Oversubscription

Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Oversubscription Meaning 

Oversubscription occurs when demand for shares exceeds the actual shares issued by the company and is common in initial public offerings (IPOs). The high demand for a company’s stocks can indicate its financial health and brand value as more people seek to purchase limited shares. It helps to is to allocate limited resources fairly and efficiently among a larger number of applicants.

oversubscription

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When a company decides to go public and issue shares for the first time, the demand for these shares can sometimes exceed the supply. This results in the number of subscribed shares being higher than the number of issued shares, creating an oversubscription. This concept has existed since the early days of the securities market and is still common.

Key Takeaways

  • Oversubscription of shares is when the demand for a company’s issue exceeds the supply, resulting in the number of subscribed shares being higher than the issued shares.
  • It aims to ensure that more applicants can access limited resources fairly and efficiently.
  • It can be seen as a positive sign and indicate a company’s financial health and brand value, enhancing its reputation among investors and the general public.
  • It can also result in some investors being unable to purchase the desired number of shares. As a result, the company may need to handle the excess demand through allocation policies such as pro-rata or higher prices.

Oversubscription Explained

Oversubscription of shares is a common scenario, especially for much-anticipated IPOs and well-established companies. Oversubscription is typically defined as a situation where the demand for shares exceeds the number of shares the company offers during its initial public offering (IPO).

It is a good option for the issuing company and its underwriters. Mainly, it helps companies raise more capital than expected. However, oversubscription can also result in some investors being unable to get the desired number of shares, leading to disappointment and potentially lower demand for shares in the secondary market.

Oversubscription gives the issuing company more control over the terms of the IPO, but the effects on investors can vary. In some cases, the company may increase the share price or increase the number of shares, reject some, or offer on a pro-rata basis. As a result, it could lead to disappointment for some investors who could not get the desired number of shares. However, it can also result in increased demand and higher secondary market prices for the investors who could purchase shares in the IPO.

The stock market uses the oversubscription ratio to represent the demand for shares in an initial public offering (IPO). It is calculated by dividing the number of requested shares by the number offered. If the ratio is greater than 1, the demand for shares is higher than the supply, and the issue is considered to be oversubscribed. In such a scenario, the issuing company can either accept all the applications and issue more shares or accept only a portion of the applications on a pro-rata basis. The oversubscription ratio indicates the level of interest in the company and can be used by both the company and the investors to make informed decisions.

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Examples

Let’s discuss some examples of IPO oversubscriptions.

Example #1

ABC Ltd. is a reputed company in the U.S. Owing to its market performance; the board decided to list the company on its twentieth anniversary. The company planned to issue 1000 shares for $15 each. However, the issue was oversubscribed 1.75 times, and the firm was left with some important decisions.

Total issued shares = 1000

Here, the oversubscription ratio = 1.75

Total subscription applications received = 1000 x 1.75 = 1750

The company decided to reject 250 applications based on the investor portfolio.

The rest 1500 shares were issued on a pro-rata basis.

In this scenario, the company originally intended to issue 1000 shares for $15 each but received subscriptions for 1.75 times that amount, or 1750 shares. The company then had to decide how to allocate the shares, and in this case, chose to reject 250 applications and allocate the remaining 1500 shares on a pro-rata basis. It is a common approach used in oversubscribed IPOs to ensure fairness among investors.

Example #2

In June 2022, Dubai’s TECOM Group issued its IPO. The issue was oversubscribed and became one of the largest in 2022. The company was able to raise $455 million in its IPO. The company issued 625 million shares (a 12.5% stake) for 2.46 – 2.67 dirhams per share. The IPO was a part of the Dubai government’s initiative to list ten state-linked firms. Some of the primary underwriters of the issue are Goldman Sachs International, Morgan Stanley, Emirates NBD Capital, First Abu Dhabi Bank, and UBS AG.

Benefits

Oversubscription in an initial public offering (IPO) can have several benefits for the issuing company:

  • Indicator of public interest: Oversubscription can indicate strong public interest in the company, which can be a positive factor in building its reputation and increasing its visibility in the marketplace.
  • Increased capital: If the share demand exceeds the supply, the company can either increase the price per share or issue additional shares to meet the demand. It can result in the company raising more capital than originally planned.
  • A diverse pool of investors: Oversubscription provides the company with a larger pool of potential investors, allowing them to select the best and most reliable investors based on their trading history and investment objectives.
  • Underwriting fees: For the underwriting syndicate, oversubscription can result in higher fees, as more applications and higher demand for shares can lead to higher revenue for the underwriters.

Oversubscription And Forfeiture Of Shares 

Forfeiture in trading refers to the cancellation of an investor’s ownership of a share due to their failure to fulfill certain conditions set forth by the company or regulatory authorities. The company can then transfer the ownership to another suitable investor. It is not specifically related to the oversubscription or under-subscription of shares.

Difference Between Oversubscription And Under Subscription

The issue of shares can be oversubscribed and undersubscribed. Under subscription is the opposite scenario of oversubscription. Under subscription refers to the condition where there are insufficient subscribers for the shares offered. Let’s understand the differences in detail. 

OversubscriptionUnder subscription
Demand is greater than supply.Demand is less than supply.
Shortage of shares. (The shortage of shares is a result of the demand being greater than the supply).Shortage of prospective investors. (The shortage of prospective investors results from less demand than supply).
A certain degree is a good sign for the company. (It’s not always a good sign, as it could also reflect unrealistic expectations or overpricing).Under subscription is generally a red signal.
Excess applications are rejected, and a refund is made.Applications are accepted to satisfy the minimum subscription. (This is not always the case and again depends on the jurisdiction and type of securities involved).

Frequently Asked Questions (FAQs)

How to check the oversubscription of an IPO?

To check the oversubscription of an IPO, one can review the IPO prospectus, which provides information about the number of shares being issued, the pricing, and the demand for the shares. Furthermore, one can check the stock exchange where the shares will be listed, as they often provide updated information on the subscription status.

What is a good oversubscription ratio?

No specific ratio is considered a “good” oversubscription ratio, as it depends on various factors such as the nature of the company, the type of securities being issued, and market conditions. However, a high oversubscription ratio may indicate strong demand for a company’s securities, which could be a positive sign for the company’s financial health and investor appeal.

Is oversubscription good or bad?

Oversubscription can be both good and bad, depending on the perspective. It is a double-edged sword – a positive sign for the company but potentially problematic for individual investors.

This has been a guide to Oversubscription and its meaning. We explain its differences with under subscription & forfeiture of shares, examples, & benefits. You can learn more about it from the following articles –

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