Apr 21, 2017 01:29 PM IST

How smart investors play the OFS bidding game

Given how the government has lined up several OFS in the coming months, it will be in the interest of the retail investor to know just how he can benefit.

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Have you ever returned empty-handed from an offer for sale (OFS) even after you placed your bid at a cut-off price or at the floor price which is set by the company? If that’s the case let’s understand how smart investors play this bidding game.

Given how the government has lined up several OFS in the coming months, it will be in the interest of the retail investor to know just how he can benefit. One feature of the government-led OFS is that it usually comes with a 5 percent discount to retail investors.

For instance, in the case of National Aluminium (Nalco) OFS, which closed on Thursday, the price was set at Rs 67 a share and retail investors were offered a 5 percent discount or Rs 63.65 per share.

Not just Nalco, we have seen similar discounts in the recently concluded offer-for-sale of Bharat Electronics, MOIL and Engineers India, where retail investors (allowed to bid up Rs 200,000 per application) were offered a 5 percent discount. Typically, the offer price of the security in OFS is set below its ruling price to attract more investors. The lure of this discount, coupled with the possibility that their capital will appreciate, has driven retail investors to OFS.

So do retail investors actually earn fantastic returns?

Theoretically, yes. But, in practice, no. Take the case of Nalco. Prior to the announcement of the follow-on-offer (FPO), the share was trading at around Rs 74 a share. The company announced the floor price at Rs 67 to make it attractive. In an ideal situation, once the offer closes the share should gradually go back to the level of Rs 74. If the retail investor actually manages to get the share at a 5 percent discount i.e. at Rs 63.65 per share and manages to sell it at Rs 74, he pockets a cool 16 percent in a few days. This trade actually encourages investors to leverage and earn quick bucks.

But the knowledge of this trade and return itself generates a lot of demand for the public offer. Therefore, shares rarely get allocated at the floor price because of increased bidding at prices above the floor price.

"From the experience of a few recently concluded IPOs like BSE and DMart owner one can easily figure out that retail investors can easily absorb applications worth Rs 2,000-3,000 crore. If the offer (IPO or OFS) is good, anything below that amount gets oversubscribed. This is also a reason that you see many of the government OFS getting oversubscribed in the retail segment leading to a huge demand, narrowing the scope for retail discount offered on such offers," said Arun Kejriwal, Founder, KRIS, a Mumbai-based investment advisory firm.

How should investors bid?

Suppose in an IPO or OFS the floor price is set at Rs 100. But because of huge demand the issue gets oversubscribed 5 times. This means that for every five share being applied for only one share will get allotted.

In this case, investors need to bid at a higher price to improve the chance of an allotment. Despite the floor price being at Rs 100, investors should bid at a slightly higher price say Rs 101 or Rs 102. This is precisely what smart investors do.

Even after bidding at a higher price, post the discount, they manage to earn close to 2-3 percent in a short time-frame. For instance, if one makes a bid at Rs 103 (where the floor price is Rs 100) she will be allotted shares at Rs 97.85 factoring in the discount (5 percent), which is still a return of 2.2 percent.

"Retail investors should not aim for higher returns. Expecting a 2-3 percent return from such an offering is good enough and has a better chance of getting an allotment. Accordingly, retail investors should adjust their bidding price rather than sit on a cut-off price or offer price," said Arun Kejriwal.

To put it in perspective, Nalco's FPO closed on Thursday, and on NSE the retail category was oversubscribed 5.84 times. Importantly, out of the total 5.81 crore shares bid on the NSE in the retail category, over 1.12 crore shares were bid at cut-off price or floor price of Rs 67 a share. This category certainly has no chance of getting an allotment. Because of the oversubscription, the applicants who have placed bids at a higher price have a far greater probability of getting shares allotted.
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