Book Building Method - Complete Guide

GP Chudal
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book-building-method

A Simplified Guide to Book Building Method

The book building method is a popular way of issuing shares in the stock market, especially for initial public offerings (IPOs). It is a process that helps companies discover the fair price of their shares by collecting bids from qualified institutional buyers (QIBs). 

In this article, we will explain what book building is, how it works, and what are its benefits and drawbacks.

What is Book Building Method?

Book building is a method of issuing shares based on a floor price which is indicated before the opening of the bidding process. The floor price is the minimum price at which the shares can be sold. The company also sets a ceiling price, which is the maximum price at which the shares can be sold. The ceiling price is usually 20% above the floor price.

The company then invites QIBs, such as banks, insurance companies, mutual funds, pension funds, etc., to submit bids for the number of shares and the prices they are willing to pay for them. The bids are collected and recorded in a book, which is confidential to the company, the underwriter, and the regulator. The book building process helps the company to gauge the demand and the valuation of its shares in the market.

Based on the bids received, the company determines the cut-off price, which is the price at which the maximum number of shares can be sold. The cut-off price is also the final price at which the shares are offered to the QIBs. The QIBs who have bid at or above the cut-off price are allocated shares proportionately. The QIBs who have bid below the cut-off price are rejected.

The company then offers the remaining shares to the general public at a discount of 10% of the cut-off price. The general public can apply for a minimum of 50 shares and a maximum of 1000 shares. The shares are allocated to the general public on a first-come, first-serve basis.

Key Terms Used in Book Building Process

Before understanding the book building process, it is important to know some key terms that are used frequently in this process.

1. Base Price: The base price is determined by reviewing the indicative price received from QIBs. The base price is used to set the threshold price for the shares.

2. Threshold Price: The threshold price is the price at which the shares are offered to the QIBs. It is usually equal to the base price or the cut-off price.

3. Cut-off Price: The cut-off price is the minimum selling price determined after QIBs place bids. It is the price at which the maximum number of shares can be sold. If a bid is below the cut-off price, the QIB will not be allocated shares.

4. Qualified Institutional Buyer (QIB): A QIB is a class of investor that is deemed financially sophisticated and legally recognized by the securities market regulator to need less protection from issuers than most public investors. A QIB is typically a company that manages a minimum investment of $100 million in securities or a registered broker-dealer with at least $10 million invested in non-affiliated securities. The QIBs are the only investors who can participate in the book building process.

Book Building Process in Nepal

The book building process in Nepal is regulated by the Securities Board of Nepal (SEBON), which has issued the Book Building Directives of 2077. The directives outline the specific procedures to be followed in conducting the book building IPO issuance. 

As per the directives, the procedure for book building in Nepal is as follows:

a. Appointment and Agreement with Issuing and Sale Manager: The company that wants to issue shares through book building has to appoint an issuing and sale manager, who is a licensed merchant banker. The company has to enter into an agreement with the issuing and sale manager, who will assist the company in preparing the prospectus, conducting the roadshow, collecting the bids, determining the cut-off price, and allocating the shares.

b. Determination of Price Range: The company, in consultation with the issuing and sale manager, has to determine the average value of the shares based on the company’s valuation and the demand of the IPO. The company also has to prepare an initial prospectus and conduct a roadshow involving the interested QIBs. The company then has to set a price range for the shares, which consists of a floor price and a ceiling price. The floor price is the minimum price at which the shares can be sold, and the ceiling price is the maximum price at which the shares can be sold. The ceiling price cannot be more than 20% above the floor price.

c. Determination of Cut-off Price: The company has to invite at least 10 QIBs to submit bids for the shares within the price range. The QIBs have to bid for 100% of the shares allocated for them. Based on the bids received, the company has to determine the cut-off price, which is the price at which the maximum number of shares can be sold. The cut-off price cannot be lower than the floor price or higher than the ceiling price. The company has to publicize the cut-off price and the details of the bids received.

d. Issue to General Public: The company has to offer the remaining shares to the general public at a discount of 10% of the cut-off price. The general public can apply for a minimum of 50 shares and a maximum of 1000 shares. The shares are allocated to the general public on a first-come, first-serve basis.

Example of Cut-Off Price Determination in the Book Building Process

To illustrate how the cut-off price is determined in the book building process, let us take an example of a hypothetical company that wants to issue 10 million shares through book building. The company has appointed an issuing and sale manager, who has helped the company to determine the average value of the shares as Rs. 500. The company has set a price range of Rs. 400 to Rs. 600 for the shares. The company has allocated 40% of the shares (4 million shares) for the QIBs and 60% of the shares (6 million shares) for the general public.

The company has invited 15 QIBs to submit bids for the shares within the price range. The QIBs have submitted the following bids:
QIB Bid Price (Rs.) Bid Quantity (Shares)
A 600 500,000
B 590 400,000
C 580 300,000
D 570 200,000
E 560 100,000
F 550 100,000
G 540 100,000
H 530 100,000
I 520 100,000
J 510 100,000
K 500 100,000
L 490 100,000
M 480 100,000
N 470 100,000
O 460 100,000


The total demand for the shares from the QIBs is 2.9 million shares, which is less than the 4 million shares allocated for them. Therefore, the company has to revise the price range and invite more bids from the QIBs. The company lowers the floor price to Rs. 350 and keeps the ceiling price at Rs. 600. The company invites 20 QIBs to submit bids for the shares within the revised price range. 

The QIBs submit the following bids:
QIB Bid Price (Rs.) Bid Quantity (Shares)
A 600 500,000
B 590 400,000
C 580 300,000
D 570 200,000
E 560 100,000
F 550 100,000
G 540 100,000
H 530 100,000
I 520 100,000
J 510 100,000
K 500 100,000
L 490 100,000
M 480 100,000
N 470 100,000
O 460 100,000
P 450 100,000
Q 440 100,000
R 430 100,000
S 420 100,000
T 410 100,000


The total demand for the shares from the QIBs is 4.5 million shares, which is more than the 4 million shares allocated for them. Therefore, the company has to allocate the shares to the QIBs proportionately based on their bid prices and quantities. The company has to determine the cut-off price, which is the price at which the maximum number of shares can be sold. The cut-off price cannot be lower than the floor price or higher than the ceiling price.

To determine the cut-off price, the company has to arrange the bids in descending order of the bid prices. The company has to find the bid price at which the cumulative demand for the shares is equal to or greater than the number of shares allocated for the QIBs. This bid price is the cut-off price. The company has to allocate the shares to the QIBs who have bid at or above the cut-off price. The QIBs who have bid below the cut-off price are rejected.

The following table shows the bids arranged in descending order of the bid prices and the cumulative demand for the shares:
QIB Bid Price (Rs.) Bid Quantity (Shares) Cumulative Demand (Shares)
A 600 500,000 500,000
B 590 400,000 900,000
C 580 300,000 1,200,000
D 570 200,000 1,400,000
E 560 100,000 1,500,000
F 550 100,000 1,600,000
G 540 100,000 1,700,000
H 530 100,000 1,800,000
I 520 100,000 1,900,000
J 510 100,000 2,000,000
K 500 100,000 2,100,000
L 490 100,000 2,200,000
M 480 100,000 2,300,000
N 470 100,000 2,400,000
O 460 100,000 2,500,000
P 450 100,000 2,600,000
Q 440 100,000 2,700,000
R 430 100,000 2,800,000
S 420 100,000 2,900,000
T 410 100,000 3,000,000
U 400 100,000 3,100,000
V 390 100,000 3,200,000
W 380 100,000 3,300,000
X 370 100,000 3,400,000
Y 360 100,000 3,500,000
Z 350 100,000 3,600,000


As we can see from the table, the cut-off price is Rs. 410, as the cumulative demand for the shares at this price is 3 million, which is equal to the number of shares allocated for the QIBs. The company has to allocate the shares to the QIBs who have bid at or above Rs. 410. The QIBs who have bid below Rs. 410 are rejected.

The following table shows the allocation of the shares to the QIBs who have bid at or above the cut-off price:
QIB Bid Price (Rs.) Bid Quantity (Shares) Allocation Ratio Allocated Quantity (Shares)
A 600 500,000 1:1 500,000
B 590 400,000 1:1 400,000
C 580 300,000 1:1 300,000
D 570 200,000 1:1 200,000
E 560 100,000 1:1 100,000
F 550 100,000 1:1 100,000
G 540 100,000 1:1 100,000
H 530 100,000 1:1 100,000
I 520 100,000 1:1 100,000
J 510 100,000 1:1 100,000
K 500 100,000 1:1 100,000
L 490 100,000 1:1 100,000
M 480 100,000 1:1 100,000
N 470 100,000 1:1 100,000
O 460 100,000 1:1 100,000
P 450 100,000 1:1 100,000
Q 440 100,000 1:1 100,000
R 430 100,000 1:1 100,000
S 420 100,000 1:1 100,000
T 410 100,000 1:1 100,000


The total number of shares allocated to the QIBs is 3 million, which is equal to the number of shares allocated for them. The average allocation price is Rs. 485, which is the weighted average of the bid prices and the allocated quantities.

Who are the Qualified Institutional Buyers (QIB)

A qualified institutional buyer (QIB) is a class of investor that is deemed financially sophisticated and legally recognized by the securities market regulator to need less protection from issuers than most public investors. A QIB is typically a company that manages a minimum investment of $100 million in securities or a registered broker-dealer with at least $10 million invested in non-affiliated securities. The QIBs are the only investors who can participate in the book building process.

The QIBs are categorized into three types: domestic financial institutions, foreign institutional investors, and mutual funds. The QIBs have to meet certain eligibility criteria to participate in the book building process, such as having a valid registration with the regulator, having a sound track record of investment, and having a minimum net worth of Rs. 25 crore.

The QIBs have to bid for 100% of the shares allocated for them in the book building process. The QIBs have to pay 10% of the bid amount as margin money at the time of bidding. The QIBs have to pay the balance amount within two days of the finalization of the issue price.

The QIBs have certain advantages and disadvantages in the book building process, which are as follows:

Advantages:

  • The QIBs have the first preference in the allocation of the shares, as they are allocated 40% of the total issue size.
  • The QIBs have the flexibility to choose the bid price and the bid quantity within the price range.
  • The QIBs have the opportunity to participate in the price discovery process and influence the final issue price.

Disadvantages:

  • The QIBs have to bid for 100% of the shares allocated for them, which may result in over-subscription or under-subscription.
  • The QIBs have to pay 10% of the bid amount as margin money, which may affect their liquidity.
  • The QIBs have to pay the balance amount within two days of the finalization of the issue price, which may expose them to market risk.

Conclusion

The book building method is a popular way of issuing shares in the stock market, especially for initial public offerings (IPOs). It is a process that helps companies discover the fair price of their shares by collecting bids from qualified institutional buyers (QIBs).

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