In raising capital from the public, book-building is a popular method in Asia. In this region, it has been used by many companies to launch their initial public offerings (IPOs). However, some people may be wondering what the difference between book-building and a public issue is.
Book-building is “a process that occurs during the underwriting of an IPO where potential investors indicate what they would be willing to buy and at what price.” Basically, through this process, investors place their orders for new shares offered by the company; while investors place these orders with their discretion, this does not mean that they can set any price they want for such an order.
Due to this, such orders are made under the supervision of an underwriter; the latter sets prices that investors cannot break. The orders placed by investors for shares bought during book-building are referred to as “indications of interest” (IOI).
At the end of book-building, which takes place during the “roadshow”, there will be a valuation of the company; i.e., the company’s value at this point is calculated based on how much it is expected to raise from the public via IPO, and the target price set by underwriters.
Compared with a public issue where companies have fixed what they want to sell to the public, book-building seems more flexible in allowing market forces to determine demand and supply for new stock being issued. However, that could be a double-edged sword since if the demand for new stock is overestimated, the price may fall short of expected.
Public issues may be better than book-building when it comes to the flexibility provided. Companies can determine what they want to sell to the public; this means that even if demand for new stock turns out high, companies can still refuse to sell their shares at higher price levels. However, in the case of book-building, where prices are set by underwriters (and not necessarily by market forces), then if there is a sudden spurt in demand, new issues will have no choice but to accept lower price levels for their stock.
Market determination of share price
As mentioned above, pricing during book building happens concerning target prices set by underwriters; however, these targets are usually based on demand during the “roadshow” or the presentation of new issues to potential investors. On the other hand, public issue is more market-determined as it allows companies to price their shares whatever they feel is best, provided they are willing to sell them at that price.
Determination of demand for new stock
Public issue determines demand by allowing investors to place orders for shares offered by a company. However, in book-building, underwriters determine demand through IOIs made by potential investors before pricing. While demand is determined by orders placed for practical reasons (i.e., no surprises later), underwriters have the most control over setting prices during book-building. Conversely, this means that the role of market forces as a pricing mechanism will be reduced.
In public issue, demand for new stock is determined by companies, which can set what they want to sell at a given price. However, there is a fixed supply level in book-building where underwriters determine how much potential investors are willing to buy before setting prices. In theory, this may help reduce volatility during trading since there would already be an equilibrium point where both buyers and sellers have agreed on a price level. However, other factors such as liquidity could also prevent share value from going up or down too much, so prices could still swing after book building has been completed.
Underwriters are the middlemen between companies and investors in book-building and public issues. However, underwriting for each may be done differently depending on the process involved. Underwriters set their target prices for new stock to be sold during book-building. Conversely, during public issue, this task of determining price levels falls on the company selling shares to the public.
The public will decide what they anticipate demand will be at each level. It’s also worth mentioning that more than one underwriter will usually help determine share price during a book-building exercise (since they may not all agree with each other). In contrast, only one underwriter is used for a public issue.