In this part, IPO oversubscription will be explained.
When a company wants to float it on the stock exchange through an Offer of Float, it offers a specific number of shares to the public. At other times, the demand for these shares goes to an extent that it surpasses the number of shares out there. This is referred to as IPO oversubscription Since it mainly focuses on listing, Primarily because of IPO oversubscription. In layman’s terms, if there are more applicants for instance through tenders for shares than is supplied in the market the IPO is regarded as having been oversubscribed.
An oversubscribed IPO can create interest since it shows that many people would like to invest in the company. But it also causes doubt for the investors because they may not get the quantity of the shares they had applied for. The situation under investigation in this article will involve analyzing how oversubscription occurs in an IPO; the factors that lead to oversubscription; and the nature of the implications it will hold for the company and investors.
Table of Contents
Analysis on IPO oversubscription
Read Why an IPO Gets Oversubscribed?
There are several reasons why an IPO may become oversubscribed:
- High Market Demand: This means that when a company has a good brand identity or is offering new products in the market and/or when its products belong to a sector that is currently on the rise, investors will rush to embrace the IPO. An example is over-subscription in tech firms or the new age start-up firms that are deemed to have high growth prospects.
- Favorable Market Conditions: Oversubscription can also be realized if the company being floated has a favorable image on the stock market as this will attract many investors. People are more likely to get involved in new issues during an economic upturn.
- Underpricing of Shares: When the company or the underwriters set the IPO price lower than the perceived value then there will be over-subscription because many investors will want to buy these so-called ‘cheap’ shares.
- Investor Hype: Publicity in the media alongside influential institutional investors alongside a few reputable underwriters, tends to create a lot of hype up the stock among small investors, most of whom are keen on making fast fortunes post offer inevitably.
How are Shares Allotted When an IPO is Oversubscribed?
The legal requirements of proportionate share amount, timeshare interest allotment process, and shared ownership interest allocation process clearly explain the proportionate allotment process.
IPO is the way firms seek to ‘-list’ companies in the stock; in an oversubscribed IPO, not all investors will receive their preferred stock. Bonus issue means that the shares are issued in proportionate to the rights of members in the event of the issue. What this means is that the investors receive the shares about the application made for the share but not fully. For instance, if an investor’s application was granted 100 shares for an IPO that was 2 times oversubscribed, he would most likely be granted 50 shares.
The allotments on the other hand normally are arbitrary especially where an IPO has been largely oversubscribed by the retailers. The allotment size depends on the investor category:
- Retail Investors: It offers an opportunity through lettering to these applicants who apply for shares within a specified monetary category though their chances are, diminished as the subscription rises.
- Institutional Investors: They are usually offered based on how many one has applied for: however, one may be let off this hook once in a while. However, even a considerable number of institutional purchasers would be vulnerable to the overall decrease in the portion of shares from them.
While many of the concepts tackled in this course have very similar principles to those in Corporate Finance, there are still some differences in what a Public Company does with the extra money.
When going for an IPO, investors are asked to apply with the full amount for the number of stocks they want to apply for. The additional money they paid is refunded if they do not get the full amount they should be given then. The refund map is usually initiated after a couple of days from the last allotment.
Impact on Investors
Positive Sentiment
The term ‘oversubscribed IPO’ is regarded as positive most of the time. Market investors may perceive that they are demanded in the market by investors most especially after they float their shares in the market. Such excitement can again lead to more purchasing in the second-hand market and consequently, push the value of the stock even up.
Potential Risks
Indeed, oversubscription may look like a good sign too if viewed from the right perspective, however, it has its fair share of dangers to investors. The primary concern is the small number of shares that may be granted to an investor in cases when the investor expects to receive a much larger number of shares. There are also situations where the demand for the IPO is so high that an investor is completely locked out of the shares.
Furthermore, the condition certainly contributes to over-subscription madness during IPO that results in overvaluation of the shares. Those investors who purchase them in the secondary market at these augmented prices might end up being at a loss once the stock price Readjusts after the initial trading hysteria/ trading mania.
Effects on the Company
Increased Valuation
For the company, excessive demand in its IPO constituency enhances its perceived valuation. The company can source more funds than it intended should there be a high demand from the public. On the same note, a high price EBIDTA multiple could be of great benefit to the business in future financing, in case the business intends to issue more shares in the future.
Long-Term Benefits
IPO can be especially useful if the company wants to make its debut on the market and enter the list of oversubscriptions, as this can increase the company’s credibility in the eyes of consumers. It can also help float more of its shares in the market since a wider set of investors owns it.
Impact on Investors
Positive Sentiment
The term ‘oversubscribed IPO’ is regarded as positive most of the time. Market investors may perceive that they are demanded in the market by investors most especially after they float their shares in the market. Such excitement can again lead to more purchasing in the second-hand market and consequently, push the value of the stock even up.
Potential Risks
Indeed, oversubscription may look like a good sign too if viewed from the right perspective, however, it has its fair share of dangers to investors. The primary concern is the small number of shares that may be granted to an investor in cases when the investor expects to receive a much larger number of shares. There are also situations where the demand for the IPO is so high that an investor is completely locked out of the shares.
Furthermore, the condition certainly contributes to over-subscription madness during IPO that results in overvaluation of the shares. Those investors who purchase them in the secondary market at these augmented prices might end up being at a loss once the stock price Readjusts after the initial trading hysteria/ trading mania.
Effects on the Company
Increased Valuation
For the company, excessive demand in its IPO constituency enhances its perceived valuation. The company can source more funds than it intended should there be a high demand from the public. On the same note, a high price EBIDTA multiple could be of great benefit to the business in future financing, in case the business intends to issue more shares in the future.
Long-Term Benefits
IPO can be especially useful if the company wants to make its debut on the market and enter the list of oversubscriptions, as this can increase the company’s credibility in the eyes of consumers. It can also help float more of its shares in the market since a wider set of investors owns it.
How to Invest in IPOs that are Floating: Ideas that Work
Diversifying Investments
A wise course for retail investors to adopt is to avoid concentrating all the money they intend to invest in a single IPO, a situation that presupposes that the IPO in question will certainly attract more subscriptions than it can handle. Therefore, through diversification, investors can minimize the likelihood of receiving fewer shares on an IPO or undergoing a share price adjustment after listing.
Using a Long-Term Approach
Yes, some investors may just want to quickly sell in hopes of making a quick buck on the first day of an IPO that attracted a lot of demand, while others prefer to invest for the long term. This translates to mean that if the company’s fundamentals are sound the investor may end up earning a handsome profit out of the investment even if he or she is subjected to short-term losses due to a fluctuating stock price.
For instance, some of the largest companies in the current world like Google and Facebook, for example, had great and highly over-subscribed IPOs. Long-term holders of the shares who did not panic during the fluctuations in the early years reaped big in the later years.
Some of the regulatory concerns relate to oversubscription
REGULATIONS GOVERNING OVERSUBSCRIPTION
IPOs exist and are regulated in many countries, including India where IPO regulation is done by SEBI to minimize fraud and irrationality. Where there is an oversubscription, there are laid down provisions on how the subscription can be awarded especially for the retail and institutional investors. Such regulations avoid any kind of unfair competition for larger investors and the process becomes somewhat fair for anyone interested.
Green Shoe Option
Oversubscription is managed by some firms using the Green Shoe Option. This mechanism makes it possible for the company to float excess shares in the market other than the initial offer. It plays a role in the stabilization of the said share price after the IPO by essentially lowering the supply of the stock which results in lower volatility. But not every company does this, and it depends on the permissions allowed by the regulations.
Conclusion: Market Implication of Oversubscription
For Investors
Therefore, IPO oversubscription is a two-edged sword for investors. On the one hand, it displays high potential that will prompt quick gains since there is much desire among consumers. On the other hand, subscription leads to low demand for the shares and normally very few shares are issued, the price of the stock fluctuates in its first few trading sessions.
Consequently, retail investors should take time and ensure they do not gamble blindly just because of the hyped prospects. Before investing it is crucial to make sure that the necessary research on the company and its basics has been done well. In addition, it means realistic expectations and getting ready for the fact that price fluctuation can happen at any time will bring more rational decision-making.
For Companies
For the company going public, an oversubscribed IPO is considered a success story. It may help it obtain more capital, establish and strengthen its image in the market, and guarantee that its stock is easily traded. However, fair pricing of the company’s shares must be weighed so hard in a manner that they do not overvalue their share prices and therefore plummet the latter in the future.
Final Thoughts
All in all, we want to note that the fact that an IPO is oversubscribed essentially indicates that the market has a high level of confidence as to the future performance of a particular company; however, it should be noted that such situations are accompanied by certain risks. The investors should consider whether he is willing to accept fewer shares or swings that are typical with other listed companies. Like any other investments, IPOs therefore require a lot of research and a long-term approach to achieve the most out of such oversubscribed market.
