Monday, February 20, 2017

Understanding Equity Share Auction and Recent Trend in Nepal

Common stocks, also known as equity share (or equities) carry the ownership of the public entities. The holders of these securities share in the rising prosperity of the company. The holder of common stock entitles the voting right on any agenda that are presented on the annual general meeting of the company. On the other side of the coin the holder of common stock bears the ultimate risk associate with the entity. They are the residual claimants of the income. The common stocks are usually listed in the stock exchange and widely traded in the secondary market. A corporation whose stock is not publicly traded is said to be closely held. Their share might be traded via Over-the-Counter (OTC) market.

The Initial Public Offering (IPO) is the first step to distribute the equity share to the public. In Nepalese perspective IPO is offered in the face value. At this stage public bid their money for the equity share offered. In the case of under-subscription, the company who underwrite the share with the authority buys the unsubscribed share. However, in the event of over-subscription, the total number of share is allocated on pro-rata basis. If pro-rata basis is not possible because of the minimum number of share to be allocated, then the share will be distributed on lottery method, so that maximum number of investor can be benefited. The Nepalese law have clearly prescribed that 40% of total public issue should be kept aside for small retail investor. An investor holding an equity share is a partial owner of the organization.
After a public issue, if the entity is in need to rise the fund again for the expansion of its business (or because of legal constraints), there are various options available for the enterprise. The first one is to provide dividend in the form of stock, in general providing stock dividend or bonus share. While providing stock dividend the investor doesn’t have to pay anything, however, their monetary return will be reduced. It will increase the core capital of the enterprise. The stock price of the enterprise in the secondary market is generally affected positively in secondary market in the event of stock dividend. This will eventually increase the market capitalization of the firm. After those stock dividends available for trading in the secondary market, the individual share price of the firm will be adjusted at lower price so that the market capitalization remains same.

The second method to hike the capital of the enterprise is to offer Further Public Offering (FPO). The process of issuing FPO is almost similar to the Initial Public Offering. The only major difference is that, in FPO public can see the performance of the equity share of the firm in the secondary market. They can analyse from the historic data and calculate the ratios & values and make comparison to other firm. Like in IPO, FPO also can have under-subscription or over-subscription situations, which are managed like in IPO. On the basis of past few year financial performance the regulatory body have provided room to offer FPO in premium price in Nepal.  The latest example of Further Public Offering in Nepal are Shikar Insurance with Rs. 550 added premium, Reliance Lotus Finance at face value and Nepal Investment Bank with Rs. 501 added premium. The FPO increases the public holding percentage in the enterprise and the promoter (or the existing management) might lose control on the firm.

The third and the very common method of increasing capital of an enterprise is Right Issue. Like other option to hike the core capital right issue also needs an approval from the annual general meeting or special general meeting of the firm. The right issue doesn’t change the ownership structure of the enterprises. Only the existing shareholder can apply for the right issue and only up to the amount of issue that has been offered. For example, an investor holding 500 units of share of ABC company and the right issue is of 50% (or 2:1) then that particular investor can apply for up to 250 units. The investor also holds the right to provide his/her right to another existing shareholder. However, the total right that investor can exercise should be within the pre-defined level. The investors also hold the right to not to exercise his right.

Why equity share is available for auction?
There are various reasons for an equity share to be available to the auction, such as;
-         In the event of right issue, if the investor is aware about the right issue but doesn’t want to exercise his right fully or partially then the number of equity share remains un-applied. In this condition, Securities Issue Guidelines 2065, Paragraph 7, Sub-Paragraph 8, has clearly mention that those un-applied shares should be sold via a fair method like auction.
-         If the investor is un-aware about the right issue or is financially default, then shares remain un-applied and again according to the same claws mention above brings the equity share to the auction.
-          In most condition, right issue brings a problem for the investor that occurs in decimal figure. For example, if an investor is holding 10 units of share and the right issue is of 25% then in such situation if the investor applies only for 2 units and 0.5 unit of share being unapplied. If there are thousands of such applicant, this will lead to significant number of share being un-applied and eventually bringing them to the auction.
-         The other situation is pretty unusual however there is a fair chance that this situation can occur in long run of an enterprise. The legal restrictions made from the regulatory body or act seek to maintain promotor and public shareholding ratio in the enterprises. In Nepalese context, Nepal Rastra Bank, NRB (Central Bank of Nepal) directs Bank and Financial Institution (BFI) to maintain at least 30% public holding and no more than 70% of promotor’s holding. In a long run because of those fractional share the holding percent of public might be less than the actual required. In such circumstances, the enterprise ask permission from regulatory body (like SEBON, NRB or Insurance Board in Nepal) to sell few thousand number of share to the public via auction to maintain that minimum legal requirement.
-         The another situation is offloading the institution’s current holding. In context of Nepal an enterprise is not allowed to hold the share similar industry, however, this was not a problem on the past. So, there are many enterprises in the market they hold the share of other enterprise of similar industry. For example, holding the share of Nabil Bank by NIDC. At present, the existing law doesn’t allow to hold such cross holding share. So, those enterprises have to offload these share. And these share generally sold to public via share auction. For example: To comply with the central bank’s directive that all BFIs give up cross holdings in other BFIs, Rastriya Banijya Bank Limited had called a tender to divest 56.52 lakh units of promoter shares of Nepal Investment Bank Limited and 1.96 lakh units of promoter shares of Nepal Awas Finance Limited. In some instance enterprises also offload their share just to rise fund from their shareholding without the concern of cross holding as well.

What is equity share auction?
Equity share auction is a method of selling equity share to the public through a fair auction process. For this, the enterprises who need to sell the share first need to get an inform the concern regulatory bodies, along with the decision of their board meeting. After this they can make a public announcement (in some unusual event they may need permission from the regulatory bodies). The public announcement can be done by publishing a notice on national level daily newspaper. In context of Nepal, such notice should be published in minimum 2 national level daily newspaper and at least 15 days ahead of such opening of sale. A brief information containing the available number of share, minimum price per share and other related things should be made available to the regulatory body and should also be published in company’s website. (SEBON, press release, 21st Baishakh, 2073). Furthermore, Securities Board of Nepal also urges to publish such information in at least 2 major online news site, 2 major FM Radio and on 2 major national level financial newspaper, so that public get adequate information.
After such information announced to the public there will be certain days available for the investor to put their bid in a sealed envelope. Before that the investor must deposit the full or partial portion of their bid on the specific bank account and attach it with the auction form. Auction form can be purchased on a very little price (sometime free of cost as well) from the company or sales representative. Some company also made these form available to download from internet. All the collected bid applications from investor will then open in front of those investor or their representative at once on the specified time and venue. However, if some investor or their representative is absent on bid opening day, this will not restrict on making the announcement result. A few adequate number of investor or their representative is supposed to be enough to remain as the eye witness of the process. There is no legal requirement, that a representative from the regulatory body should be present at the announcement result.

After all the submitted bid is checked then the investor willing to pay highest per unit price will get the share. If that investor bid for the fewer unit then the investor with second highest per unit price will get the share. This process will continue until the last unit of share is sold. In the event that there are two or more investor willing to pay exactly same price and the remaining unit of share is less than what they have asked, then usually those shares are sold on a pro-rata basis. The minimum value that the share has been sold is called ‘cut-off-price’.  The investor buying share at cut-off-price make the highest initial profit. Here, the term profit has been used because the cut-off-price is assumed that will remain below the market price of the stock exchange. In the event of equity share being very scarce to trade on secondary market, there might be significant chances that the cut-off-price will be higher than the Last Transaction Price (LTP).

Merits and Demerits of Purchasing Share via Auction.
There are few pro and cons while purchasing securities via auction, they can be summarised in following points.
1.     The decision of auction is made in short span of time while comparing to IPO or FPO. Generally, it takes two weeks' period for an investor to get decision on their investment, while, it take about two months' period to get decision on their investment in IPO and FPO. The benefit is that the investors' money will freeze for very little time and the opportunity cost will be nominal.
2.     The Cut-Off price in the equity share auction is generally less than the secondary market price (see table below), which indicates that investor can buy equity share at discounted price. Some time it is as low as 54% (Ref: Premiere Insurance auction data). This indicates that the investor has to wait less time to get desire profit amount.
3.     The investor can analyse the performance of the stock in advance. This means the stock is already being listed in secondary market and the behaviour of the stock can be analysed more carefully based on the previous data. The investor does not have such option while purchasing stock through IPO or FPO.
4.     The share being sold through auction get listed in secondary market in very little time with compare to IPO or FPO. So the securities can be traded in very short span of time. (Except few exception)
5.     The investor doesn’t have to pay brokerage commission and regulatory fee while purchasing via auction method.

Similarly, there are few demerits as well. They are;
1.     The investor has to wait for the bid to open and to get result of the auction. This process roughly takes two weeks' time to get the decision. The investor has to sacrifice longer time to get share comparing to share purchasing via secondary market.
2.     Cut-Off price works as a mystery price level, it differs in each and every share suction (see table below). It is almost impossible to predict the cut-off price in share auction. So, while targeting to bid near cut-off price investor may bid at the lower value than the cut-off price.
3.     The process of equity share auction is less monitored by the concerned regulatory bodies. The process lacks some kind of legal support as well. 

The following table is shows the data of recent share auction in Nepal. Auction for more than 50,000 unit and securities which has been regularly being traded at secondary market has only been considered for the discussion.
Unit available for auction
LTP before auction
Cut off price
Cut off Percent of LTP
Sunrise Bank (1)
Century Bank
Neco Insurance
United Insurance
Progressive Finance
Premier Insurance
Garima Bikash Bank
Western Development Bank
Taragoun Regency Hotel
NIC Asia Bank
Prime Bank
Himalayan General Insurance
Butwal Power Company
Shangrila Dev. Bank
Innovative Dev. Bank
ICFC Finance
Sunrise Bank (2)
Laxmi Bank
Citizens Bank
Sanima Bank
Table 1: Recent equity share auction data of Nepal.

Chart 1: Concentration of Cut-Off percentage of LTP on equity share auction
This chart shows the stock's cut off price percent with Last Transaction Price (LTP). The line is highly concentrated with the range of 80% to 100%. The cut off percent of Premier Insurance was record low among the data, at 54.85%. The cut off price of Taragoun Regency Hotel was above 99% and Laxmi Bank was exactly 100%. The data also shows that the Cut-Off price for Sanima Bank's 1,68,532 units' equity share was above the LTP. It was recorded 107.64%, which is highest among the data we have considered. And it is the only stock whose cut off price recorded above the LTP. It is one of the abnormal decision that investor had made while bidding. The last day to make the bid was on 2nd October 2016, the transaction history of Sanima Bank on 2nd Oct at Nepal Stock Exchange looks like as below;
% Change

Table 2: Stock transaction data of Sanima Bank on 2nd October, 2016.

This shows that, almost 14,000 units of equity share were traded at the range of 640 – 650 on 2nd October but on the other hand the investors were interested to pay premium price to the for the same stock. This is a very unusual event to see. The wise decision is to buy stock from secondary market at the lower price rather than bidding premium price on auction.

Chart 2: Showing the relation between actual cut off price and LTP.

The above presented chart shows the actual cut off price amount with respect to each individual share, the chart shows that regardless with the price of the share the cut off price generally lies slightly less than the last transaction price of the share excluding some exceptions. It can be generalized that, regardless of the price of the stock, the usual trend is that the range of the cut off price generally lays just below to the Last Transaction Price (LTP). The first chart indicates the concentration zone at the range of 80 to 90%. The simple mean of the Cut off percent of LTP comes to be 89.5% If we exclude the abnormal case of Sanima Bank, whose Cut Off price was set at 107.64% of LTP, then the simple mean of the data will be 88.55%. This means any investor bidding at the price range of 88 to 90% of LTP can expect to get share on auction. Being more specific and excluding the data of Premier Insurance whose cut off price was considerably very low with reference to the above range, the simple mean of the data will be 90.42%. The above three figure indicates that the appropriate range to bid to expect for allocation of share is 88 – 90%. If the stock is not trading regularly in the secondary market, then LTP varies with the current circumstances and that makes it difficult to predict the range. For example, let's take the auction data of NB Insurance, whose LTP was Rs. 154 on 4th October, has auctioned 41,837 units of ordinary equity share. The cut off price was Rs. 1151 and the highest bid amount was Rs. 1860. The actual reason behind this is that the script was halted for trading for long period in Nepal Stock Exchange. When the trading resumed it was traded below the par value. It gradually gets the pace to rise and was traded at Rs. 154 before the closing day for the auction. However, the demand for the stock was very high and the supply was almost zero, this imbalance leads to the rise in the stock price which was reflected in the bidding amount by the investor.

Buying share through auction is an option available for the investors. Most of the investors do not want to lose the option available to them. Investment decision are based on the risk and return principle of the finance, and this process is not an exception to the principle. The process of buying share mostly rely on the assumptions of arbitrage, which means, buying a particular item at lower price on a one market and selling it on another where it has been highly priced. The difference is the arbitrage profit. Auction bidder seeks for that arbitrage profit and the interesting thing is that each and every investor makes the different profit on the same stock depending on their bid amount. The investor who makes the maximum profit bids at the cut off price and the investor who bids less than the cut off price, will get no return but only bears the cost. The cut off price differs in each and every auction, it's impossible to find the exact cut off price. By analyzing the recent trend with similar nature of auction, the safe range can be identified where investors can expect to be allocated share for them. But there is no guarantee at all. However, the rational decision than an investor can make is to bid around or slightly below than the identified range and make a regular study and follow the other investors investing behavior carefully.

Ajaya Dhungana
Officer, Securities Board of Nepal
MBA (Finance), University of Gloucestershire, UK
(Views are based on personal judgement.)

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