What are the two types of offerings in a public IPO ?
- Primary offering: New shares are issued and proceeds used for investment or operating activities.
- Secondary offering: Existing shares held by insiders are sold to the public.
What is the obvious benefit of an IPO ?
Liquidity
What are the reasons of doing an IPO ?
- Create public shares for use in future acquisitions
- Establish market price/value for the firm
- Enhance reputation of the firm
- Broaden base of ownership
- Allow one or more principals to diversify personal holdings
- Minimize cost of capital
- Allow venture capitalists to cash out
- Attract analysts’ attention
- When company runs out of private equity
- Debt becoming too expensive
What are the costs of offering ?
- Underwriting fees = 7%
* Under-pricing avg = 15%
Is the increased disclosure a cost or a benefit ?
- Administratively costly (need to produce documents for investors)
- May be strategically costly (allows competitors to learn the growth plan of the firm)
- Reduces moral hazard (CEOs need to convince investors about their investment plans)
- Reduces asymmetric information (investors learn more about the quality of the firm’s projects)
What are the reasons to avoid doing an IPO ?
- Desire to maintain decision-making control
- Bad market/industry conditions
- Avoid ownership dilution
- Disclosing information to competitors
- SEC reporting requirements
- Enough capital
- Cost/fees of an IPO
- Low price of stock
- Officer liability
- Prefer to be acquired by another firm
- Avoid EPS dilution
What is the best effort basis ?
The underwriter does not guarantee that the stock will be sold, but instead tries to sell the stock for the best possible price
What is a all-or-non clause ?
Either all of the shares are sold on the IPO or the deal is called off
What is the firm commitment ?
An agreement between an underwriter and an issuing firm in which the underwriter guarantees that it will sell all of the stock at the offer price
What is an auction IPO ?
A method of selling new issues directly to the public (happens very rarely). Rather than setting a price itself and then allocating shares to buyers, the underwriter in an auction IPO takes bids from investors and then sets the price that clears the market
What is the underwriter’s tasks ?
Provides consulting services, manages process,
buys and distributes offering through syndicate
What are the steps to the IPO (Pre closing) ?
- Select underwriter Underwriter
- Submit registration statement to SEC.
- Prepare prospectus for investors.
- Set preliminary offering price (range)
- Road show: Pitch company to investors, identify potential buyers, bookbuilding (compile indications of interest, not committed bids)
- Approval from SEC.
- Final offering price set.
What are the steps post-closing and beyond an IPO ?
- Deal closes, firm gets cash, underwriters get fees.
- Underwriting syndicate sells securities at offering price.
- Quiet period ends 25 days after offering. (Insiders can talk.)
- Lock-up period ends 180 days after offering. (Insiders can sell)
What is the underpricing for an IPO ?
Stock prices tend to increase on their first day of trading
Why are IPO’s underpriced ?
- To compensate investors for taking the risk of the IPO
- To increase post-issue trading volume of the stock
- Underwriter underprice to incur favour of institutional investors
- To ensure wide base of owners
- Increase publicity on opening day
- Increase stock price by starting a cascade effect among investors
- Insiders are willing to underprice because the IPO creates personal wealth
- Mitigate future litigation by investors who claim the offer price was too high
- Makes flipping possible
- Compensate investors for truthfully revealing the price they are willing to pay
- Underperforming reduces need of additional IPO marketing costs
- Makes spinning possible
- Creates large blockholder to serve as watchdog over management
What is the consequence of underpricing and what is it ?
Winner’s curse is a consequence of adverse selection, when the parties bidding for an object are asymmetrically informed about its value. Discovering that you have won the auction informs you that you have overestimated the value of the object.
What is signaling ?
- Underpriced IPOs «leave a good taste» with investors.
- Allow firms and insiders to sell shares in the future at a higher price than would otherwise be the case.
- Signalling by leaving money on the table in the IPO is a relatively inefficient way to signal.
- Underpricing then should predict more stock issuance in the future (Seasoned Equity Offerings).
- Empirical studies have shown that the hypothesized relation between initial returns and subsequent seasoned new issues is not present.
What do the abnormally low long return and seasoned equity offering evidence ?
- Markets are not impounding all available information.
* Firms are less risky after issuing equity
