Book Building: Meaning, Process and

Comparison
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Read this article to learn about the meaning of book building, its
process and comparison with fixed price method and reserve book
building.

Meaning of Book Building:

Every business organisation needs funds for its business activities. It
can raise funds either externally or through internal sources. When
the companies want to go for the external sources, they use various
means for the same. Two of the most popular means to raise money
are Initial Public Offer (IPO) and Follow on Public Offer (FPO).

During the IPO or FPO, the company offers its shares to the public
either at fixed price or offers a price range, so that the investors can
decide on the right price. The method of offering shares by providing
a price range is called book building method. This method provides
an opportunity to the market to discover price for the securities
which are on offer.

Book Building may be defined as a process used by companies raising

capital through Public Offerings-both Initial Public Offers (IPOs) and
Follow-on Public Offers (FPOs) to aid price and demand discovery. It
is a mechanism where, during the period for which the book for the
offer is open, the bids are collected from investors at various prices,
which are within the price band specified by the issuer. The process is
directed towards both the institutional investors as well as the retail
investors. The issue price is determined after the bid closure based
on the demand generated in the process.

Book Building vs. Fixed Price Method:

The main difference between the book building method and the fixed
price method is that in the former, the issue price to not decided
initially. The investors have to bid for the shares within the price
range given. The issue price is fixed on the basis of demand and
supply of the shares.

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On the other hand, in the fixed price method, the price is decided
right at the start. Investors cannot choose the price. They have to buy
the shares at the price decided by the company. In the book building
method, the demand is known every day during the offer period, but
in fixed price method, the demand is known only after the issue
closes.

Book Building in India:

The introduction of book-building in India was done in 1995 following
the recommendations of an expert committee appointed by SEBI
under Y.H. Malegam. The committee recommended and SEBI
accepted in November 1995 that the book-building route should be
open to issuer companies, subject to certain terms and conditions. In
January 2000, SEBI came out with a compendium of guidelines,
circulars and instructions to merchant bankers relating to issue of
capital, including those on the book-building mechanism.

Book Building Process:

The principal intermediaries involved in a book building process are
the companies, Book Running Lead Manager (BRLM) and syndicate
members are the intermediaries registered with SEBI and eligible to
act as underwriters. Syndicate members are appointed by the BRLM.
The book building process is undertaken basically to determine
investor appetite for a share at a particular price. It is undertaken
before making a public offer and it helps determine the issue price
and the number of shares to be issued.
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The following are the important points in book building process:

1. The Issuer who is planning an offer nominates lead merchant

banker(s) as book runners.

2. The Issuer specifies the number of securities to be issued and the

price band for the bids.

3. The Issuer also appoints syndicate members with whom orders are
to be placed by the investors.

4. The syndicate members put the orders into an electronic book.

This process is called bidding and is similar to open auction.

5. The book normally remains open for a period of 5 days.

6. Bids have to be entered within the specified price band.

7. Bids can be revised by the bidders before the book closes.

8. On the close of the book building period, the book runners

evaluate the bids on the basis of the demand at various price levels.
9. The book runners and the Issuer decide the final price at which the
securities shall be issued.

10. Generally, the number of shares is fixed; the issue size gets frozen
based on the final price per share.

11. Allocation of securities is made to the successful bidders. The rest

bidders get refund orders.

How is the Price Fixed?

All the applications received till the last dates are analyzed and a final
offer price, known as the cutoff price is arrived at. The final price is
the equilibrium price or the highest price at which all the shares on
offer can be sold smoothly. If the price quoted by an investor is less
than the final price, he will not get allotment.

If price quoted by an investor is higher than the final price, the

amount in excess of the final price is refunded if he gets allotment. If
the allotment is not made, full money is refunded within 15 days
after the final allotment is made. If the investor does not get money
or allotment in a months time, he can demand interest at 15 per
cent per annum on the money due.

Example:
In this method, the company doesnt fix up a particular price for the
shares, but instead gives a price range, e.g., Rs. 80 to 100. When
bidding for the shares, investors have to decide at which price they
would like to bid for the shares, e.g., Rs. 80, Rs. 90 or Rs. 100. They
can bid for the shares at any price within this range. Based on the
demand and supply of the shares, the final price is fixed.

The lowest price (Rs. 80) is known as the floor price and the highest
price (Rs. 100) is known as cap price. The price at which the shares
are allotted is known as cut off price. The entire process begins with
the selection of the lead manager, an investment banker whose job is
to bring the issue to the public.

Both the lead manager and the issuing company fix the price range
and the issue size. Next, syndicate members are hired to obtain bids
from the investors. Normally, the issue is kept open for 5 days. Once
the offer period is over, the lead manager and issuing company fix
the price at which the shares are sold to the investors.

If the issue price is less than the cap price, the investors who bid at
the cap price will get a refund and those who bid at the floor price
will end up paying the additional money. For example, if the cut off in
the above example is fixed at Rs. 90, those who bid at Rs. 80, will
have to pay Rs. 10 per share and those who bid at Rs. 100, will end up
getting the refund of Rs. 10 per share. Once each investor pays the
actual issue price, the share are allotted.

Book Building vs. Reserve Book Building:

While book building is used to raise capital for the companys
business operations, reverse book building is used for buyback of
shares from the market. Reverse book building is also a price
discovery method, in which the bids are taken from the current
investors and the final price is decided on the last day of the offer.
Normally the price fixed in reverse book building exceeds the market
price.

Adv of BOOK BUILDING

Within the region, there are two methods of pricing shares in an IPO. The first is
to sell shares at a single fixed price. This is the approach taken across much of the
region, including for companies on the Dubai Financial Market. The second is the
bookbuilding method, used internationally and also the DIFX's method of choice.
In the fixed price method, the company, or 'issuer', values the company and
prices the share at a pre-determined price. On the DFM, for example, IPOs are
usually sold at AED 1 per share. It is with fixed price offerings that we see high
oversubscription levels of, in some cases, several hundred times. Of course, these
IPOs are often viewed as a success and the method is popular with investors in
the region due to the immediate returns it often generates in the first few days of
trading.

However, fixed pricing can lead to an undervaluing of the issuing company as the
price of the company's shares at IPO is often lower than a "fair" market value.
As a result, the low price attracts investors and the share price often rises
dramatically in the first few days of trading after the IPO, as investors positively
revalue the company. For the company, and its pre-IPO shareholders, they may
have given away substantial value as a result.
More efficient
The book building method is more efficient as it solves the "leakage" of value
often seen with fixed priced IPOs. Here the issuer sets a price range within which
the investor is allowed to bid for shares. The range is based on where comparable
companies are trading and an estimate of the value of the company that the
market will bear. The investors then bid to purchase an agreed number of shares
for a price which they feel reflects fair value. By compiling a book of investors, the
issuer can ascertain what price range the shares should be valued at, based on the
demand of the people who are going to buy them, the investors. In this process
supply and demand are matched.
Globally, the book building method is favoured for its mutually beneficial nature:
investors get the shares at a fair price that typically has potential upside, and the
issuing company receives fair compensation.
However regionally it is likely to take some time to adapt to this method. Issuers
clearly have a vested interest in moving to an approach that is more likely to lead
to a better price for their companies. This will upset some investors in the short
term, who are used to making a lot of money from these fixed price IPOs.
In the longer-term, however, efficient pricing should be seen as a sign of the
growing maturity of the capital markets in the region.