Milking the Public.. Price Fixing!!! not Match Fixing!!

We saw in the previous posts that the premium is the extra money that the public is willing to pay. Suppose I am an umbrella seller.. (Haha.. I am an entrepreneur!! ) In autumn or spring, the demand for my umbrellas is less and I would probably sell it at cost price, or a minimum profit. But in the rainy season, I can sell it at a upto 20% above its cost, because it would sell anyway. This difference between the actual price and the actual value is called a premium.

If my company / sector is doing well, people will be willing to spend more on my company, ie they are willing to pay extra (a premium) to get my shares. Now, one of the primary things a company does, when it goes for a public issue (ie raising money from the public by shares) is to determine its share price. The share price (the exact number) is generally determined by SEBI (Securities and Exchange Board of India, a regulating body of the Indian Govt. ) by:
1) Fixed price process
2) Book building process.

Though the exact price may be determined by the above processes, the company specifies a price range for its shares. That is, it specifies a range a range between which the actual price may fall.. i.e. if the band specified is from Rs.690 to Rs. 750, my prices can vary in that range only. So, how is this price band determined?

The price band is determined by the valuation of the company. This valuation is a pretty complex process and is done by the CFO (chief financial officer) with his team, or sometimes by banks like ICICI, Kotak Mahindra etc. There are a lot of ways of valuing a company, but it predominantly depends on the market forces.

Assume that I own a cement company (I can expand from umbrellas to cement u know.. it’s a cake walk!! ) that’s going public, to build a new plant in Orissa. Since India’s GDP is growing at a staggering 8% or more, it is logical to assume that a lot of infrastructural developments will take place. If infrastructure is growing, that means cement will do well. Hence, people will be ready to invest in the cement sector. Hence, my cement company can have a high price band and still be sold.

On the other hand, after the Reliance Power IPO, the public would not be ready to invest in the power sector, at least for some time. Hence, any power company that’s thinking of a public issue would have to price its shares lower to attract investors.

The price band may also be fixed on the basis of the other share prices in the sector. For ex, I can fix my price (Remember the cement company I own?? ;) ) on the basis of the share price of other cement companies.

If my cement company has a brand image of its own, (like the TATA’s, Ambani’s or the TVS group) my pricing may be in a different band altogether. It may not be comparable to my peers, because the public trusts me and my brand. They are ready to pay more to acquire a share in my company!! (How I wish!!)

There are a lot of other ways also, in which the price band may be determined, but let’s leave them to the companies. We will see the method of fixing the exact price, at a later stage. Cya..