Posted in Finance Articles, Total Reads: 2006
, Published on 04 December 2013
Twitter IPO has finally hit NYSE on 7th Nov 2013. An issue priced at 26 $ opened up with 75% high at about 45$, thus putting an end to all the talks going on about the credibility of its valuation and the response it is likely to get on the D day. But not many people know how actually this whole process of Initial Public Offering is done. In this article we are going to study about the complete IPO process right from the scratch.
image courtesy : worradmu, freedigitalphotos.net
Whenever a company wants to expand its business, it requires capital which can be raised in two ways. It can either go to a Bank/Financial Instiution and ask for a loan or it can allow other people to invest in company by selling its shares. Making company’s share available to general public for the first time is known as Initial Public Offering. This process of raising capital obviously has an advantage over other in terms of risk associated with it. In latter company has to repay its loans over a certain period of time, no matter it is making profit or loss with interest rates being fixed whereas in former dividends are to be paid back only if company has made profit and dividend rates are not fixed either.
This entire process through which a company goes public isn’t carried out overnight but takes days which involve combination of several steps before shares are actually made available on a stock exchange for trading.
Underwriting : The first step involves appointment of an Investment Bank which acts as an underwriter for the company. Selection of Bank is done entirely on the basis of its reputation or its past rapport with the company. Depending upon the size of issue more than one Bank can be appointed. In that case the leading bank is known as Book runner and assisting banks are called as Co-managers. Underwriting involves filing the registration with regulatory body, consulting company in determination of IPO price, determination of type and number of securities to be issued and marketing of company to prospective investors. Goldman Sachs, JP Morgan, Morgan Stanley and Credit Suisse are some of the worlds most preferred underwriters.
Red Herring : In second step a preliminary document called as Red Herring is to be filed with (SEC) Securities and Exchange Commission, a regulatory body of US federal government responsible for protecting investors against fraudulent in securities market. This prospectus clearly mentions purpose of issue, official details about Chairperson, BODs of the company, details of underwriter appointed and their commission and company’s financial statements of last 3 years. This document does not disclose any information about the price and number of securities to be issued. SEC takes around 20 days to review and investigate details mentioned in this document before granting final approval to the company to go ahead with offering process. Once the approval is given SEC assists company in deciding the issue date which depends on factors like market condition etc.
IPO Pricing : The third step is the pricing of issue which can be done in two ways known as fixed price method and book building method. In fixed price method underwriter values the company to prices the shares and then put it up for subscription whereas in book building process underwriter sets a price range within which investors are allowed to bid for shares and depending on the demand and supply issue price is decided. To price an issue complete financial model of company has to be prepared making it one of the most complicated steps of this whole process.
Roadshow : After the issue price is decided money is to be raised from IPO. Roadshow is process of meeting and giving presentations to large Institutional Investors like Pension funds, Hedge Funds in order to sell large blocks of stock at IPO price. This process lasts for around two weeks with lead underwriters travelling across the country and meeting prospective investors. Depending upon the response received during the roadshow, if the interest in the IPO is week issue price and number of securities to be issued are reduced day before they are released on stock exchange for trading and vice versa.
Issue Day : Finally comes the day that has been a hot news in stock market for quite some time and issues are made available on a stock exchange for trading, however, role of lead Underwriter doesn’t ends here. During the initial trading days that are considered to be very crucial from the company’s point of view, they have the responsibility of ensuring smooth trading of stocks. In some cases they also buy company’s stocks in order to support issue price.
What do Underwriters get out of this?
Underwriters charge around 3-8 % commission on the total capital raised through Initial Public Offerings. This means if a company has raised 100 million USD through IPO underwriter gets 3-8 million USD and that is why major investment banks are so wealthy.
An IPO marks a new era in company’s history. The whole process has to be handled with significant care because a little mistake here or there would end up company falling flat of expectations. Not to forget what happened with Facebook, one of the biggest issues in history of IPO.
The article has been authored by Saurabh Tripathi, Department of Management BITS Pilani