From bookbuilding to auction: The winner is the Government

Securities and Exchange Board of India (SEBI), pursuant to a notification dated December 11, 2009, has introduced an additional method for allotment of securities, the Auction Method, in case of further public offers by amending the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009.

Briefly stated, under the Auction Method, the issuer shall disclose a floor price in the red herring prospectus and investors other than retail individual investors shall bid at any price above the floor price. The bidder who bids at the highest price shall be allotted the number of securities that he has bided for and then the bidder who has bided at the second highest price and so on, until all the specified securities on offer are exhausted. Allotment shall be on price priority basis for investors other than retail individual investors.

It seems that in the Auction Method, apart from the retail individual investors, other investors will be allotted securities at different prices depending upon their bids. Thus there will be no uniform pricing of securities as it is in the bookbuilding or a fixed price issue. This Auction Method can be contrasted with another auction method in public offering of securities in other jurisdictions popularly referred to as the “Dutch Auction”. In a Dutch Auction, the price is initially set high, and gradually lowers depending on the bids received. Investors bid on the offering by stating the number of shares they want to purchase and their preferred price. The price continues to lower until all the shares are spoken for. At auction's end, bidders get the number of shares they agreed to buy, but at the price bid by the last bidder. For details see, what is a Dutch auction IPO? Thus, even in a Dutch Auction, the selling price is uniform for all the bidders. This does not seem to be the case for the Auction Method.

The price and share allocation in Auction Method is determined by the investors as opposed to by the investment bankers and the company in the traditional bookbuilding method. Hence one can argue that in the Auction Method under pricing of securities will be much lesser that in the bookbuilding method. This is because in bookbuilding, inter alia, investment bankers tend to underprice so as to make the issue successful. On the other hand, when investors directly participate in setting up the market price, the real market price is arrived at. Thus Auction Method adds substantial gains to the issuer. This outcome will be of substantial importance to the Government of India which is planning a series of disinvestment in the coming months. Provided one develops the infrastructure for the Auction Method before the disinvestment- 2010 kicks in, Government will end up earning more money through the Auction Method than the bookbuilding method. From government’s standpoint, Auction Method is more beneficial than the Dutch Auction since every bidder is allotted securities at the price bid by him unlike in a Dutch Auction where allotment is made at the price bid by the last bidder.

Another point to note is the possible lacunae in the Auction Method. Since there is no uniform price for allotment, the amendment does not provide for the price at which underwriters will subscribe to the issue in case there is under subscription. One can argue that it would be left to the discretion of the company and the underwriters to arrive at a price, provided it is above the floor price.