BIZCHINA / Backgrounder
Initial public offering
Updated: 2006-09-26 09:35
Initial Public Offerings (IPOs) are the first time a company sells its
stock to the public. Sometimes IPOs are associated with huge first-day
gains; other times, when the market is cold, they flop. It's often
difficult for an individual investor to realize the huge gains, since in
most cases only institutional investors have access to the stock at the
offering price. By the time the general public can trade the stock, most
of its first-day gains have already been made. However, a savvy and
informed investor should still watch the IPO market, because this is the
first opportunity to buy these stocks.
Reasons for an IPO
When a privately held corporation needs to raise additional capital, it
can either take on debt or sell partial ownership. If the corporation
chooses to sell ownership to the public, it engages in an IPO.
Corporations choose to "go public" instead of issuing debt securities for
several reasons. The most common reason is that capital raised through an
IPO does not have to be repaid, whereas debt securities such as bonds
must be repaid with interest. Despite this apparent benefit, there are
also many drawbacks to an IPO. A large drawback to going public is that
the current owners of the privately held corporation lose a part of their
ownership. Corporations weigh the costs and benefits of an IPO carefully
before performing an IPO.
Performance
The aftermarket performance of an IPO is how the stock price behaves
after the day of its offering on the secondary market (such as the NYSE
or the Nasdaq). Investors can use this information to judge the
likelihood that an IPO in a specific industry or from a specific lead
underwriter will perform well in the days (or months) following its
offering. The first-day gains of some IPOs have made investors all too
aware of the money to be had in IPO investing. Unfortunately, for the
small individual investor, realizing those much-publicized gains is
nearly impossible. The crux of the problem is that individual investors
are just too small to get in on the IPO market before the jump. Those
large first-day returns are made over the offering price of the stock, at
which only large, institutional investors can buy in. The system is one
of reciprocal back-scratching, in which the underwriters offer the shares
first to the clients who have brought them the most business recently. By
the time the average investor gets his hands on a hot IPO, it's on the
secondary market, and the stock's price has already shot up.
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