Initial Public Offerings have become a common phenomenon on the Indian stock exchanges. Besides being a medium for companies to raise funds, IPOs are also an indirect indicator of the strength of the economy. With economic growth mellowing down in 2019, the activity in the primary market slowed down. Companies raised just Rs 12,362 crore through IPOs in 2019, as against Rs 30,959 crore last year.
The primary markets can give you interesting insights into the condition of the economy, which makes it important to understand even the minute details of an IPO. While the major terms like IPO size, price band and opening and closing dates are well-known, some terms can be confusing.
What is an IPO?
When a private company issues shares to raise funds from the public through the stock markets, it is known as an initial public offering. A public offering is generally conducted by a company to raise funds for expansion or to provide existing shareholders with an avenue to unlock some value of their stake. The dominant method of IPO is the book building method.
The book-building method discovers the issue price during the IPO process by assessing the demand for the IPO. In the book building method, the company announces a price band for the issue and investors place their bids for a specific number of shares at different price points. Depending on the bids for the number of shares at each price point the final issue price is determined. The subscriber data is updated daily in the book building method.
During an IPO through the book building method, the company declares a price band of shares, but along with the price band, face value is also announced. The lower end of the price band is known as the floor price and the upper end of the ceiling price. The final issue price is set above the floor price but equal to or below the ceiling price.
Face Value
The floor price, ceiling price and the issue price are important terms, but why do companies announce face value of the shares. The face value, also known as the par value, is the nominal value of the shares. The face value is either Re 1, Rs 2, Rs 5 or even Rs 100. The issue price or the price band are the face value of the shares with an added premium that the company decides to ask from potential subscribers.
The issue price= face value + premium
The premium is not a randomly decided amount but depends on the performance metrics of the company like sales, profit and growth. There have been IPOs that have set the price band near the face value of the shares, which means the company sought minimal premium. The meaning of face value is clear, but what is the utility of the face value.
After listing, the stock price of a company changes according to the market conditions and the performance of the company. The share price is dependent on the market, but the face value is not, which is why companies use the face value to announce share splits. For instance, suppose the share price of company ABC has touched Rs 5000. Its face value is Rs 10. Paying Rs 5000 per share would be out of the question for many retail investors in India. To increase the liquidity of the shares, the company could split the shares into five shares. After the split, the face value will be Rs 2 and the shares price will come down to Rs 1,000.
Similarly, when companies announce a dividend, they use the face value rather than the share price. If a company with a face value of Rs 2 and share price of Rs 200 announces a dividend of 100% of the face value, it means a dividend of Rs 4 per share.
How are Shares Sold at Face Value?
When you purchase a share from the market, you typically acquire it at a price different from its nominal or face value. In most cases, you buy it from another individual or entity willing to sell the share for an amount lower than its official face value. The difference between the face value and the actual purchase price is commonly called a “discount.” This difference in price arises due to various market factors, such as supply and demand, investor sentiment, and the company’s financial performance.
It’s important to note that the face value is often significantly lower than the market value, as it simply represents the nominal value at which the shares were originally authorised. Consequently, investors may still experience capital gains or losses depending on the share’s performance in the open market after purchase. Therefore, shares are not sold at the face value.
Face Value vs Issue Price
Face value is the price the company can sell its shares when it goes public. While the issue price is the price, the company offers its shares to the public for the first time through an IPO. The issue price can be higher than the face value.
When a company goes public, it collaborates with an investment bank to determine the optimal selling price for its shares, known as the issue price. This price is crucial as it dictates the amount of capital the company can raise through the IPO. Striking the right balance is essential, setting it high enough to meet the company’s funding needs but not so high that it deters potential buyers. The issue price also impacts shareholders’ ownership stakes. Ultimately, the investment bank underwriting the IPO, considering market conditions, the company’s financial track record, and demand for the stock, plays a pivotal role in determining this critical price point.
How is Face Value Calculated in an IPO?
The face value represents the per-share price, determined by dividing the total number of shares to be issued by the total outstanding equity shares. For instance, if a company with 1000 outstanding equity shares plans to issue 100 new shares, the face value per share would be 10 (1000/100).
In bonus or rights issues, the face value is calculated proportionally by dividing the proposed issue size by the existing number of outstanding securities. However, in an offer for sale (OFS) or buyback, the face value and the IPO price are also determined based on the existing outstanding securities.
According to SEBI regulations, shares in an IPO must be sold at the Nominal Price, and it’s uncommon for investors to buy shares at their face value since brokers typically avoid selling shares below the issue price.
Importance of Face Value
The face value of a share holds significance in determining the company’s capital structure and its nominal value per share. For instance, a company with a face value of ₹10 per share and 10,00,000 shares outstanding has a total nominal capital of ₹10,000,000. This nominal capital plays a role in various financial calculations, such as the calculation of dividends and earnings per share, and it helps investors gauge the company’s financial structure. However, it’s important to note that in practice, the face value often has little bearing on a share’s market price, which is influenced by market demand, earnings potential, and other factors.
Conclusion
With a clear understanding of terms like face value and premium, you can make a more informed decision while investing. Many corporate actions announced by companies mention the face value. Getting caught up in technicalities, however, should not be a reason to delay investing in the capital markets.
FAQs
Why is the IPO price higher than face value?
Face value is the initial value assigned to shares when a company is created, while the IPO price is the actual selling price when those shares are offered to the public. IPO prices are higher than face value because they’re determined by market demand and a company’s perceived value, usually reflecting growth prospects. Typically, companies choose to sell their shares at a price higher than the face value during an IPO.
Can we buy an IPO at face value?
Investors cannot buy shares of a company at face value because no company will sell their shares at face value. You can buy an IPO according to the issue price.
Is face value related to the stock's market performance?
Not particularly as the market performance is influenced by various factors beyond face value, such as earnings, demand, and market sentiment.
Does a higher face value indicate a better investment opportunity?
Not necessarily, as face value is primarily a nominal figure and doesn’t determine the attractiveness of an IPO; it’s the IPO price that matters.
Should I consider face value when investing in an IPO?
While face value is a starting point, it’s more crucial to assess the IPO price, as it reflects the market’s sentiment and true value.
