Understanding what is DRHP and its Components: The Indian markets have gone gaga with IPO’s raising billions thanks to the bull markets. If your current strategy is to listen to friends and family or to just desperately apply for any of the IPO in an attempt to get allotted and make short-term gains, then sorry to break it to you but it can prove to be disastrous in the long run. But what should one do then?
Enter DRHP! This is one of the most powerful tools investors have in their hands that assists them in making informed decisions. In this article, we understand what is DRHP is and its important components.
What is DRHP (Draft Red Herring Prospectus)?
Before we directly jump into its definition, let us understand why its need even arises. Whenever a company plans to raise funds from the public they approach merchant bankers to prepare an offer document. This document is known as the Draft Red Herring Prospectus.
The DRHP document acts as a source of information so that investors can get insights as to why they should even consider investing in the company IPO. This document is filed with the Securities and Exchange Board of India (SEBI), which has made it mandatory for companies to file a DRHP. The SEBI then would review this document and ensure that adequate disclosures are made.
It must be remembered that the document is a draft reviewing which the SEBI may ask the merchant bankers to make adequate disclosures if needed. The SEBI does this in the interest of the investors as otherwise, the DRHP prepared may present the company too favorably.
The DRHP includes important information about the company, its business, the industry it is in, current shareholders, and its financials among various other important information which is otherwise not available to the public.
The document also clarifies the reasons why the company is raising funds and where these funds will be used. The DRHP however does not include key details about the issue like the price at which the securities will be offered.
Why is it called the Draft Red Herring Prospectus?
The document initially was called the red herring as it included bold disclaimers in red stating that the document has been filed with the SEC and is still not effective or complete and the information may be subject to changes.
But today we can still see sections of the cover page printed in red. For eg. we can see the same in the DRHP filed by Zomato.
What to look for in a Draft Red Herring Prospectus (DRHP)?
Going through the DRHP completely may be a daunting task as the document may extent to almost 500 pages. To make it easier some fine details that are very important and must not be missed.
However, it is still advisable to skim through the document in search of fine details that could be a deal maker or breaker for the company. Some Key Details to look for in a DRHP:
1. About the Company and its Industry
This is one of the most important sections in the DRHP. This is because it offers details about the company which makes its background clearer and on how it functions. Investors will get a better idea if they feel that the company’s business idea is actually worth it or not.
In addition, the prospectus also includes information on the industry the company is in. This allows investors to assess what the future prospects of the company could be if the industry is actually growing and to what extent.
The DRHP also informs investors about the company’s current competitors and its current position in the industry.
2. Purpose of the IPO
As investors, we obviously want to know what our money is eventually going to be used for. The ‘Objects of the offer section gives us this information.
It is very important to go through this section as one would not want to simply invest in a debt-ridden company that is going to use funds simply to pay off debt and fund its internal working capital. This is a lax alternative as compared to investing in a company that is going to use funds to fuel further growth.
Investors must ascertain by looking at this which investment could be productive and unproductive for him.
3. Strengths and Risks
Certain companies develop moats that give them added advantage over their competitors in the industry. This section lists out the strengths that a company could already have.
In addition to this, the company also includes the risks that it faces or could possibly face in the future. This gives investors a clearer picture of what they are getting into. The company also includes the legal cases it is fighting.
4. Company’s Management
This section gives you insights into who actually runs the company. It includes their names, age, and even their qualifications and remuneration.
It will also include the scams or frauds the individuals have committed in the past making it all the more transparent for promoters.
5. Promoter Holdings
Here the investors will get to know who actually owns the company. Investors must watch out for promoters who are diluting their stake heavily in the IPO.
Promoters selling off a small portion of their holdings is normal in every IPO. But investors should take notice when a substantial portion is being sold off by the promoters.
It is rare that a promoter would sell huge amounts if he believes that the company has a multi-billion dollar potential. Substantial stake being sold off could mean that he does not believe that the company has what it takes.
6. Key Financials of the Company
Finally the most important portion of the DRHP. The information included here will probably not have been available anywhere else before if the company had been private. It shows us the profitability of the company, cash flows, and its assets and liabilities.
The section includes income statements, balance sheets, cash flow statements. All these give a better idea of the financial situation of the company.
Where can you find the prospectus?
Investors can find the DRHP on any of the following websites
- SEBI Website.
- Stock Exchange Website.
- Respective Company’s Website.
- Merchant Banker.
In this article, we covered what is DRHP and how to read a DRHP from an investor’s prospectus. The DRHP is not just some regular document and shouldn’t be treated as such. Although it may be easier to simply base your investments on what others say reading the DRHP helps you make a more informed decision. Or in the words of Peter Lynch, “Behind every stock, there is a business. Try understanding what the business is all about.”
That’s all for this post. Do let us know if this is helpful for you in the comments section below. Happy Investing!
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
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