ARIHANT KNOWLEDGE INSIGHTS

(IPO)

The first time that a company issues its shares to the public is done by a process called the initial public offering (IPO). The companies that issue IPOs have not been traded previously on an exchange. Basically the idea of issuing the shares is to raise money from the public against sharing the ownership of the company with them. In an IPO the company offloads a certain percentage of its total shares to the public at a defined price.

IPO Guide

Most IPOs launch their issues using a book building method. In this method the final price of the IPO is known only after the bidding is closed. Under the book building process the offer price of the IPO is placed in a band with a highest and lowest band price. The public can bid for the shares at any price in the given band. Once the bidding process is done, the company evaluates all the bids and depending on the bids received it decides on an offer price in that range. After the offer price is fixed, the company either allots its shares to the investors who have applied for its shares or returns them their money.

How to go about investing in IPOs? It's very simple, really. Investigate before you invest. Get a copy of the prospectus, you can request a copy from your broker or get a digital copy online. Study it. Are there any similar companies that are publicly traded? What are the valuations of these companies?

4

Did you know? You can get a copy of the prospectus from Arihant’s website www.arihantcapital.com from News and Markets  IPO section.

easy steps to apply for an IPO

1. Keep your eyes and ears open: IPO’s are normally heavily advertised in the media. Not only because it is statutorily required but because companies want maximum publicity to ensure that are their issues a success. Before applying, be sure to read the prospectus for the issue. This is a document inviting the public to subscribe to the shares of the company and contains plenty of information on the company's financials, its track record, and what the management plans to do with the money that it is raising. It's free and available on the company's web site or on the SEBI web site. More information on the prospects follows later in this guide. 2. Get an application form: You can pick up the application forms at any broker's office. All application forms are free. 3. Fill it up: Fill up the form -- the directions are given in the form -- and write a cheque for the amount you want to apply for. Every issue has a minimum number of shares, i.e. the lot size, which you must apply for that is specified in the application form and the number of shares you apply for should always be a multiple of the

Generating Wealth. Satisfying Investors.

IPO Guide

2

specified lot size. Otherwise your application will be rejected. Submit the form along with the cheque within the time frame specified. 4. Submit the form: You will have to submit it to the collecting bankers (a list is given in the form), or to the collecting agents for the merchant bankers (financial players managing the entire issue for the company) to the issue. You can apply online too if you have trading accounts with online brokerages.

On a cautious note, please note that there are plenty of not-sogood companies who come out with IPOs. Make sure that you know enough about the company and are confident about its management and its growth prospects before investing.

With Arihant investing in IPO has become much easier. You don’t need to go through the hassle of filling-up the application form. You can invest in IPO online and all you need is to login, select the IPO you want to apply for, type the number of shares you want to subscribe form and submit. Rest all the paperwork would be managed by us. All through i-Trade IPO. It’s that simple. i-Trade IPO. Just:

SELECT LOGIN

IPO & investment quantity

SUBMIT

What’s on your mind? Is allotment of shares guaranteed after applying for the IPO? No. If the offer is oversubscribed by a few times then the chances of getting an allotment are high. However, if it is oversubscribed heavily, then the chances of getting an allotment progressively decrease. SEBI uses a lottery system as well as a proportionate allotment formula. The key is to remember that there is no guarantee that you will get any shares at all if you apply for an IPO. When and how you come to know when the allotment is received? If you have applied, you can know the status of your subscription by calling the registrar, whose name will be listed on the prospectus or the application form, after 30 to 40 days from the closing date of the issue. In a bookbuilding issue, you can know the status by calling the registrar after 20 days from the closing date. If you have received an allotment then the shares will be credited to your demat account or the account you had specified in the application form.

Generating Wealth. Satisfying Investors.

IPO Guide

3

How is the money refunded in case of non allotment of shares? You will get a refund 40-45 days from the closing date of the issue. In a book-building issue, you will be getting the refund in 30-40 days from the closing date. In fact your money can be directly credited in your bank account just request for this when filling the application. It’s a lot easier and faster. INVEST IN IPOs through ARIHANT – we ensure you a great service. Our executives help you with everything from selecting the IPO to filling the form to getting your shares/money back. We also offer you an online IPO service – i-Trade IPO that is simple and convenient.

How to judge an IPO – Parameters & analysis IPOs can be a risky investment. For the individual investor, it is tough to predict which company’s shares will perform good on its initial day of trading and in the near future since there is often little historical data with which to analyze the company. Also, most IPOs are of companies going through a transitory growth period, and they are therefore subject to additional uncertainty regarding their future value. Smart investing requires that you analyse the company and study the minutest of details before investing in an IPO. Here are some of the parameters you should evaluate before making your investment decision. 

Company background, Business Profile: Company background and business profile are important and need to be considered before investing in an IPO. These factors play a pivotal role in determining the profitability of a company. > >



Does the product or service that the company is offering have a good demand and scope of profit in the market? What is the competitive landscape in the market for the business's products or services? What is the company's position in this landscape?

Object of the issue: It is very important to know why the company requires money. Is the company offloading more equity than required? Where will be the issue proceeds utilized? Check the total cost required for the project and how will it be financed. Check the assumptions the promoters are making for the project’s success and do these assumptions or expectations sound feasible. It can be a new product launch because the company envisages its demand or expansion of current business because of increased demand outlook.



Valuations: The most important thing to look at it is how aggressive the IPO is priced at with respect to listed companies in its segment. One way of checking the valuation is to look at the Price-Earnings (P/E) multiple. More details on P/E ratio are given below under the financial parameters section.

Generating Wealth. Satisfying Investors.

IPO Guide

4

The more aggressively an IPO is priced, the lesser the chances of price appreciation. The following are some examples of companies that came with their IPOs in January-February 2008 and a more recent one of 2009.

P/E P/E P/E P/E

Wockhart Hospital (IPO) 169-195 Emaar-MGF 165-197 Reliance Power 5625 JSW Energy 59-68

Apollo Hospitals 29.8 DLF 73.8 NTPC 21.8 NTPC 18.44

2008 2008 2008 2009

Wockhardt Hospitals came up with an IPO in February 2008. Its price-to-earnings (PE) ratio could have varied between 169 and 195 depending on the price it was subscribed at. In comparison, a major existing player like Apollo Hospitals at that time was currently quoting at a PE of 29.8. This basic comparison clearly tells us that Wockhardt Hospitals was very aggressively priced. In fact, the company had to withdraw its IPO as they were not getting sufficient collections. Another example is of Emaar-MGF. The company came up with an IPO in Feb 2008 and the P/E of the company varied from 165-197 (based on annualised earning per share of Rs3.20). When compared to a listed entity like DLF that was quoting at a P/E of 73.8 that time, it seemed very aggressively priced. Indeed, Unitech, the oldest listed real estate stock, was quoting at a P/E of 48. So it is very important that you look at the P/E ratio and other valuation parameters of the IPO you are planning to invest in. It is often seen that when the markets are going through a bull-run and there is lot of optimism seen in the investors, generally all the IPOs when listed give good returns to the investors, despite being overvalued. Investors get carried away by the greed and often forget to look at the quality of the IPO and its valuations before investing and get trapped. Investing in IPO should be seen as a long-term investment and not like a cash machine that can generate money by press of a button. Remember, when making an investment valuations are the key. Therefore if you feel that a particular IPO is overpriced you should look for the opportunity to invest in a similar business in the secondary market. You can get enough information on the listed companies. 

Investment positives: The investment positives are the reason behind investing in particular IPO scrip. It helps to know the future benefit that the investor would accrue by investing in it.



Know the promoters and management: Before investing in any company it is important to check the quality of management. If the driver is not good, no matter how good car you are driving, it will lead to a fiasco. A critical factor here to remember is that the promoter is the biggest risk in investing. Great projects can be damaged by dubious promoters and seemingly bad projects can be revived by strong promoters. Experience of the promoters and the management team and their expertise are some of the important factors that need to be considered before investing in an IPO. Does a background check of the promoters. Some points to that should be evaluated about the promoters and management:

Generating Wealth. Satisfying Investors.

IPO Guide > > > >

5

Do they have a history of success in business ventures? Do the people involved have previous experience running a publicly-traded company? Do they have sufficient business experience and qualifications to run the company? Does management itself own any shares in the business?

The promoters and top professionals of the company should have professional qualifications and/or have a good experience in the specific type of business. For example, in case of Emaar-MGF (the company that came with its IPO in February 2008), the Indian promoter, MGF, had a limited track record in real estate development. At the same time, DLF has been in the real estate business since 1946, and was responsible for building most of South Delhi and Gurgaon. We all know that due to market sentiments and overvaluation of the issue price, the company had to withdraw its IPO as they could not get sufficient collections. Ultimately it’s the people who drive the business, and you don’t want to invest in a company whose founder’s have no idea how to run their business or who have cheated people in the past. 

Concerns: These are the risk factors that the company faces for the effective completion of the project. The risk factors are available in the initial pages of the RHP.



Financials: The Company’s balance sheet is a very important document and investors should look at it carefully. Investors should look at not just the current balance sheet but also that of the last three to four years to get an idea of the company's growth and focus.



Know the Lead Managers: Every IPO will have lead managers and merchant bankers. The offer document mentions the name of the lead managers. Do a check on the merchant bankers managing the issue. The advantage of having a credible merchant banker means that most of the due diligence of the issue has been done by a trusted agency. Reputed merchant bankers are careful of not having their reputation tarnished and will go the extra mile to ensure credibility. There are certain bad issues which are managed by certain merchant bankers, having little or no background, that make huge promises and list it handsomely. After some time, these literally go underground. You can check the track record of the merchant bankers through SEBI’s website.



Read the brokerage reports: IPO recommendation reports of brokerage houses are easily available. You should read the reports put out by various brokerages, but don’t take the recommendations too seriously. Brokerage reports on IPOs can provide the investor with all the information he needs on the company. However, companies engaged in stock broking are also into investment banking, and investment bankers are hired by companies to manage the entire IPO. Hence, if a particular investment bank is handling an IPO, it is highly unlikely that its sister broking division will put out a negative report on the stock. So, the trick is to look at reports written by brokerages whose investment banking divisions are not handling the IPO. Remember that most brokerages do not like to put out “do not subscribe” recommendation on any IPO. But even a “neutral” recommendation should be read as avoid.

The Financial Parameters to be looked at are: 1. Operating margins: The operating margin of a company is a key measure of profitability and performance. The operating margin is determined by deducting operating expenses (e.g.. cost of goods and services, sales Generating Wealth. Satisfying Investors.

IPO Guide

6

and marketing, general and administrative, and depreciation and amortization) from total revenues and then dividing the result by total revenues. Note that operating margin excludes interest expense, interest income, other income, one-time gains or losses and taxes. 2. Net Profit margin: Net Profit margin is the net profit after Tax divided by the total revenues. 3. Earnings per share (EPS): EPS is the total earning per equity share. Growth in EPS determines increase in returns to the equity share holders. 4. Valuations: Investors need to decide if the issue is worth investing in at that price. One way of checking the valuation is to look at the Price-Earnings (P/E) multiple. The P/E multiple is the ratio of the share price to EPS which is listed in the balance sheet. P/E of the issue should be compared with the industry average and the other companies in that sector. Apart from these three important points other factors like amount to be paid on application, the lead managers for the issue, the stock exchanges that issue plans to list on and the current market sentiment are other factors to watch out for. Ask for an Arihant IPO Research Report. Each report digs into the fundamentals of the issuer. The report gives an in-depth analysis of the company, issue positives and concerns and investment recommendation with rationale. We rate each IPO based on relative valuation, issuer fundamentals, performance and valuation of peer group, and shareholder-oriented issues. We have a good track record of being able to distinguish the good deals from the bad.

Red-Herring Prospectus Making an investment decision is always a difficult decision. Even analysing the share of an established company which is under investment consideration is a tricky job. So when it comes to investing in an IPO, the decision gets even daunting and trickier as there is not a lot of historical information about the company. The main source of data for an IPO is the Red Herring Prospectus, so it is very important to examine this document carefully.

Company’s name / Issuer

Lead Manager’s name

What is Red-Herring Prospectus (RHP)? Where to get all the information about the company? The prospectus called as red-herring prospectus is a document that every company that goes for a public offering has to file with the Securities and Exchange Board of India. The prospectus includes company facts that are vitally important to potential investors. Because the prospectus is a legal declaration and must meet transparency standards, most companies include certain facts and statements to ensure investors aren’t mislead in any way. Generating Wealth. Satisfying Investors.

Every IPO publishes a Red Herring Prospectus. Above is the RHP of DLF Limited

IPO Guide

7

Where to get the RHP from? Getting a Prospectus is easy. If you’re reading this online, you can easily download the prospectus electronically without any problem (if your connection is not very slow). RHPs of all the forthcoming IPOs are available for free from SEBI’s website www.sebi.gov.co.in, www.sebi.gov.co.in. However, if you don't have access to a computer or your access is too slow for downloading a prospectus (which is an extremely long document), you can also obtain the RHP prospectus by calling the lead managers that are involved in selling the shares of an IPO or the registrar of the issue. It can also be sourced from the stock brokers or IPO distributors. Calling the company will also work. What to look for in the Red-Herring Prospectus? RHP contains all the necessary information about the company, but the problem with the prospectus is that it is massive and it is difficult for an individual investor to read the whole prospectus. For example the RHP of DLF Limited had 455 pages, Emaar-MGF’s prospectus ran into a total of 780 pages, Wockhardt Hospital’s 358 pages and Reliance Power’s 312 pages — no way an investor can read all of this. Following are some of the important areas to look for in the RHP to help you make an investment decision. 

Issue Summary: It gives the details of number of shares to be issued, price band of the issue, details of the shares allocated to public, QIP’s, corporate etc.



Object of the issue: Objects of the issue gives the details of the total cost of project & how the total cost is financed. Investors will come to know how the issue proceeds will be utilized to finance the total cost of the project.



Pre-IPO placements: A good metric is what price the company has made its pre-IPO placement to big investors. Emaar-MGF had made a placement with New York Life investments at a price of Rs248 per share in May 2007. The IPO, however, was priced in the Rs 530-630 range. So, what had changed so drastically in 8 months that demanded such aggressive pricing? Sometimes pre-IPO placements are used as a marketing tool by various companies during their IPOs. But it is debatable whether the sailing is easier for those with big names on their pre-IPO placement list.



Company Valuations, Promoter’s experience, Investment Positives and Risk Factors: explained earlier.

Pay special attention to the management team and how they plan to use the funds generated from the IPO.

Generating Wealth. Satisfying Investors.

IPO Guide

8

The IPO game – Lessons to be learnt 1. Plan the period of holding the investments: investments One of the biggest mistakes that investors make while entering into the IPO market is not having the desired time frame of holding the IPO scrip. In other words the investors should plan whether (s)he he wants to book the listing profits or wants wants to hold the scrip for a longer period of time. Listing gains can be a tricky game me to play, as it is also driven by the sentiment factor. Outrageously horrible issues list at handsome gains in bull phase while in bearish phases even good issues are listed at a discount. Then there are unscrupulous promoters who are involved in price rigging rigging as there is no circuit breaker for IPO listing. Isolating them can be a challenge, something that the investor community can stay away from. It is often seen that a majority of companies with high listing gains often see the share price retreat back to the listing price within a month. So if you are playing the listing gains game, the strategy should be to cash out quickly. The other game is long-term term investing. And this requires patience and diligence normally associated with investing. If you want to subscribe for an IPO as a long-term term investment, then make sure that you pick a sound company with good fundamentals. 2. Do your homework: One should not get carried by the market tom tomming omming about the issue. issue Investors should involve a due diligence before investing in the IPO Scrip. The he Red Herring prospectus is a great source of information. This document is available at the Sebi website and can be downloaded with ease. All matters regarding the company, its promoters and their dealings are listed in the document. The regulator has made sure that all relevant information required to take a wise investment decision is included in this document. 3. Understand the sector: Sectoral sentiments would also help the he investors to know, how much return they will get from that particular issue. There are chances that a weak investor sentiment for a particular sector would see share prices drop on listing, despite strong credibility. 4. Don’t get panic in volatile market: A company getting listed in a sell-off sell ff time might not get listing gains. Longterm investors need not panic. It just pays to be pegging away at the game that you are playing.

Beware – Pay close attention Adequate research is, without a doubt, the most effective way to identify and stay away from the IPO disasters waiting to happen. The RHP, which contains nearly all aspects of a company's business and game plan, is the first place any investor interested in purchasing a new issue should look. Following are some of the things to watch out for as warning signs in an IPO investment. 

Pay close attention to the fine prints given in the prospectus: These are the certain disclaimers and cautionary statements found in the RHP under the section “Risk

Generating Wealth. Satisfying Investors.

IPO Guide

9

factors”. This helps to understand the risk factors that the company might come across having negative impact on its future earnings. For instance, the Company may be over relied on particular customer. Loss of such customer may have negative impact on the company’s future earnings. In general, the IPO investors should pay close attention to the Risk Factors that are found in the prospectus from the front of the document till the end. 

Reputed Investment Banker: An investment banker hired by the company does the fair amount of Due Diligence. So it is always comfortable to invest in IPO scrip which had a reputed investment banker.



Sale of shares: If large number of shares in an IPO comes from the stake sale of the promoters, it may have a signaling effect for the future earnings of the company. On would wonder why investors would want to sell their shares so quickly if a company’s prospects are strong. Investors should judge the true intentions behind the IPO offer, i.e. whether it is for the expansion purpose or something else.



Use of Issue Proceeds: Investors should watchout the use of issue proceeds. The Company may use the issue proceeds to retire its debt or pay huge dividends to the pre IPO investors. It's comforting if a company has more specific ideas about where your money will be invested -- acquisitions, advertising, capital formation, research and development, etc. This is found under the section “Use of Proceeds” in the RHP.

 Valuations: Investors need to decide if the issue is worth investing in at that price. One way of checking the valuation is to look at the Price-Earnings (P/E) multiple. The P/E multiple is the ratio of the share price to EPS which is listed in the balance sheet. P/E of the issue should be compared with the industry average and the other companies in that sector. For instance: Let us consider the valuation of Vishal Retail Ltd at the time of its IPO of Rs 110 cr in June 2007. Company

EPS (Profit After Tax/ No of Equity Share)

P/E (Issue Price Per Share / EPS)

Vishal Retail Ltd

Rs 11 per share

25x

Pantaloon Retail Ltd

Rs 5 per share

90x

Shopper Stop Ltd

Rs 6 per share

80x

Trent Ltd

Rs 17 per share

39x

As we can see from the above table, the issue of vishal retail was cheaply valued in comparison to its peers at the time of its IPO. Therefore, considering its valuation compared to its peers, its business model and future growth plans, it was worth investing in the issue. It pays to do your homework before investing in an IPO. A good investment can help you plan for your retirement, fund you child’s education and provide you for the living you deserve.

Generating Wealth. Satisfying Investors.

IPO Guide

10

ARIHANT ONLINE IPO SERVICE – it’s hassle-free

We’ll manage all the paperwork for you SMS: Activate Online IPO to know more about the service Or Email us at: [email protected]

www.arihantcapital.com

At ARIHANT, your growth has always been our objective. We understand that different people have different investment needs. But no matter what type of investor you are, we have the resources and expertise to help you reach your financial goals.

rd

Regst. Office: E-5 Ratlam Kothi, Indore. Corporate Office: 67 Nehru Road, 3 Floor Krishna Bhavan, Vile Parle (E), Mumbai. T. 022-42254800, E. [email protected] This guide is solely for the purpose of explaining the potential benefits of investing in a Systematic Investment Plan and not for solicitation of investments with Arihant. Net asset values of schemes may go up and down depending upon the factors and forces affecting the securities markets. Mutual funds like securities investments are subject to market and other risks and there can be no guarantee against loss resulting from investment in any scheme, nor can there be any assurance that a scheme’s objective will be achieved will be achieved.

Generating Wealth. Satisfying Investors.