About IPOs

Good investors always do their homework, especially when it comes to initial public offerings or IPOs. It's hard enough to select good stocks when you're evaluating companies with a long history of excellent performance. But investing in the right IPO not only takes a lot of research, but also an individual willing to take on a good deal of risk too.

In this publication, we're going to talk about initial public offerings. As part of that discussion, we'll start by providing a definition of the term. Next, we'll describe how the IPO process works, and the advantages IPOs offer investors. Then we'll finish up with some helpful information such as where to find calendars as well as the best time to launch an IPO.

Initial Public Offerings

Additional Resources

Also known as a floatation or "offering," an IPO is defined as the first sale of shares of common stock to the public. Companies often issue stock to raise capital so they can expand operations. IPOs are also one of several ways venture capital firms can "cash out" their investment in an expanding business.

IPO Process

The IPO process is ultimately regulated by the U.S. Securities and Exchange Commission, since the end state is the sale of common stock in the company "going public." A stepwise explanation of the process appears below:

Selecting an Investment Bank - acts as an advisor and performs the underwriting function. Companies typically select the investment bank based on their industry experience. The underwriter establishes the schedule for the issue, pricing of the stock, as well as the distribution of shares.
Letter of Intent - drafted between the issuing company and Investment Bank / underwriter. This letter spells out the terms and conditions by which the issuing company and underwriter will conduct the IPO. This includes the fee structure, as well as a firm commitment by the underwriter. A firm commitment is an agreement by the underwriter to purchase all issues of the security. The underwriter would then resell these securities to the public.
Assemble Syndicate - if the issue is large, the underwriter will engage a syndicate of underwriters to help with the sale of the securities.
SEC Filing - with the help of the underwriter, the company will file a Form S-1 with the U.S. Securities and Exchange Commission (SEC). This form will contain basic business and financial information with respect to the securities offered. The form will also be the basis for a prospectus to aid in the marketing of the initial public offering. This document is often referred to as a Red Herring prospectus.
Marketing of the IPO - once the S-1 is approved by the SEC, the underwriter will begin the process of marketing the IPO to both private investors as well as institutional investors. These investors can place "market orders" for shares of the IPO. No shares can be sold at this point, only orders are recorded.
Effective Date - once the marketing phase of the IPO is completed, the underwriter will file an acceleration request with the SEC. This request will establish the date of the IPO.
Underwriting Agreement - just prior to the date of the IPO, the underwriter will enter into a final agreement with the issuing company. This will establish both the price of the offering as well as the number of shares to be issued.
Stabilization - the underwriter is not only obligated to bring the shares of stock to market, but also responsible for stabilizing the price of the offering. Generally, the underwriter will actively trade the stock for several months, and sometimes years, after the IPO. By doing so, the underwriter lowers the perceived risk of the issue, and increases demand for the offering.

Initial Public Offering Advantages

It's possible for the IPO's price to increase significantly on the first day they trade on the stock market. This occurs for two reasons. The first has to do with the marketing of the IPO. Underwriters want to ensure that demand outpaces supply during the IPO. Throughout the marketing phase of the offering, the underwriter may take orders for two to three times the number of shares trading on the first day of the IPO. This translates into extremely high demand for a somewhat limited supply.

The second reason IPOs offer investors a short-term advantage has to do with the pricing of the securities. IPOs often start out as under-priced shares of stock. As the price of the stock increases dramatically during the IPO, this helps to create "headline" news for the company. These positive news stories further increase demand for the offering.

For investors, the aggressive marketing of IPOs can lead to a temporary run up in prices. This is especially true if a large number of shares are held by company insiders, who are often prohibited from selling their shares for six months following the IPO. In addition, companies may release a second wave of stocks into the market. As the supply of stock catches up with its demand, a once hot IPO can quickly turn into a poor long term investment.

Google IPO

In January of 2004, Google announced they were hiring Morgan Stanley and Goldman Sachs Group to manage their IPO. On April 29, 2004, Google completed their SEC S-1 form filing, and the IPO process was underway. Google was one of the few dot-com companies offering investors real profits. In the first half of 2004, Google reported earnings of $143 million on sales of close to $1.4 billion.

Co-founders Sergey Brin and Larry Page insisted on a somewhat unconventional approach to the IPO. They wanted to hold a Dutch Auction for all sales, so that anyone could participate in the process. This was at odds with Wall Street, as well as investment banks, because this process would reduce their fees.

After a falling out with Goldman Sachs, the lead underwriters for the Google IPO would be Morgan Stanley and Credit Suisse First Boston. In addition, as many as 29 financial institutions were named as underwriters including: Allen & Co., Ameritrade, Blaylock & Partners, Cazenove, Citigroup, Deutsche Bank, E*Trade Financial, Epoch Partners, Fidelity Capital Markets, Goldman Sachs, J.P. Morgan Chase, Lazard, Lehman Brothers, M.R. Beal, Merrill Lynch, Piper Jaffray, Thomas Weisel Partners, UBS, Wells Fargo Securities, William Blair & Co., and WR Hambrecht.

Just prior to the IPO, Google attempted to win over investors by reducing the price range of their shares from $108 to $135, down to $85 to $95 per share. The number of shares was also reduced from 25.7 million to 19.6 million.

Google's initial public offering occurred on August 19, 2004. On that day, a total of 19,605,052 shares were offered at $85 per share. Although the IPO was surrounded by negative press, it remains one of the most successful technology company offerings to date.

Launching an IPO

The best time to launch an IPO is when the stock market is near a peak. Admittedly, this is nearly impossible to predict. Companies also need to be forward thinking when launching an IPO because it typically takes three to six months to go through the entire IPO process.
Before deciding if it's the right time to launch an IPO, companies need to consider the following:

Market Conditions - investors should be both confident in the stock market, as well as actively participating in the market.
Industry Conditions - investors should be both confident in the specific industry in which the company competes, as well as actively investing in this industry.
General IPOs -recent IPOs introduced into the market should be performing at, or above, expectations.
Industry IPOs - recent IPOs for companies in the same or similar industries should be performing at, or above, expectations.

IPO Calendar (Upcoming IPOs)

If you're interested in learning more about upcoming IPOs, then the resources below provide up-to-date information including IPO calendars:

NASDAQ - one of the largest stock exchanges in the world also provides information on IPOs via an online calendar.
NYSE Euronext - an exclusive stock exchange, the NYSE Euronext lists some of the largest, most recognized companies in the world.
Renaissance Capital - another calendar, this time from Renaissance Capital, a global leader in independent IPO research and IPO investment services.
Hoovers - requires a subscription to gain access to in-depth information about IPO filings, recent offering performance, as well as upcoming IPOs.

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