Read a red herring prospectus (DRHP) — Stock-Market notes

WHY does the DRHP exist?

WHY omit the price? Because Indian IPOs use book-building: the price is discovered from investor bids inside a price band (e.g. ₹100–₹105). You cannot print a final price before the market tells you what it wants.

WHY under SEBI? To protect small investors from fraud. The core principle is disclosure-based regulation: SEBI does not say "this is a good company." It only ensures the company disclosed enough truth for you to decide. Buyer beware, but buyer is informed.

The document family (don't confuse them)

Document	When	Has price?	Has final rupee size?
DRHP (Draft RHP)	Filed with SEBI first	No	No
RHP (Red Herring)	Filed with RoC before bidding opens	Price band only	No (only a band/range)
Prospectus (final)	After bidding, before listing	Yes, final price	Yes

HOW to actually read one (the 80/20 map)

You will never read all 500 pages. 20% of sections carry 80% of the decision. Here they are, in the order a smart investor scans them:

Figure — Read a red herring prospectus (DRHP)

Worked Example 1 — Reading Offer Structure

A DRHP says: Total issue ₹1,000 crore = Fresh Issue ₹300 cr + OFS ₹700 cr. Price band ₹200–₹210.

Q: How much does the company get, and what's the flag?

Step 1: Company proceeds = Fresh Issue = ₹300 cr. Why this step? Only fresh shares are new; OFS is old shareholders selling.
Step 2: Promoters/selling holders get = ₹700 cr. Why? OFS proceeds bypass the company entirely.
Step 3: Interpret: 70% of the raise is insiders exiting. Why a flag? The business only got ₹300 cr; the rest funded someone's exit. Not fatal (PE funds must exit sometime) but read who is selling and how much of their stake.

Worked Example 2 — Basis for Issue Price (valuation sanity check)

DRHP: EPS = ₹5. Upper price band = ₹210. Peer average P/E = 25.

Q: Is the pricing rich?

Step 1: IPO P/E $= 210 / 5 = 42$ . Why? Divide the price you'd pay by the profit you get per share.
Step 2: Compare to peers: $42 > 25$ . Why this step? Peer P/E is the market's "going rate" for similar businesses.
Step 3: The IPO is priced at a 68% premium to peers ( $42/25 - 1 = 0.68$ ). Why care? You're paying 42 years of current profit vs 25 for competitors. Justified only if growth is far superior — check the growth numbers in Financials.

Worked Example 3 — Objects of the Issue

DRHP Objects (fresh issue ₹300 cr): (a) ₹150 cr to repay debt, (b) ₹100 cr for new plant, (c) ₹50 cr "general corporate purposes."

Q: Rate the quality of use of funds.

Step 1: Debt repayment (₹150 cr): reduces interest cost → okay but defensive, not growth. Why? Paying old loans doesn't add new revenue; it just cleans the balance sheet.
Step 2: New plant (₹100 cr): productive growth capex. Good. Why? This directly builds capacity to earn more.
Step 3: "General corporate purposes" (₹50 cr $= 50/300 \approx 16.7\%$ of the fresh issue): vague. Why a mild flag? SEBI caps this bucket (usually ≤25% of fresh issue) precisely because it's undefined. Here it's within the cap, but the larger it is, the weaker the plan.

Forecast-then-Verify drill

Before reading answers, predict:

If an IPO is 100% OFS, how much cash does the company receive? → Predict, then check: ₹0.
Price band ₹95–₹100, EPS ₹4 → upper-band P/E? → Predict: 25.
Which section lists lawsuits against the company? → Predict: Risk Factors / Management & Promoters.

Flashcards

What does DRHP stand for?

Draft Red Herring Prospectus.

Why is it called a "red herring"?

Because of the red-ink disclaimer that the info is incomplete and the final price is not yet fixed.

What key piece of information does a Red Herring Prospectus omit?

The final issue price and/or exact number of shares (issue size), because price is set later via book-building.

Does the RHP fix the final rupee issue size?

No — RHP gives only a price band; the final price and total amount raised appear only in the final Prospectus after bidding.

Does SEBI clearance of a DRHP mean the IPO is a good investment?

No — it only means disclosures are complete and compliant. Quality/price judgement is yours.

Difference between Fresh Issue and Offer for Sale (OFS)?

Fresh Issue = new shares, money goes to the company (growth). OFS = existing holders sell old shares, money goes to them, company gets nothing.

In a ₹1000cr issue with ₹300cr fresh + ₹700cr OFS, how much does the company receive?

₹300 crore (only the fresh issue).

Formula for company proceeds in an IPO?

Fresh Issue Shares × Issue Price.

What is the "Objects of the Issue" section?

Statement of how the company will use the IPO money (debt repayment, capex, working capital, GCP).

How do you compute the IPO's P/E at upper band?

Upper band price ÷ EPS; compare to peer average P/E.

Correct document sequence for an IPO?

DRHP → SEBI review → RHP → Bidding → Final Prospectus.

Is Grey Market Premium (GMP) part of the DRHP?

No — GMP is unofficial and unregulated; it is not in any prospectus.

Which section lists everything that could go wrong?

Risk Factors.

Recall Feynman: explain to a 12-year-old

Imagine a lemonade stand wants strangers to give it money to grow. Before anyone pays, the kid must write a giant honesty letter: "Here's how much lemonade I sell, here's my debt to mom, here's the risk that it rains and no one buys." That letter is the DRHP. It doesn't say the exact price of one share yet — that's decided later when buyers say how much they'll bid. A referee (SEBI) checks the letter is complete and honest, but the referee never says "this stand is a great deal." You still have to read the letter and decide. And watch out: if the letter says all the money goes to the kid's old partners leaving, the stand itself gets nothing (that's OFS).

Connections

Primary vs Secondary Market — the DRHP belongs to the primary market (first sale).
Book Building & Price Band — explains WHY the price is omitted in an RHP.
SEBI Role & Disclosure Regulation — the philosophy behind mandatory disclosure.
IPO Process Timeline — where DRHP/RHP/Prospectus sit in the flow.
Fresh Issue vs Offer for Sale — deep dive on cash-flow direction.
Valuation P-E Ratio — the pricing sanity check tool.

Concept Map

Hinglish (regional understanding)

Intuition Hinglish mein samjho

DRHP ka matlab hai Draft Red Herring Prospectus — jab koi company pehli baar public se paisa lene aati hai (IPO), tab use apne baare mein sab kuch sach-sach batana padta hai, ek badi si honesty letter ki tarah. Isme company ke financials, risk factors, business, aur promoters ki poori kundli hoti hai. Ise "red herring" isliye kehte hain kyunki cover pe red ink mein likha hota hai ki "info abhi complete nahi hai, final price baad mein aayega." Price isliye nahi hota kyunki India mein book-building hoti hai — investors bid karte hain price band ke andar, aur usi se final price discover hota hai. Yaad rakho: RHP mein bhi sirf price band hota hai, final rupee amount sirf final Prospectus mein aata hai jo bidding ke baad file hota hai.

Sabse zaroori baat: SEBI ka clearance ka matlab yeh nahi ki IPO accha hai. SEBI sirf yeh check karta hai ki company ne saari sachchai disclose ki hai ya nahi. Business accha hai ya price sahi hai — yeh tumhe khud decide karna hai, Risk Factors section padh ke. Yaad rakho: SEBI honesty check karta hai, quality nahi.

Sabse important cheez samajhne wali hai Fresh Issue vs OFS. Fresh Issue mein nayi shares banti hain aur paisa company ke paas jaata hai (growth ke liye). OFS (Offer for Sale) mein purane maalik (promoters/PE funds) apni shares bechte hain aur paisa unke paas jaata hai — company ko kuch nahi milta. Agar IPO 100% OFS hai, matlab andar wale log cash nikaal rahe hain aur company ko funding nahi mil rahi — yeh ek yellow flag hai.

Padhne ka smart tarika: poore 500 page mat padho. Sirf 7 sections — Risk Factors, Objects of Issue, Offer Structure, Financials, Business, Management, aur Basis for Issue Price. Basis for Price mein IPO ka P/E nikaalo (price divide by EPS) aur peers se compare karo — agar bahut zyada hai to IPO mehnga hai. Aur ek baat: GMP (Grey Market Premium) DRHP mein nahi hota — woh unofficial afwah hai, uspe decision mat lena.

Test yourself — Primary vs Secondary Market & IPOs

Connections