Investing in shares is an exciting prospect as it allows you to participate in the growth story of a company. When a company launches shares via an Initial Public Offering (IPO), many investors try to assess the potential it holds. This usually involves assessing the company’s business, competition, financials, etc. To successfully make this assessment, investors need detailed information about the company.
The Securities and Exchange Board of India (SEBI) has mandated all companies launching an IPO to share certain information about their business, financials, risks, etc., via a document called the Red Herring Prospectus or RHP.
In this article, we will share pointers to help you read an RHP efficiently and make an informed decision about investing in the company.
As an investor, you might not be aware of all industries. The Industry Overview section of the RHP offers a macroeconomic view of the Indian economy that includes the GDP growth and consumption patterns in the economy.
It also offers an industry-specific view of the favourable demographics, growth drivers, opportunities, challenges, and macro & micro-level analysis of the industry and its sub-segments. This is a highly detailed section and offers a bird’s eye view of the industry to which the company belongs.
After explaining the industry dynamics, the RHP also offers a detailed view of the issuing company and its business operations. It typically lists the range of products and services offered by it, its size of operations, and the principles that drive its business.
The Red Herring Prospectus also lists the strengths of the company – both internal and external. These strengths differentiate the company from its competitors. It is important to go through this section only after understanding the company’s business and its competition.
The strengths of the company can help you understand the potential it has to grow in the near future.
This section lists the strategies adopted by the company to establish and grow its business. This can include product-level strategies, geographic strategies, market-level strategies, etc.
This can help you understand the approach taken by the issuing company to generate profits.
The Operations section offers insights into the processes and systems followed by the company to offer products and/or services to its customers. You can understand manufacturing processes, pricing policies, internal processes, quality monitoring systems, marketing plans, etc.
This offers a better understanding of the way the company goes about its business.
This section offers a summary of the laws and regulations applicable to the issuing company. It lists the name of the Acts under which the regulations are mandated, environment regulations, Tax laws, and Employment regulations. This allows you to understand the extent of regulation in the said industry.
Usually, under-regulated industries are prone to attract the wrong companies, and investing in them can be counterproductive.
Typically, a company launches an IPO after several years of being in business and generating profits. Therefore, to understand the growth trajectory of the company, you must look at its history and how it grew.
This section lists the Board of Directors of the company along with the following details about each Director:
It also includes a brief biography of each Director, the payment details of all Directors, and committees of the Board.
You can find complete details about the promoters and/or promoter groups of the company in this section.
It is not mandatory for a company to declare dividends. However, some companies have a formal dividend policy that is declared in this section. You can also look at the dividend declared by the company on equity shares in the previous financial years (if applicable).
Investing in equity shares carries risk. This section lists all possible risks faced by investors of the company.
This section offers all details about the IPO, including the number of shares offered via fresh issue and offer for sale. It also offers a break-up of the QIB, Non-Institutional, and Retail portions.
This section offers details about the Equity Share Capital of the issuing company as of the date of the Red Herring Prospectus. This includes the authorized share capital and issued, subscribed, and paid-up capital before the offer.
It also has information regarding the history of the equity share capital held by the promoters of the company.
This section offers details about how the company plans to utilize the funds collected via the IPO. As an investor, this can be used to assess if the company is focusing on growth or steadying the ship, or any other goal.
This section includes the following:
Each of these statements offers insight into a particular financial aspect of the company. While these statements might seem overwhelming at first, it always helps to seek professional assistance if you are unable to make sense of these financial statements.
This section carries information about outstanding litigation and material developments. It helps you understand if there is any serious civil, criminal, or tax-related litigation outstanding involving the company, its subsidiaries (if any), and promoters.
In this section, you will find detailed information about the terms of the offer, including:
It is important for all investors to go through this section to understand the finer details about the offer.
This section has qualitative and quantitative factors that have been used by the company to arrive at the Offer Price. While the qualitative factors take into consideration the Strengths of the company, the quantitative factors include:
This section needs to be studied carefully to determine if the IPO is valued correctly or is over/undervalued.
You can find an RHP at any of the following places:
Further, the issuing company is required to make a public announcement through at least one newspaper after submitting the RHP to SEBI. It can be a Hindi, English, or Regional language newspaper.
A Draft Red Herring Prospectus or DRHP is the draft prospectus of the IPO.SEBI goes through the DRHP and recommends changes (if any) and/or approves it. Post-approval, the DRHP becomes an RHP.
Let’s understand some basic concepts to understand the relevance of a Red Herring Prospectus or RHP.
It is a document that contains all the relevant information about the company, promoters, projects, financial details, objects of raising the money, terms of the issue, etc. It is called “Prospectus” in case of a public issue and “Letter of Offer” in case of a rights issue.
The IPO can be classified into two types based on pricing:
With these three concepts clear, let’s look at the definition of an RHP:
Red herring prospectus is an offer document used in case of a book-built public issue. It contains all the relevant details except that of price or number of shares being offered.
As you can see, the RHP packs a lot of information about the company. If an investor goes through the entire RHP carefully, assessing its fundamental strength can be easy. We hope that this article helped you de-mystify the Red Herring Prospectus and made you comfortable with the information made available through it.
Spend some time analyzing the information before investing in an IPO.