The recent facebook has created a huge controversy. But lost in all of this is how an ipo works. Experts throw big words that the common person does not understand. This thread will attempt to state in layman’s terms how an ipo works and place the fb ipo in this context.
Re: IPO's -who benefit and who dont
When a company wants to go public they hire one ormore underwriters to do the ipo.the valuation of the company is estimated taking into account profits growth rate business model etc. Let us say it is valued at 100 billion. Shares with a fraction of this valuation are isssued. So let us say 10 billion worth of shares are issued. Let us also assume one billion shares are issued. So the ipo price is 10 dollars per share.
Re: IPO's -who benefit and who dont
It is in the company's best interest to have the price reflect true value. The money raised goes to its treasure chest. The early investors such as venture capital folks also get to cash in.
On the other wide are the people who getvto buy the stock at the offer price. In a popular ipo the common man - otherwise known as a retail investor gets offered only a small % of the shares at the offer price. The underwriters give most of these shares to their preferred big clients - who are big individuals or institutional investors. It is in the best interest of this set if ipo is offered at a low price relative to fair value.
Re: IPO's -who benefit and who dont
And most of the time this happens. The underwriters leave "money on the table" - ipo priced at lower value relative to fair value. In other words the offer is priced at say 7 dollars - 30% lower than 10$. So facebook gets to ra8se 7 billion $ instead of 10 billion dollars. The preferred clients and small amount of ratail investors who got in on the offer price get to buy the shares at $7/share. The market figures out the shares are worth at least 10$/share. So the preferred clients sell the shares in the open market at >10$/share. And make a tidy profit.
Re: IPO's -who benefit and who dont
Sometimes the demand is so high the price shoots up in curtsy few minutes or hour to say $15. So the preferred clients just got fatter. Wall street is happy- the underwriters get a fat fee their preferred clients just made a 50-100% profit are happy - so will give more business to underwriters by moving more assets there.
The retail investor who has to buy in the open market gets the pleasure of buying high at 15-20$/share. The company raised $7billion instead of $10billion.
So in a typical ipi the underwriters and their preffered clients win big. The company leaves monryon the table. The retail investor at best makes 20% but mostly buys at high end and loses money.
Re: IPO's -who benefit and who dont
In the case of facebook the offer price of $38 corresponded to total valuation of 105-110 billion dollars.maybe 3 times whatfacebook is worth. 20% of shares were sold. So facebook raised about 20 billion $.
Since ipo offer price was >> fair value the institutional investors did not make any money. In fact they lost 15% as of recent close price. The common man not affected - he still got the privilege of buying high!
Hence the outrage from wall street- the big boys instead of getting a free lunch - lost their lunch.
Re: IPO's -who benefit and who dont
There has been hype about underwriters giving information on selective basis to their client. But this is the law. No analyst reports can be issued for 40 days after ipo. But they can still give information to preferred clients! Normally these fat clients end up making money. This time those who did not get this information lost their shirt. Hence the whining.
The information was publicly available anyway. Facebook had announced its revenue or profit had slowed from previous quarter! The issue of monetization from mobile devices also well known.
Goes to show the wall street types are "smart" when they have access to information others dont. Else they are pretty common.
Look forward to comments from those who know more about this topic. Would like any errors here to be set straight. This is a layman's perspective.
Big boys got reamed, great
I am not shedding tears
They are talking smack about what zuckerberg wears and how his focus on UI over profit is not how businesses are run. All because he outsmarted these excel gymnasts.
Fact is that Facebook watched for its interests, went public and with the class of shares zuckerberg controls the decisions, so these short term focused analysts pushing for stupid decisions for short term EBIDTA have minimal say.
Re: IPO's -who benefit and who dont
And most of the time this happens. The underwriters leave "money on the table" - ipo priced at lower value relative to fair value. In other words the offer is priced at say 7 dollars - 30% lower than 10$. So facebook gets to ra8se 7 billion $ instead of 10 billion dollars. The preferred clients and small amount of ratail investors who got in on the offer price get to buy the shares at $7/share. The market figures out the shares are worth at least 10$/share. So the preferred clients sell the shares in the open market at >10$/share. And make a tidy profit.
Underwriters do take the risk in case there is not enough demand for the shares, they have to hold the shares and are left with a potential loss in case the price nosedives which will happen if the IPO is not fully subscribed. Not every flotation is Facebook. Plenty out there where the underwriters are at risk. Further more in your example if the shares is priced at $7 face book doesn't raise $7bn. They will have to pay hefty fees to various parties involved in the flotation. These costs include but are not limited to the following:
Legal Fees, Audit Work, filing fees, advertising costs Sales commissions typical around 10% of proceeds, underwriting costs of around 4%. All these costs stack up.
Re: IPO's -who benefit and who dont
Thanks Ehsan Baha'i. I did know the underwriters take on risk when ipo not fully subscribed. Very useful information. (If I knew the siggn for thumbs up I would place it right here) - thumbs up.
Re: IPO's -who benefit and who dont
I meant to say I did not know about underwriters taking on this risk.
Re: IPO's -who benefit and who dont
Moving on to the monologue portion of the program I did some crude back of the handkerchief calculations to estimate market cap of lead tech stocks when they came public. I used the total gains since ipo. I divided the current market cap by the gain. For example market cap of Microsoft 240 billion. It has given 30000% return or gain of 300x. So market cap at ipo $0.8 billion.
Mictosoft (1980) $0.8B
Intel (1980) $1.8B
Csco (1990)$0.4B
google (2004) $26B
Facebook (2012) $107B
The ipo year is also given based on my best guess.
The trend is obvious. Tech companies' ipo is getting more and more closer to or greater than fair value.
Re: IPO's -who benefit and who dont
Moving on to the monologue portion of the program I did some crude back of the handkerchief calculations to estimate market cap of lead tech stocks when they came public. I used the total gains since ipo. I divided the current market cap by the gain. For example market cap of Microsoft 240 billion. It has given 30000% return or gain of 300x. So market cap at ipo $0.8 billion.
Mictosoft (1986) $1.6B Intel (1980) $4.5B Csco (1990)$0.8b google (2004) $30B Facebook (2012) $107B
The ipo year is also given based on my best guess.
The trend is obvious. Tech companies' ipo is getting more and more closer to or greater than fair value.
Microsoft ipo was 1986. This post gives inflation adjusted n
Market cap assuming 3% inflation on average. No change in trend.
Re: IPO's -who benefit and who dont
Stock is downv25% from offer price. Looks like facebook benefitted from this - got to raise more money than what irlt sells for now.