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IPOs

Discussion in 'Business, Careers & Education' started by NameBack, Jul 25, 2011.

  1. NameBack

    NameBack Senior member

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    I had a quick question about IPOs:

    I know that the price of an IPO generally goes up, sometimes dramatically, before it hits the open market. Is this an instant jump, or does the price gradually rise during the "closed" (for lack of a better word) part of the IPO? For instance, if my broker says they can get me shares of an IPO, can I be assured I'll get them at the IPO price, or could I end up with shares priced anywhere from the IPO to the price when shares hit the open market?
     
  2. Saturdays

    Saturdays Senior member

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    Unless your broker is in the loop, he won't be able to get you the shares at the starting price. If he does get you shares its probably going to be while its rising, the earlier on in the day the better return you'll get. (that is considering that the IPO itself is good)
     
    Last edited: Jul 25, 2011
  3. NameBack

    NameBack Senior member

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    Gotcha. So it does rise before it hits the open market?
     
  4. itsstillmatt

    itsstillmatt Senior member Dubiously Honored

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    Is this another one of your trick questions? The answer is no, it doesn't really rise before it hits the open market. What happens, sometimes, lets not sink into the silliness that says IPOs always open above pricing, is that the original investors get it at the IPO price, and that their sell and the buyers' buy price may be, at the open, above the IPO price, but the price rises at the open, not before it, because before the open there is no market for the security. Also, the answer to your other question is that it depends who you are, and who your broker is. You can get shares at IPO price if they are available to you.
     
  5. patrickBOOTH

    patrickBOOTH Senior member Dubiously Honored

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    From a business' perspective who is trying to raise the most amount of capital for the least cost I would not want my IPO to be jumping at the bell. This means the bankers that are being paid millions to underwrite the IPO drastically undervalued the company at the time of the offering. If an IPO jumps 18% on the first day, that is 18% less capital that could have been raised for the firm.
     
    Last edited: Jul 25, 2011
  6. Beckwith

    Beckwith Senior member

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    ^ +/-, when you factor in that no company will really price an IPO at $100. The CEO and all controlling shareholders aren't complaning that the money is going in their pockets and no the companies. Most of the time the insiders are looking to monetize their stakes in the company, so they don't care where the stock comes out but rather where it ends up.
     
  7. patrickBOOTH

    patrickBOOTH Senior member Dubiously Honored

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    I can see that logic there. Shareholders are buying for capital appreciation, not a stream of earnings due to actual capital investment.
     
  8. NameBack

    NameBack Senior member

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    No, it was not a trick question, just genuinely something I didn't understand and I was having trouble with my google-fu in trying to find the answer. And thank you for the answer, because what you said is exactly what I was looking for: to use the example of LNKD, the IPO price was $45, and it opened at $83 (or whatever). I was wondering if some of the investors/institutions participating in the closed part of the IPO were paying $50, $60, etc, all the way up to the opening price of $83. If I've understood you correctly, that's not the case. Everyone who purchases before it hits the open market purchases at the IPO price. That's exactly what I was looking for--thank you for the clear answer. I appreciate it.

    And yeah, I understand it's generally fairly difficult to get shares at the IPO price. Out of curiosity, do you know if that's equally true for all IPOs, or is it easier to get shares of small-cap, less-well-known IPOs? Is it not meaningfully different for an individual investor? edit: I ask because I'd be interested in investing in some IPOs if I could -- and not big buzzworthy ones like Zynga -- but I don't know if it's any more realistic to think that as an individual investor (without a great deal of capital) would have an easier time with random small-cap IPOs.
     
    Last edited: Jul 25, 2011
  9. NameBack

    NameBack Senior member

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    Yeah, it does make sense. I mean, there must be some explanation, because it seems like IPOs are consistently "underpriced." IIRC, over the last nine months, the average gain from IPO to the open was just over 12%. From my limited reading on the subject, I guess there's a fair bit of academic literature on the subject of the consistent underpricing of IPOs. But don't take my word for it -- obviously I don't know much about this stuff.
     
  10. Saturdays

    Saturdays Senior member

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    IPOs are sometimes underpriced to ensure all shares are sold. Remember the company is trying to sell the shares and cannot ask for a premium in some cases. The banks that set up the IPO generally underprice to ensure every share sells without any delays.
     
  11. patrickBOOTH

    patrickBOOTH Senior member Dubiously Honored

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    True, but it shortchanges the firm raising the funds. I personally feel that most companies are insane for going public anyway. It is the most expensive form of financing and you have the deal with shareholders.
     
    Last edited: Jul 25, 2011
  12. Saturdays

    Saturdays Senior member

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    I don't think its as bad as you say it is. It is much better than putting a company in way over its head in debt.
     
    Last edited: Jul 25, 2011
  13. itsstillmatt

    itsstillmatt Senior member Dubiously Honored

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    My understanding, and this is from a couple of years back because IPOs are not part of my strategy in any way, is that the average return from an IPO is no higher, and often lower, than the market itself. That said, sure, you can get some unwanted ones, and that isn't all bad, because the important metric is not how much something is worth, but the discrepancy, in your analysis, between the price and the value, or how your appraisal differs from that of the bankers. Still, I don't know that I would ever suggest the fact that something is an initial offering as a reason to buy, anymore than I ever understood a premium put on splits back in the roaring 90s.
     
  14. NameBack

    NameBack Senior member

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    I agree that they often underperform in the long run; I think I saw a study that actually showed that over the last 20 years IPOs substantially underperformed the market, actually. In the short run, however, there's massive profit to be made. Unfortunately usually only large institutional investors are allowed to buy and flip IPOs in the first day, it seems (again, this is my not-super-informed impression of things). I was just playing with a historical dataset from the last 10 months or so, and it was just pretty clear from at least that sample that investing at-random in IPOs and flipping at the market-open price would generate pretty insane returns in short periods of time, assuming reinvestment -- and this held up (albeit to a lesser extent) even if you focused on smaller-cap firms. The strongest correlation (probably not surprisingly) was the difference between the proposed price range and the actual price of the IPO; and the change from IPO to open. I figure that any gain from the proposed price represents "buzz," but I found that if you limit the at-random investment solely to IPOs that don't experience a strong gain from proposed price to actual IPO listing, you still generate very large positive returns in just a few months. It also held up even if you sold at the close instead of the open on the first day, but gains were smaller.

    Of course it's a small sample and I'm sure there are any number of places I could have made errors but it did seem like the persistent underpricing of IPOs is something close to free money for those big institutional investors who can flip the first day.
     
  15. scientific

    scientific Senior member

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    you are a great candidate for buying today's IPOs. they are just like your debt theories - who says they can't keep going up up up??
     
  16. NameBack

    NameBack Senior member

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    God, you're an idiot
     
  17. patrickBOOTH

    patrickBOOTH Senior member Dubiously Honored

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    But I think that this is why most IPO companies are a flop in the long run. Financing and capital structure sends signals to investors. If a company truly believed in their product or service they wouldn't have any qualms about debt financing. Outside equity, to some degree, says to me "having more money to do things with would be kind of cool, but if we waste it all and don't generate more earnings, meh, at least we can stick around with whatever earnings we do have."
     
  18. Valor

    Valor Senior member

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    This is incorrect, according to Ibbotson, Sindelar and Ritter (1994), the average IPO is underpriced by 15% meaning you get 15% abnormal return over the market from the IPO price. There are lots of arguments for why the underwriter (I-Bank) underprices the security for the IPO despite their incentive to overprice (they get 7% of the money raised). I don't really want to get into their incentives but they generally do underprice and they actually don't profit from it, at least not significantly unless they bear the risk of holding the security for themselves which most underwriters don't.

    The reason the stock price goes up after IPO (for "good" companies) can be attributed to information asymmetry. Basically, outsiders don't know about the company whereas insiders (the company itself and the underwriters) know about the company. Once more and more credible/sophisticated investors invest into the company, the market realizes what the company is actually worth more so the price rises. This is basically the gist of one of the theories on information diffusion.
     
  19. Valor

    Valor Senior member

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    Debt financing is risky and most people are in business to make a profit, they can't really realize that profit without an IPO or some sort of sale.
     
  20. patrickBOOTH

    patrickBOOTH Senior member Dubiously Honored

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    Debt financing is risky, but it is cheaper than outside equity financing. Most companies seeking an IPO already have sales and are making a profit. Going public allows for capital for further growth, plus why would owners want to dillute their profits with shareholders? To me, if you have a profitable company and want to expand use internal equity (retained earnings), or debt. Otherwise you are diluting your own profit and creating a headache for yourself with activists, accounting standards, shareholders, lobbists. I would love to do a study to see if companies who seek outside equity actually see any real income growth. There are some small studies out there that say they in fact don't. I'd like to see what the hell they are doing with the capital raised through equity. I think it is largely wasted, that is why they didn't finance with debt.
     

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