The New York Stock Exchange is ready. Investment bankers are taking the field. Capital starved companies have been waiting for this day, and investors are chomping at the bit. The rising market has given hope to a dormant market and if all goes well we could see a sharp change of pace over the next three months.
The IPO market (Initial Public Offerings) has been dormant for quite some time now. While it used to be normal to have between 250 and 500 new offerings in any given year, 2008 saw just 43 deals priced. So far this year there have been closer to 20 which indicates just how illiquid our equity markets have become. When the market is in turmoil, it is very difficult to convince investors to take a shot on an untested, never been traded before, new public company.
Many small and mid-cap companies rely on IPO transactions to provide much needed capital as they build their business to a sustainable size. Often an entrepreneur will begin to build a business by putting up his own personal capital and then seek private funding along the way. But when the company reaches a certain critical size, the best option for additional financing may be to sell a portion of the company to the public. This type of transaction not only provides the company with an initial capital infusion, but often gives the brand name more recognition, and allows for future capital raises as the market is already established for the stock.
An IPO transaction benefits many different market participants as underwriters (usually well known brokerage firms) are able to collect very lucrative fees for assisting the company in placing the stock with investors. Even the exchanges see a benefit as the NYSE or NASDAQ typically charge a listing fee and then also benefit from having the volume trade on their exchanges for years to come. In late August, NYSE Euronext (NYX) announced that they would be reducing fees charged for new stock listings which will put the big board in a more competitive position with NASDAQ. There are some that believe this move will cheapen the NYSE brand, but the chance certainly shows that NYSE has a desire to capture market share in what could be an interesting fall for IPOs.
Investors stand to reap potential windfall gains at least for the first few transactions that are brought to market. This is because the general public is still a bit gun shy about buying untested stocks and will likely be hesitant until a few successful deals are made. The underwriters know this and so it will be paramount for them to make the next few transactions work. In order to do this, the underwriters will likely take a close look at what each equity should trade at and then apply a significant discount to the price. So if based on earnings and the economic outlook, they believe that the market will pay $35 for a stock, it’s not unreasonable to think that they will offer the stock in the low $20’s just to make sure the deal works.
After a few IPOs that are offered at $22 and immediately trade to $33, investors will be a bit less skeptical and then the underwriters can begin commanding a price closer to true market values. But for the next two to three months, the deals should be slanted in favor of investors. Underwriters are desperate for the deal fees and many small companies have been waiting months for a chance to sell to the public. So based simply on which parties are motivated, investors appear to have the upper hand.
Secondary offerings may also provide some attractive opportunities. A secondary offering usually occurs when a public company sells additional shares to the market to raise capital for some purpose. Similarly, sometimes a large shareholder of the company will offer to sell a portion or the entirety of his holdings. Either way, there is usually an announcement ahead of time stating that the stock will be sold to the public. Then overnight, the underwriters determine an appropriate price and distribute the shares to buyers who have expressed an indication of interest or IOI. The next morning when the stock begins trading these new shares are included in the mix and can be bought and sold.
There is often a unique opportunity to trade around these secondary offerings because the stock is often offered to investors at a discount to the closing price (this is how underwriters can garner enough interest to get the block of stock sold). So an opportunity usually exists to hedge your expected position the afternoon before the deal comes out, and then pick up stock at a discount on the offering. In this case, the key is to have a good relationship with your underwriter in order to make sure your hedge matches your allocation the next morning.
As we enter the last four months of the year, there should be some very interesting opportunities setting up from both the long and the short side. If you would like help in crafting an investment approach to capitalize on unique opportunities such as IPO and secondary offerings, please send me an email and I will be happy to discuss some options with you. Wishing you every success!
Disclosure: Author has a position in NYX in the ZachStocks Growth Model
