Initial public offerings (IPOs) are one of the most common ways for companies to get access to capital by issuing their equity shares to the public. However, IPOs are an avenue only for unlisted companies.
So then, what about companies already listed and traded on the stock exchanges? Here is where a follow-on public offering (FPO) comes into the picture. Through an FPO, a listed company can issue more equity shares to the public to raise capital.
In this article, we are going to explore the concept of FPO in the stock market in detail. We will look at how FPO works, the various types companies can opt for, the benefits for investors and a detailed comparison of FPO vs. IPO.
What is FPO in the Stock Market?
The term FPO in the stock market refers to a follow-on public offering. It is the process through which a company already listed on an exchange issues additional shares to the public for additional capital.
Unlike an IPO, which is the first sale of equity shares to the public, an FPO is a secondary offering designed to help listed companies raise more capital from the stock market. One of the key features of a follow-on public offering is that it allows companies to tap into the equity market multiple times. In fact, there is no limit to the number of FPOs a listed company can offer.
Types of FPO
Now that you are aware of the meaning of FPO in the stock market, let us look at the two types available for listed companies desirous of raising capital from the public.
Dilutive FPO
A dilutive FPO is when a listed company issues new equity shares to the public in exchange for capital. The issue of new shares increases the total number of outstanding shares in the market, diluting the ownership percentage of existing shareholders.
While these types of FPOs are disadvantageous for investors, they are highly beneficial for companies as they receive funds, which can be used for business expansion, debt reduction or funding new projects.
Let us take a look at how FPO works with the help of the following hypothetical example.
Assume there is a listed company, ABC Limited. The company currently has outstanding equity shares of 1 crore. Since it requires capital to repay its debt obligations, ABC Limited has decided to issue an additional 20 lakh equity shares through a dilutive FPO.
Once the follow-on public offer is completed, the total number of outstanding equity shares will become 1.2 crore. Now, if an investor held 1 lakh shares before the FPO (which would have amounted to 1% ownership), their ownership would have dropped to just 0.83% after the issue.
Non-Dilutive FPO
A non-dilutive FPO involves no new equity share issuance. Instead, existing shareholders like promoters, early investors and institutional shareholders sell a portion of their holdings to the public
Since no new shares are created, the total number of outstanding equity shares remains unchanged, and there is no dilution of ownership for other shareholders. However, one of the major drawbacks of these types of FPOs is that the company itself does not receive any funds from the issue. Instead, the sale proceeds from the FPO would go directly to the selling shareholders.
Non-dilutive FPOs are often used by shareholders to divest their ownership or to meet minimum public shareholding norms.
Let us look at how FPO works with the help of the following hypothetical example.
Assume there is a listed company, ABC Limited. The company has a promoter who owns 30% of the company’s equity shares. The promoter decides to sell 5% of his stake to the public through a non-dilutive FPO.
Once the non-dilutive follow-on public offer is completed, the promoter’s stake will reduce from 30% to 25%. However, the total number of outstanding equity shares will remain the same since there is no creation of new equity shares. All existing shareholders would continue to enjoy the same percentage of ownership within the company.
Why Do Companies Issue FPOs?
Listed companies often prefer to issue follow-on public offers to raise additional capital. The funds that are so raised can be used for a variety of strategic purposes such as business expansion, research and development, launching new products or entering new markets.
Some listed companies also use the proceeds from FPOs to strengthen their balance sheets and improve creditworthiness by repaying their debt obligations. There have been a few cases where companies have used the funds from follow-on public issues for acquisitions or strategic partnerships to enhance their competitive edge.
Apart from giving access to additional funding, FPOs can also increase a listed company’s market visibility and investor base, boosting overall credibility in the financial markets.
FPO vs. IPO: A Comparison
Understanding the difference between FPO vs. IPO can help you make informed decisions. Here is a quick comparison between the two types of public offerings.
Parameters | Initial Public Offering (IPO) | Follow-On Public Offering (FPO) |
Definition | An IPO is when a company issues its equity shares to the public for the first time. | An FPO is when a company already listed on the stock exchange offers its equity shares for sale to the public once again. |
Purpose | The main purpose of an IPO is to raise capital for the first time and become publicly listed. | The purpose of an FPO is to raise additional capital after the company has already been listed. |
Company Stage | An IPO is issued by a privately held company in the early phases of growth. | An FPO is issued by an already-listed company that is generally more established and mature. |
Risk Level | IPOs are considered a higher risk as the company has no trading history and limited public information. | FPOs carry relatively lower risk because investors can review the company’s financial performance and stock history. |
Investor Data | In an IPO, investors have limited access to financial data and must rely on the prospectus and initial disclosures. | In an FPO, investors can access a wealth of historical financial data, performance metrics and market sentiment of the company. |
Price Discovery | The IPO price is usually determined through book-building or fixed price mechanisms. | FPOs are often priced at a discount to the prevailing market price to attract more investors. |
Benefits of FPOs for Investors
An FPO in the stock market offers a plethora of advantages to investors. In this section, we will explore some of the key benefits of FPOs and why investors should consider them.
Opportunity to Invest in an Already Listed Company
Investors get to purchase shares in a company already listed on the stock exchange, often at a discounted price compared to its current market price. Listed companies offering FPOs often issue new equity shares at a price lower than their market price to attract investor interest and ensure full subscription. Additionally, since the company is already listed, there is already a track record of performance and financial data to base investment decisions on.
Lower Risk Compared to IPOs
Unlike IPOs, which involve companies entering the public market for the first time, FPOs in the stock market are issued by companies with a proven market presence. Investors can analyse historical earnings, past market behaviour and financial disclosures before investing. This significantly reduces the uncertainty and risk typically associated with public issues.
Enhanced Liquidity and Trading Volume
When a company issues a follow-on public offer, it essentially increases its share float in the market. This often results in higher trading volumes and better liquidity, making it easier for investors to buy or sell shares without significantly impacting the stock price. The increase in liquidity also attracts institutional investors, which adds stability to the stock.
Things to Consider Before Investing in FPO
If you are planning to invest in an FPO in the stock market, here are some key aspects you must focus on to ensure that you make smart decisions.
Company’s Financial Health
As with any investment in the stock market, you must carefully analyse the financials of the company offering the FPO. When conducting fundamental analysis, make sure to focus on the issuing company’s recent earnings, revenue trends, debt levels and profitability. This should give you a fair idea of its financial health and make decisions easier.
Purpose of FPO
Before investing in an FPO in the stock market, you must thoroughly look into the purpose of the issue. Is the company planning to use funds for productive growth or just to cover its liabilities? A company raising funds for strategic business activities is often likely to experience growth in the future, making it a good long-term investment.
Market Sentiment
A positive or negative outlook on the stock market or the industry can influence the success of a follow-on public offering. Therefore, it is advisable to look into the broader market sentiment before investing. You can consider investing in the FPO if the market sentiment is positive. On the other hand, if the sentiment is negative, it is advisable to adopt a wait-and-watch approach.
Pricing of Shares
Before investing in any FPO in the stock market, always compare the issue price to the current market price. Most listed companies tend to offer shares at discounted prices to make them more attractive to investors. However, investing in a follow-on public offering may not be prudent if the issue price is equal to or only slightly lower than the current market price.
Promoter Intent
If the follow-on public offering is non-dilutive in nature, make sure to assess why the promoters or other selling shareholders are offloading their stake. Investing in an issue is not advisable if the share sale is fueled by distress or corporate governance lapses.
Conclusion
An FPO in the stock market plays a vital role in helping listed companies raise further capital. Whether it’s a dilutive or non-dilutive offering, an FPO can provide a solid investment opportunity, especially for investors looking for lower-risk options compared to IPOs.
As an investor, the benefits of FPOs might be attractive enough to make you want to invest in them. However, it is essential to conduct a thorough due diligence exercise and fundamentally analyse the company before investing. This will help you make well-informed decisions that align with your financial objectives.
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