The term Initial public offering (IPO) slipped into everyday speech during the IT bull market of the late 1990s & also in the period of Ketan Parakh when we had the best run in the IPO market. Back then, it seemed you couldn’t go a day without hearing about a dozen new companies who were cashing in on their latest IPO. And after that bubble investors found them self in a trap and also they lost their hard earn money during that time.
So, what is an IPO? How did everybody get so rich so fast? And, most importantly, is it possible for simple mortals like us to get in on an IPO? All these questions and more will be answered in this write up.
An initial public offering, or IPO, is the first sale of stock by a company to the public. A company can raise money by issuing either debt or equity. If the company has issued equity to the public, it’s known as an IPO.
Companies are mainly belonging to: private and public.
A privately held company has fewer shareholders and its owners don’t have to disclose much information about the company. Anybody can go out and incorporate a company: just put in some money, file the right legal documents and follow the reporting rules of your command. Most small businesses are privately held. But large companies can be private too. What is the need for IPO?
It usually isn’t possible to buy shares in a private company. You can approach the owners about investing, but they’re not forced to sell you anything. Public companies, on the other hand, have sold at least a portion of themselves to the public and trade on a stock exchange. Public companies have thousands of shareholders and are subject to strict rules and regulations. They must have a board of directors and they must report financial information every quarter. In India, public companies report to the Securities and Exchange Board of India (SEBI. From an investor’s point of view, the most exciting thing about a public company is that the stock is traded in the open market, like any other commodity. If you have the cash, you can invest.
- Because of the increased analysis, public companies can usually get better rates when they issue debt.
- As long as there is market demand, a public company can always issue more stock. Thus, mergers and acquisitions are easier to do because stock can be issued as part of the deal.
- When your stock traded in the open market you can offer your equity to your Employee to get best talent for your company.
Now if you want to apply for IPO here you have some points to watch out for.
No History
It’s hard enough to analyze the stock of an established company. An IPO company is even trickier to analyze since there won’t be a lot of historical information. Your main source of data is the red herring, so make sure you examine this document carefully. Look for the usual information, but also pay special attention to the management team and how they plan to use the funds generated from the IPO.
Successful IPOs are typically supported by bigger brokerages that have the ability to promote a new issue well. Be more wary of smaller investment banks because they may be willing to underwrite any company.
The Lock-Up Period
If you look at the charts following many IPOs, you’ll notice that after a few months the stock takes a steep downturn. This is often because of the lock-up period. Flipping
When a company goes public, the underwriters make company officials and employees sign a lock-up agreement. Lock-up agreements are legally binding contracts between the underwriters and insiders of the company, prohibiting them from selling any shares of stock for a specified period of time. The period can range anywhere from three to 24 months. but the lock-up specified by the underwriters can last much longer. The problem is, when lockups expire all the insiders are permitted to sell their stock. The result is a rush of people trying to sell their stock to realize their profit. This excess supply can put severe downward pressure on the stock price.
Flipping is reselling a hot IPO stock in the first few days to earn a quick profit. This isn’t easy to do, and you’ll be strongly discouraged by your brokerage. The reason behind this is that companies want long-term investors who hold their stock, not traders. There are no laws that prevent flipping, but your broker may blacklist you from future offerings - or just smile less when you shake hands.
Of course, institutional investors flip stocks all the time and make big money. The double standard exists and there is nothing we can do about it because they have the buying power. Because of flipping, it’s a good rule not to buy shares of an IPO if you don’t get in on the initial offering. Many IPOs that have big gains on the first day will come back to earth as the institutions take their profits.
Avoid the Hype
It’s important to understand that underwriters are salesmen. The whole underwriting process is intentionally hyped up to get as much attention as possible. Since IPOs only happen once for each company, they are often presented as “once in a lifetime” opportunities. Of course, some IPOs soar high and keep soaring. But many end up selling below their offering prices within the year. Don’t buy a stock only because it’s an IPO - do it because it’s a good investment. Best examples of hype are NHPC & Adani Power when people are simply rushed to apply for the IPO & just see the results.
Tracking the Stock
Tracking stocks means when a large company de merges one of its divisions into a separate entity. The rationale behind the creation of tracking stocks is that individual divisions of a company will be worth more separately than as part of the company as a whole.
From the company’s perspective, there are many advantages to issuing a tracking stock. The company gets to retain control over the subsidiary but all revenues and expenses of the division are separated from the parent company’s financial statements and attributed to the tracking stock. This is often done to separate a high-growth division with large losses from the financial statements of the parent company. Most importantly, if the tracking stock rockets up, the parent company can make acquisitions with the subsidiary’s stock instead of cash.
While a tracking stock may be spun off in an IPO, it’s not the same as the IPO of a private company going public. This is because tracking stocks usually have no voting rights, and often there is no separate board of directors looking after the rights of the tracking stock. It’s like you’re a second-class shareholder! This doesn’t mean that a tracking stock can’t be a good investment. Just keep in mind that a tracking stock isn’t a normal IPO.
Conclusion:
So before investing in the IPO one should be very clear whether he would go for short term or long term investment. Than he should know in which company he is going to invest. Normally companies with good fundamentals won’t give better returns at the time of listing but over the period of time they would give good return so watch out for these types of companies also.
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