Flexibility in pricing for IPOs
With the newly-launched pricing flexibility mechanism on initial public offering (IPO) pricing, companies can opt to have some flexibility in their IPO price without having to withdraw and relaunch the offer.
In an IPO, companies are required to disclose the offer price of the stock in the prospectus. The offer price indicates how much investors need to pay per share for the stock, the valuation of the IPO, and the amount of funding to be raised from the IPO. Companies normally price their IPO at the offer price or within the offer price range. Pricing an IPO outside the offer price range will trigger the withdrawal mechanism. Now, with the introduction of the pricing flexibility mechanism, companies can price their IPO of up to 10% below the offer price without triggering the withdrawal mechanism.
Key features of the pricing flexibility mechanism
Companies can opt whether or not to adopt the mechanism. If the mechanism is not adopted, the withdrawal mechanism will apply whenever the final offer price differs from the indicative offer price, or falls outside the indicative offer price range.
Price reduction cap
The mechanism applies to price reductions only. The possible price reduction is capped at 10% of the offer price or the bottom end of the offer price range (the range must not be more than 30% above the bottom end of the range) disclosed in the prospectus.
- If the offer price is set at $10, the final price can be adjusted downward to $9 ($10 X (1-0.1)) at most.
- If the offer price range is set between $9 and $10, the final price can be adjusted downward to $8.1 ($9 X (1-0.1)) at most.
If the price reduction is greater than 10%, the withdrawal mechanism will apply.
There are certain disclosure requirements in the prospectus, application forms and formal notice, and companies are required to make a separate announcement on the final adjusted offer price as soon as practicable.
Cost and time effective
The requirements set out in the withdrawal mechanism including issuing a supplemental listing document, extending the offer period and adopting an opt-in approach for investors withdrawing their applications for shares, are not applicable under the pricing flexibility mechanism. These requirements can be costly, complicated and may delay the IPO process. Issuers may rather withdraw and subsequently relaunch the listing application with a lower offer price. With pricing flexibility, companies can just adjust the pricing provided that they comply with certain disclosure requirements.
Implications of price reduction
Provided that there is no change in the financial metrics disclosed, it will lower the valuation of the IPO in terms of financial ratios such as price-to-earning (P/E) ratio. Also, it can be viewed as a way to drum up interest in the IPO.
Investors will purchase the IPO stock at a lower cost. However, this does not imply that the IPO stock is a bargain.
The company will raise less funds from the IPO. The smaller proceeds from the listing may impact future development plans, and its fundamentals such as working capital, cash flow and profit forecasts.
The mechanics of IPO pricing
IPO pricing can be somewhat complicated but the basic objective is to set a price which balances the supply and demand of the stock. There are many factors affecting the demand of an IPO, such as the company's financial history and earning potential, investor sentiment and confidence in the company, marketing of the IPO, and current market sentiment. After taking into account the various factors, companies will price their IPO at the low-end, midpoint or high-end of the offer price range, or below the offer price if they have adopted the pricing flexibility mechanism.
Retail investors should do their homework and consider the valuation of the IPO. You can compare the company's valuation with those companies in the same industry or the industry benchmark. Also, you need to understand the fundamentals including the company's business strategy, future plans and growth prospects, as well as the risk factors and the use of proceeds from the prospectus.
2 February 2018