RED HERRING PROSPECTUS: A CAREFUL EXERCISE

Initial Public Offering (IPO) is an exercise done by a company for raising capital by going public. IPO is raised generally in two ways either through fixed price or through Book Building. Generally, most of the companies follow the book building process. For this purpose, the company assigns the Merchant Banker as a Book Running Lead Manager (BRLM) for the IPO to handle the responsibility of Book Building Process.

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Book Building is a mechanism through which a consensus price of IPO can be determined on the basis of bids received from the informed investors such as Qualified Institutional Buyers (QIBs), Non-Institutional Buyers (NIBs) and Retail Investors. The process helps in making a correct evaluation of a company’s potential and the price of its shares. In most of the IPOs generally the allocation of the total issue into these 3 categories comprises of 50%, 15%, 35% of the total issue respectively.

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However when the dilution of the promoters stake is less than 25% the minimum allocating proportion for these categories changes to 60%, 10%, 30% of the total issue,respectively. The company aspiring to be public, files Red Herring Prospectus (RHP),framed by merchant banker, to the regulatory body SEBI that is supposed to cover all the important information about the company, its promoters and its businesses with due diligence.

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RHP is supposed to be the most important document for the company as it acts as a medium of imparting all the critical information regarding the issuer company to the public.Generally prospectus spreads over 300-400 pages. However, investors can concentrate on few key chapters to have the overall understanding of the public issue. Industry Overview, Company Overview, Capital Structure, Objects of the issue, Financial Information and Management discussion and Analysis are some of the chapters that one should necessarily focus on.

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Let’s understand the relevance of each of these topics one by one:

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Industry Overview: This chapter covers the prevailing market scenario of the industry in which the company operates. We get to know that how much the particular industry contributes to the growth of the country’s economy. That is the behavior of the industry with respect to the growth momentum of the country’s economy. Moreover it entails the government plans and initiatives, budgetary allocation in accordance with five year plans for the industry. This gives the picture of potential opportunity in the industry and its key drivers. It also includes the various linkages regarding the relation of industry to the domestic and global economy.

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Business Overview: This compasses all the information related to the business domain of the company – how the business commenced its operations, grown over the period. The product details of the company and where does it lies in the value chain of the industry. The product scope,how the distribution channel works, the marketing strategy, raw material procurement, details about the vendors, clients and their relation withthe company, the revenue generation process, target market, location of operation. All these information helps in knowing the strengths and weaknesses of the company. It also gives information regarding the future aspects of the company.

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How the company is expecting to expand its business, strategies to increase the market share of the company.

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Capital Structure: It tells us about the shareholding pattern of the company. The constituents of the present equity capital of the company, since inception to the present pattern of the shareholding. The details of the how it has raised its capital under the due period. It gives us the details aboutwho are the stakeholders along with their respective stake in the company.

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Objects of the Issue: This chapter assumes high degree of significance in the RHP as it answers the very first question that comes to the mind of the investors that for what reason the company is going public. It entails the objectives of the issue as where and how the company is going to deploy the funds raised from the issue. At times the company induces the fund requirements from the internal accruals that can be from the present business profits of the company or through the debt syndication from banks along with the issue proceeds.

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Company sometimes also utilize the issue proceeds to repay its debt so as to reduce its interest burden. Thus, it contains the purposes of the issue with their respective amount being required.

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Financial Information: This includes all the financial statements of the company on the stand alone and consolidated basis viz. Profit and loss statement, balance sheet, fund flow statement. These statements show the performance of the company from past 4-5 years along with the annexure that details various heads of these statements. Financial Statements helps the investors in knowing the health of the company in numbers.Various ratios and multiples are arrived with the help of these statements.

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Management Discussion and Analysis: This chapter summarizes the company businesses and its development in due course of time. Year-on-year financial comparison is explained in this part of the document. This helps us in knowing the management’s efficiency to grow a company. Certain important events, factors affecting the operations of the company or some specific strategies of the company are explained in this part of the document.To sum up, RHP being the formal document of the company plays an integral role in assessing the company’s business prospects and thus helps investors in taking decision for subscribing an IPO or otherwise.

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However, it is generally perceived as a lengthy exercise by some section of investors.This can be achieved by going through the above discussed topics that can impart all the relevant information of the company leading to a wise investment decision. After all, “Moneywise Be wise”.

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One response to this post.

  1. Posted by shammisarwan on December 15, 2010 at 11:56 AM

    Thanks for such an informative article…

    Shammi Sarwan
    Executive

    Reply

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