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.
In this article
- Things To Look Out For In A Red Herring Prospectus
- 01: Industry and Business Overview
- 02: Strengths
- 03: Strategies
- 04: Operations
- 05: Regulations and Policies
- 06: History
- 08: Promoters and Promoter Group
- 09: Dividend Policy
- 10: Risk Factors
- 11: Details of the Offer
- 12: Capital Structure
- 13: Objects of the Offer
- 14: Financial Information
- 15: Legal Information
- 16: Offer Information
- 17: Basis for the Offer Price
- Where Can You Find an RHP?
- What is a Draft Red Herring Prospectus?
- Terms You Need To Know When Reading An RHP
- Summing Up
Things To Look Out For In A Red Herring Prospectus
01: Industry and Business Overview
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 principle 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.
05: Regulations and Policies
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:
- Date of Birth
- Director Identification Number (DIN)
It also includes a brief biography of each Director, the payment details of all Directors, and committees of the Board.
08: Promoters and Promoter Group
You can find complete details about the promoters and/or promoter group of the company in this section.
09: Dividend Policy
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).
10: Risk Factors
Investing in equity shares carries risk. This section lists all possible risks faced by investors of the company.
11: Details of the Offer
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.
12: Capital Structure
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.
13: Objects of the Offer
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.
14: Financial Information
This section includes the following:
- An independent auditor’s examination report on restated consolidated financial information
- Restated Consolidated Statement of:
- Assets and Liabilities
- Profit and Loss
- Changes in Equity
- Cash Flows
- Property, plant, and equipment
- Other Intangible assets
- Non-Current Loans
- Non-Current Financial Assets
- Other non-current assets
- Current Investments
- Trade Receivables
- Cash and Cash Equivalents
- Other current financial assets
- Other current assets
- Share Capital
- Reserves and Surplus
- Borrowings, etc.
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.
15: Legal Information
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.
16: Offer Information
In this section, you will find detailed information about the terms of the offer including:
- Ranking of the equity shares
- Mode of payment of dividend
- Face value, offer price, and price band
- Rights of the shareholders
- Offer details including:
- Offer structure
- Offer Procedure
- Important dates
- Do’s and Don’ts
- Technical rejection grounds
- General terms and conditions pertaining to the offer
It is important for all investors to go through this section to understand the finer details about the offer.
17: Basis for the Offer Price
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:
- Basic and Diluted Earnings Per Share (EPS)
- P/E Ratio based on the peer group from the industry
- Average Return on Net Worth (RoNW)
- Net Asset Value per Equity Share
- The comparison of accounting ratios with industry peers
This section needs to be studied carefully to determine if the IPO is valued correctly or is over/under-valued.
Where Can You Find an RHP?
You can find an RHP at any of the following places:
- The official website of SEBI. You need to go through the “Offer Document” section to find it.
- Websites of Stock Exchanges and select Merchant Bankers
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.
What is a Draft Red Herring Prospectus?
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.
Terms You Need To Know When Reading An RHP
Let’s understand some basic concepts to understand the relevance of a Red Herring Prospectus or RHP.
- Offer Document – It is a document which 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.
- Book Built Issue – The IPO can be classified into two types based on pricing:
- Fixed Price Issue – Where the issue price of the shares offered in the IPO is predetermined by the company and specified in the Offer Document.
- Book Built Issue – Where the issue price is discovered on the basis of demand received from the prospective investors at various price levels.
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. Good Luck!
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