On Tuesday, when the Power Finance Corporation (PFC) follow-on public offer (FPO) had opened for subscription, many investors would have been wondering if it was a good time to enter the stock.
What is an FPO?
An FPO is a primary market issuance when companies issue further fresh equity or when promoters dilute their stake in the company. These companies, hence, are already listed on the bourses.
Similar to an initial public offering, FPOs have a price band fixed for the issue. Unlike the corporate actions (such as bonus, rights' issue that are applicable only to the existing stake holders, etc), FPOs are open to all investors.
The price band for an FPO depends on the market value of the existing company shares and the reason for raising funds.
Arbitrage opportunity
Typically, FPOs provide a good arbitrage opportunity. If the company's share price is more than the FPO price, a buyer gets a chance to exit the company at a higher price and enter at a lower level.
But the window of opportunity may not last long, because the stock price will return to the FPO price before listing. Things can be completely different if the share price is lower.
What can help a retail investor is the discount offered during FPOs. Usually, retail investors are given up to 5-10 per cent discount on the issue price.
Once a company announces its FPO, the stock movement also depends on the float. Typically, stocks of companies with a low float (implying the number of stocks of the company is low) are in demand and command a scarcity premium.
What to look for?
A merchant banker says the decision to invest in PFC's FPO can be based on the discount differential in the price of the issue and its market price.
He says in a public sector issue, although the discount is lesser compared to a private company's FPO, retail investors are given a discount on the issue price as well.
Companies are usually advised to keep a discount of 10 per cent to the market price, he adds.
The price band for the issue has been fixed at Rs 193-203, with a five per cent discount for retail investors. The company's shares are trading at a premium to the FPO price at Rs 214.
Investors, as a result, will get a discount differential of more than 10 per cent (this includes the five per cent discount to retail investors).
After listing, there is a likelihood of the share price dipping below the issue price. Since fresh shares will be added to the company's free float, the earnings per share (EPS) is likely to come down.
This will put pressure on the share price. Although the volumes traded of the company will increase, there will be some pressure on the price, he adds.
Although the markets on the whole have been volatile, FPOs that have got listed since 2009 have seen a massive drop in their share prices.
The Sensex has risen more than 90 per cent since 2009. Most FPOs that have been listed during this period have fallen quite a bit.
Birla Shloka Edutech has dipped 67 per cent below its issue price since its listing. Shipping Corporation of India has shed 24 per cent, NTPC 14 per cent, NMDC 10 per cent and Tata Steel 2.5 per cent.
The FPOs of Rural Electrification Corporation and Power Grid have given positive returns (9.36 per cent and 14 per cent, respectively).
Hemant Rustagi, CEO at Wiseinvest Advisors, says along with the fundamentals of the company, one should look at the pricing of the issue before making any investment decision.
