Most investors understand that shares rise and fall, but not everyone appreciates how they become available for public trading in the first place. Few businesses begin operations with freely traded shares. Most are initially owned by an individual or small group of investors, such as venture capitalists, and "come to market" only after operating for a while. Today, I am going to look at the different ways shares are first offered for sale because some can provide good short-term profits. "Short term", you hear me say? Well, even in a long-term investment portfolio there must be a place for IPOs.
Initial Public Offerings - or new issues or flotations - provide a company with the means to raise capital through a listing on a stock exchange. Some of the biggest flotations have involved the privatisation of government-owned enterprises, such as Deutsche Telekom in Germany. IPOs create a lot of excitement and, because the flotation process usually generates big fees, lawyers, accountants, investment bankers and PR specialists are keen to ensure the company gets plenty of advance publicity. This is usually co-ordinated by the investment bank or issuing house.
There are four types of IPO. An Offer for Subscription is where the company sends a prospectus and subscription form direct to investors who, if they take up the offer, receive new, not existing shares. An Offer for Sale is the more usual procedure. Here, the issuing company will sell the shares to its investment bank which "underwrites" the issue by taking the full offer with its own capital. This can be a risky business because the shares need to be resold to the public at "the right price". If the share price is too high, the public may not buy and the investment bank is stuck with shares; if too low, the company will complain they were sold too cheaply, reducing the capital raised. Offers for Sale are often used by company founders to release part of their equity stake, and by governments to implement privatisation programmes.
In a Placing, an intermediary simply offers the shares to selected clients, which is not quite as democratic as the previous options. Finally, there is an Introduction, where a company decides to list on a particular stock exchange without issuing shares. The intention here is to gain extra liquidity. So how do you decide what is a good IPO for your portfolio? IPOs are accompanied by a Prospectus giving detailed information about the company. This includes profit performance and outlook, a full balance sheet, details of executives and pay packages, more than enough information to allow you to carry out your due diligence.
Buying shares through an IPO is always worth considering. They can be a good deal because companies want to bring shares to market at a little less than they might be worth: companies want good headline exposure to gain better profile for the future. An IPO can also indicate improving prospects for an enterprise. Private limited companies seeking a full listing on the LSE, for example, must meet stringent entry criteria, or Listing Rules, administered by the Financial Services Authority.
One important tip: keep a very close eye on the share dealings of directors and large shareholders. They are an important thermometer of a company's health. John McGaw is a financial adviser based in Dubai. Contact him at email@example.com