO, OFS, and FPO – How are they different?

IPO

Initial Public Offering is when a company is introduced in to the publicly traded stock markets for the very first time. In the IPO, the promoters of the company choose to offer a certain percentage of shares to the public. The reason for going public and the process of an IPO is explained in detail in Chapter 4 and 5.

The primary reason for going public is to raise capital which would be to fund expansion projects or cash out early investors. After the IPO is listed on the exchange and is traded in the secondary market, promoters of the company might still want additional capital for which there are three options available: Rights Issue, Offer for Sale and Follow-on Public Offer

Rights Issue

The promoters can choose to raise additional capital from its existing shareholders by offering them new shares at a discounted price (generally lower than Market Price). The company offers new shares in proportion of shares already held by the shareholders. For example, a 1:4 Rights Issue would mean that for every 4 shares held 1 additional share is offered. Although this option looks good, it limits the company to raise the capital from a small number of investors who are already holding shares of the company and might not want to invest more. A rights issue leads to creation of new shares that are offered to the shareholders, which in turn, dilutes the value of the previous held shares.

An example of a Rights issue is of South Indian Bank which announced a 1:3(One share for every 3 held) issue at a price of Rs 14 which is 30% lower than the Market Price the stock was trading (Rs 20 as on Record date 17 Feb 2017). The bank offered 45.07 lakh shares to the existing shareholders.

Rights issue is covered in detail in Chapter 11 covering key Corporate Actions

OFS

The promoters can choose to offer the secondary issue of shares to the whole market unlike a rights issue which is restricted to existing shareholders. The Exchange provides a separate window through the stock brokers for the Offer for Sale. The exchange allows company to route funds through OFS only if the Promoters want to sell out their holdings and/or to maintain minimum public shareholding requirement (For example, Govt. PSU have a public shareholding requirement of 25%).

There is a floor price set by the company, at or above which bids can be made by both Retail and Non-Retail investors. The shares are allotted, if bids are at cut-off price or above will be settled by the exchange into the investor Demat account in T+1 Days.

An example of an Offer for Sale is NTPC limited which offered a maximum of 46.35 million shares at a floor price of Rs 168 and was fully subscribed in the 2 day period. The OFS was held on 29th August 2017 for Non-Retail Investors and 30th August 2017.

FPO

A FPO also has the same intent of raising additional capital after it has been listed but follows a different mechanism for the application and allotment of shares. Shares can be diluted and fresh shares can be created and offered in an FPO. Just like an IPO, a FPO requires that Merchant Bankers be appointed to create a Draft Red Herring Prospectus which has to be approved by SEBI after which bidding is allowed in a 3-5 day period. Investors can place their bids through ASBA and shares are allotted based on the Cut-off Price decided after the book building process. Since the introduction of OFS in 2012, FPOs are seldom used due to the lengthy process of approvals.

The company decides on a Price Band and the FPO is publicly advertised. Prospective investors can bid for the issue using ASBA portal through Internet Banking or apply offline through a Bank Branch. After the bidding process is complete, the cut-off price is declared based on the demand and the additional shares allotted are listed on the exchange for trading in the secondary markets.

An example of an FPO is of Engineers India Ltd which underwent an issue in February 2014 with a price band of Rs 145-Rs 150. The issue was oversubscribed by 3 times. The shares on the day of starting date of the issue was trading at Rs 151.1. The lower price band was at a 4.2% discount from the market price.

Difference between OFS and FPO

  • An OFS is used to offload the shares of Promoters while a FPO is used to fund new projects
  • Dilution of shares is allowed in a FPO leading to change in Shareholding structure while OFS does not affect the number of authorized shares.
  • Only the top 200 companies by Market Capitalisation are allowed to use the OFS route to raise funds while FPO option can be used by all listed companies
  • Ever since OFS has been introduced by SEBI, FPO issues have come down and companies prefer to choose the OFS route to raise funds

33 comments

  1. Suraj S Jagtap says:

    Excellent Efforts on clearing the contents… Thank You So Much….

  2. Ash says:

    Is there a feature in Kite to see the price action of an underlying for a particular day in the past by choosing a date? It is very tedious to scroll all the way back by pulling the cursor.

  3. Sabarivasan A says:

    Hi Karthik,
    The modules are informative and useful for someone like me who is new to the share market. I am holding 1890 shares of Rana sugars and bought it for 10.20 per share and did not put a stoploss( I was not aware about it). Now the share price is 7.70 Rs as of today. Please let me know the future of the shares

    • Karthik Rangappa says:

      Happy learning, Sabarivasan 🙂

      As a business, we do not advise clients on individual shares. So I’m afraid I cannot help you with this.

  4. Shivam Bhatia says:

    The content was excellent..but i have one confusion..if compnay has done IPO so it will again go for OFS…it can issue additional shares as a bonus also..

    • Once the company is listed on the exchange by means of an IPO, it can choose to raise additional capital through OFS(or FPO or Rights Issue)- Cash inflow
      Bonus issue is different where the company chooses to reward the shareholders by giving additional shares using its reserves- Cash outflow

  5. Chakradhar Reddy says:

    Hi karthik,
    I need a small clarification on how the stock price is fixed .. I have given few examples as per my understanding…please clarify me on this:

    Example:

    A company ABC is trading at Rs.325 at a particular time
    1)Two persons have placed an order: one for a buy with bid 324 and another for a sell with ask 326.
    Assuming these are the only two persons trading for that company at that time.
    What happens in this situation. (I think the trading value will remain same!)

    A company ABC is trading at Rs.325 at a particular time
    2)Now there are three bids and four asks
    Bid: 325; quantity -2
    Bid: 324; quantity -10
    Bid: 323; quantity -6

    Ask: CMP(325); quantity -2
    Ask: 326; quantity -8
    Ask: 327; quantity -4
    Ask: 328; quantity -2
    In this case, after the shares are traded at 325, the trading price will still remain same at 325…Am i right?

    3) How is the open price of a day decided?
    4)How is the listing price of an IPO decided?

    • Karthik Rangappa says:

      1) Since the bid-ask does not match, no trade happens. One of them will have to change the price to match the counterparty.
      2) Yes, because the top bid-ask does not match. However, if a new guy comes and places a market order, the transaction will go through (for either buying or selling)
      3) Based on the bid-ask order book build during the pre-open
      4) Book building process

      • Chakradhar says:

        Regarding 3, I would like to quote another example… please do tell me if I am right
        Day 1: closing price of a stock ABC is Rs200
        Day 2:
        As soon as the trading starts company hits UC(240)
        MY query is stock price keeps increasing only when there is a buy at any price… But before the market opened no one would have placed a bid for 240 or 230( i think so because no one exactly knows that it will exactly increase by that much percentage) then how will it reach that price as soon as the market opens.
        And regarding 4 I was asking how the listing price of an IPO sometimes opens at a higher price…how is this decided.
        Example: DMART
        I think if i get an answer for 3, probably 4 will also be answered

        • Stock ABC will only hit upper circuit if a trade occurs at Rs 240(A buyer willing to buy at 240 and a matching seller). At Pre-market between 9:00 and 9:15AM there is buying interest for this to occur. Once a non-F&O stock hits 20% limit, buying is not allowed anymore.
          For IPO, Pre-open session runs between 9.00 AM and 9.45 AM where orders are accepted. Between 9.45 AM and 10.00 AM, the orders are matched and the listing price is decided at 10.00 AM when it commences for normal trading

          • Chakradhar says:

            Hi faisal,
            I still lack some clarity.
            day 0 : closing price of abc is 200
            day1 : open is 240(UC)

            So between 9 and 9:15 am of day1, there should be a bid placed at 240 with an ask at the same price..
            But during that pre open session, no one knows how many bids are placed, right?
            Why would someone want to place an order at such a price… ( This point is where I am not getting)

          • Although you are not able to see the bid and ask during pre-open, the exchange does order matching and that’s how the open price is determined. In your hypothetical case, I’m assuming there’s a lot of demand for the script, and there are buyers willing to pay ₹240. You can read more here.

          • Chakradhar says:

            Thanks faisal

        • Karthik Rangappa says:

          Regarding 3 – this really depends on the kind of buying or selling pressure in the market. The best way to think about this is by thinking about it as a pressure cooker 🙂
          When there is excessive bullishness, price tends to gap up. Likewise with gap downs.

  6. Soni says:

    Sir, is there any virtual simulator available for commodity(MCX) and equity trading so that we can try out our strategies without using real money

  7. Vaibhav says:

    Hi

    It was great content.

    I Just have a doubt. How does an Offer for sale helps the company to fund itself when the shares which promoters holds are offered in the market. When promoters sells shares the amount received must be accrued to the promoter itself and not to the company.

    • Karthik Rangappa says:

      It depends on who is offering the shares. If the company is tendering the shares, then the proceeds will go to the company. If it is the promoter or some other investors tendering the shares, the proceeds will go to them.

  8. Ram says:

    Seriously great content.. I always read this google chrome… When I search zerodha in chrome.. 1st link will be anglebrokering.Com offering zero interest 2nd link will be shown as zerodha.
    I request your software team to make zerodha appear 1st when searched about it.

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