In a first for an Indian company, state-run power utility NTPC Ltd took recourse to the ‘French Auction’ route for selling the institutional portion of its follow-on public offer (FPO). The rationale was to garner higher valuations through better price realisations. However, expectations have turned out to be largely misplaced, with the issue taking a beating. The government is now rethinking whether the French Auction model is appropriate.
Under the French Auction method, the highest bidders get a priority on allotment. As such, qualified institutional buyers (QIBs) were expected to jump onto the bandwagon, since they get preference on the price bids they place for the shares. However, the government failed to take cognisance of some preconditions essential for the success of any issue based on this model.
For a French Auction to work its magic, two conditions have to be satisfied—first, a robust demand should exist for the shares, where potential buyers are willing to fight it out for getting more allocation. This is where the Google IPO (which adopted the Dutch action rout) worked wonders. Second, there should not be a reference market price (as is the case in an IPO). If such a price exists, then the offer should be substantially lower than the prevailing price, so as to attract buyers’ attention. Both these conditions were conspicuously missing from the NTPC issue. At Rs201, the floor price of the issue was not low enough to offer any significant upside in terms of the prevailing market price of Rs205. Not only was there no element of mystery as regards the price (being a follow-on public offer), but more relevant was the complete apathy towards the issue, especially from retail and foreign investors.
Under conventional book-building, even if you bid high and if the book gets built at the middle of the price band, you will still get the discovered price. But in case of a French Auction, the fund manager is stuck with the higher price—and the higher allocation as per the model.
Next on the government’s divestment agenda are Rural Electrification Corporation (REC) and NMDC, where it is likely to replicate the French Auction model for the institutional portion of the public offers. Unfortunately, many of the issues that weighed upon NTPC’s offer feature prominently in these offers as well. Unless market conditions and investor sentiments improve dramatically, these public offers may go the NTPC way. — Debashis Basu & Sanket Dhanorkar