Sarbottam Cement Limited is all set to issue Initial Public Offering (IPO) through the Book Building method. The company has announced that it will issue six million units of shares to the general public. Of these units, 2.4 million units will be allocated to institutional investors, another 800,000 units will be sold to local residents affected by the cement project and the remaining 2.8 million units will be allocated to the general public and staff of Sarbottam Cement. With this, Sarbottam Cement will become the first company in Nepal to issue shares to the general public through the book building method.

What is Book Building Method?
The book building method is an alternative method of issuing shares publicly through price discovery. The process of price discovery involves generating and recording investor demand for shares before arriving at an issue price that will satisfy both the company launching the initial public offering (IPO) and the market.

In simple terms, it is a process of discovering the price of shares through demand of shares in market, where an underwriter, generally an investment bank, is appointed to build a book by inviting institutional investors (fund managers) to submit bids for the number of shares and the price(s) they would be willing to pay for them.

Currently, organisations in need of capital are collecting funds from the primary market by launching IPO and follow on public offer (FPO). In the case of Nepal, IPOs have been issued at par value of Rs 100 by companies, and investors are obliged to buy the shares at the same price for every company regardless of their financial performance. In some cases, companies set a premium value to the price of the IPO. For instance, RMDC Laghubitta Bittiya Sanstha Limited offered 1.56 million units of primary shares for Rs 180 per unit — at a face value of Rs 100 with an added premium of Rs 80. Hence, the process of price discovery is not efficient in the Nepali primary market.

During its 27th anniversary, the Securities Board of Nepal (SEBON), the securities market regulator, introduced and implemented the book building system and issued the Directive for Book Building 2077, allowing companies to issue IPOs at more than Rs 100 par value.

How it works?
In the Book Building method, a company looking to issue an IPO hires a merchant bank or investment bank to determine a range of prices at which the shares are to be issued instead of a fixed price. The merchant bank, also known as an underwriter or book runner, conducts research on the performance and position of the company and determines a price range for its IPO shares.

The book runner then drafts a prospectus and invites large potential investors such as financial institutions, corporations or high net-worth individuals, along with retail investors to submit bids within the price range, on the number of shares that they are interested in buying and the prices that they would be willing to pay. If the company’s base indicators such as financial statements, credentials, performance appraisals, etc. are good, the demand for shares will be high and vice-versa. The book runner records the demand and price received from potential investors in a book. The book is ‘built’ by listing and evaluating the aggregate demand for the issue from submitted bids. It remains confidential to the book runner and issuing company. However, some countries require the bidding to be transparent.

In the case of Sarbottam Cement, Global IME Capital has been appointed as the book runner, while Prabhu Bank and NIBL Ace Capital have been appointed as secondary book runners. These book runners have set a base price of Rs 750 for each share of Sarbottam Cement up for grabs. As per the SEBON directive, institutional investors can bid for these shares at a range of prices 20 percent above or below the base price. This price range is also known as price band. The minimum price of a price band is called the floor price and the maximum price is known as the cap price. The floor price for each share of Sarbottam is Rs 600, or 20 percent below the base price of Rs 750, and the cap price is Rs 900, or 20 percent above the base price of Rs 750. Institutional investors would have to bid for Sarbottam shares by remaining within this price range.

How cut off rate is derived?
In the last seven months, SEBON has allowed a total of 64 companies to become institutional investors to participate in IPOs through the book building method.

Once the book is opened, investors can submit and revise their offers on the number of shares they are willing to purchase at a price that falls within the band. After a certain period, the book is closed and the final issue price, also known as a cut off price, is determined on the basis of the highest price at which the company will be able to sell its issue, which falls within the price band. Investors bidding at or above the cut off price shall receive the shares.

Let’s assume, 100,000 applicants sought to purchase each share of Sarbottam at Rs 650, another 150,000 applicants submitted their bids expressing interest to purchase each share at Rs 750, another 200,000 applicants applied to purchase each share at Rs 800, and another 100,000 applicants said they’re will to invest Rs 850 in each share. The cut off rate for each share of Sarbottam would be set at Rs 800, as that price has attracted the largest number of investors. This means all investors who have sought to purchase each share at Rs 800 or more would be allotted the shares. Those investors who had sought to purchase shares at less than Rs 800 would not be able to purchase the shares. The money made available by such investors should be returned within three days of share allocation with interest. The bids should be made electronically, according to the SEBON.

After this process is complete, a final prospectus is issued with details of the final issue price and issue size, thus completing the IPO issuance process. In case the shares are undersubscribed or not subscribed, the shares must be bought by the book runner as it has agreed to act as underwriters of the shares.

The SEBON has said the shares should be offered to the general public at 10 percent less than the cut off rate.

A popular method for share issuance
Facebook is one of the companies that used the book building method to issue its shares. Before Facebook’s IPO issuance on May 18, 2012, the book building process was used to determine how much the stock was worth before it was sold to the public. The investment banker appointed for such an issue was Morgan Stanley and the price band fixed was USD 28 to USD 35 a share, however looking at the high demand, the price band changed to USD 34 to USD 38.

The book building method of price discovery mechanism dominates IPO and FPO issuance worldwide. Relative to other IPO issuance mechanisms such as fixed price, tender, auction, public offer method, book building is recommended by major stock exchanges and regulators as it is considered to be the most efficient mechanism to price securities in the market. Several developed countries such as the United States, China and SAARC countries like India, Pakistan and Bangladesh have adopted this method.

The book building method helps companies to gain price relevant information from potential buyers; provides riskier projects an access to the stock market; broadens the functions of institutional investors as it broadens the scope of services before and after IPO issuance; and encourages local and international companies to launch IPOs as it involves a fair process.

The policy announced by the government to attract more manufacturing companies in the stock market has been a failure as most of the manufacturing and technology companies are hesitant to enter the stock market. So, book building might be a helping hand to attain this objective, as companies will not be forced to issue shares at par value.

Types of Book Building method
Accelerated Book Building
An Accelerated book building process can be used by the companies to obtain quick financing from the capital market. This can be the case when a company is unable to finance its short-term project via the debt financing route. So, the issuing company contacts a number of investment banks that can act as underwriters on the evening prior to the intended placement. Under this process, the offer period is open only for a day or two days with no time for marketing for an issue. The underwriter overnight contacts its network and gives details about the current issue to institutional investors. If this investor finds the issue interesting, then the allotment happens overnight.

Partial Book Building
This method itself states that the issue will be built partially, where the investment banker only invites bids from the selected group of investors and based on their bids, they take the weighted average of the prices to finalise the cut-off price. Then other investors, such as retail investors, take this cut-off price as the fixed price. So, under the partial book-building process, the bidding happens with a selected group of investors.

(This article is based on report titled ‘A Detailed Report on Book Building Method of IPO Issuance’ prepared by Bidur Luitel. He is a Chartered Accountant.)