Shares, General

What is an IPO? A complete guide to going public

Ben Weiss, Monday, 20 May 2019

NYSE balcony

Download this as a PDF - Complete Guide to IPOs

IPO is a term well known in the finance and trading industry. Due to the number of new companies growing and going public, ‘IPO’ will come up frequently, so it’s important to understand exactly what an initial public offering is and how you can use them as trading opportunities. Here’s our complete guide to IPOs.

What is an IPO?

An IPO, short for initial public offering, is the process of a company enlisting themselves on the stock market as a publicly tradable company. The IPO consists of selling off shares from the company in return for investment.

What is the purpose of an IPO?

The purpose of an IPO is primarily for a company to raise capital and investment. ‘Going public’ and being listed on a major stock exchange is also not only good for company exposure in terms of (effectively) free marketing, but is seen as a sign of stature and that a firm is performing well.

 

What is the process for a company going public? How do IPOs work?

For a company to go public and launch its IPO, there’s a specific, time-consuming process that it must go through. Here are the steps briefly outlining the journey a company must take to go public.

  1. Firms find an underwriter that is usually a bank, to assist with the IPO in both a financial and operational capacity.
  2. Due diligence and in-depth research then takes place, with everything from plausibility of an IPO to the price of shares, being looked at and discussed intensely.
  3. Registering with SEC (Securities and Exchange Commission) is next, where all the necessary documents must be filed for and the S-1 form completed.
  4. Red Herring documents are then filed by the firm, outlining specifically what price they intend to trade at.
  5. SEC approves all the documents, allowing the firm to go public. Then, the firm undertakes a (usually) two-week period of effectively selling its IPO to potential investors, in an attempt to drive interest.
  6. Following that, the firm is then ready to go public and the IPO is launched.

What are the advantages/disadvantages of going public?

Although it may seem like an IPO can only be good for a company, this is not always the case. Uber and Lift, for example, had somewhat disappointing IPOsv in early 2019, resulting in their shares not being sold off at the initially, intended price. Of course, an awful lot of money was still raised, but the bad press and reduced company market value did the firms no favours. Here are all of the advantages and disadvantages of going public.

Advantages of going public

Disadvantages of going public

-Raises a significant amount of financial capital that can be used to reinvest into the business to support growth.

-Company’s must abide by stronger regulations.

-With a direct proportion of funds raised going to the company’s owners, they will earn a lot of money from an IPO.

-The current owners of a company may be in danger or selling off too much control, meaning decisions may not remain in their hands.

-Provides the opportunity for the public to invest in a company that they perhaps see potential in or even support.

-A company’s performance will always be under severe scrutiny and will be susceptible to drastic falls in market value should sentiment turn negative.

-Gives a company a certain credibility and status, in being listed on a top exchange.

-Filing to go public is very time consuming and can take around nine months. For the smaller firms, this can be very costly as it will require a lot of time and manpower.

-Means a company must be more transparent with everything, from operations to finances, which provides a clearer indication of the company’s performance for traders and investors.

 

-Being publicly listed is more attractive for future investors.

 

-Provides an ‘exit’ for current investors if they wish to release their equity.

 

 

When should a company go public?

Timing is crucial in determining at what point a company should go public, but sometimes things can happen after the process has begun that are unforeseen. For instance, if a company is swarmed with bad press as it floats, investor sentiment will be low and it’s likely to trade at a lower price as it goes live on the markets.

Alternatively, if a company is going public at a time when it has just released record profit figures and announced new investment, investors may have more confidence and demand should push prices higher.

The truth is though, that there is no exact time that a company should or should not go public. There are too many independent factors that differ from firm to firm to suggest a common time in a company’s history. However, the purpose of going public should determine when that company hits the stock exchanges.

If it is purely about money and they feel they will raise the maximum amount possible at a certain time, then the IPO should be then. If it’s about exposure, wait until the time that will most benefit the firm (i.e. a travel firm should do it at the start of the summer, a period just before number of people travelling domestically and abroad peaks).

Which companies have gone public?

Most major companies have gone public to this date or are in the process of becoming public very soon. The most notable are the likes of Apple, Amazon, Alphabet and Tesla. In terms of largest IPOs, the most notable are Facebook, Alibaba and SoftBank Group.

Some of the most recent companies to go public are Uber, Spotify and Pinterest.

Which companies haven’t gone public?

There are not too many recognisable names that haven’t gone public or aren’t intending on having an IPO soon. However, those companies that have so far resisted have done so for specific reasons. Such companies include Enterprise Holdings, Mars and Deloitte.       

Largest private firms 
Source: Forbes              

IPOs in 2019

So far in 2019, several high-profile companies have had their IPOs. Uber was by far the most notable, with pre-float estimations predicting it would be one of the largest offerings ever. Amidst driver protests and questions over its profitability, or rather, lack of profitability to date, Uber floated below what it was expected and the San Franciscan firm had a terrible opening day on the markets.

Uber rival Lyft also went public this year, along with Chinese coffee-shop revolutionist Luckin, social media firm Pinterest and video communications specialists Zoom.

There are plenty of IPOs still expected for 2019, however exact timeframes are difficult to calculate as it’s dependant on a number of factors.

Here are the major equities that are expected to have an IPO in 2019:

  • Postmates
  • Airbnb
  • Slack
  • Robinhood
  • WeWork

What is a secondary offering?

A secondary offering is similar to an IPO but involves a firm either releasing additional shares that were previously kept private, or offering completely new shares. This dilutes the market value of each share, as the accumulative wealth of all shares is unchanged.

What are the largest IPOs in history?

Chinese company Alibaba has the largest IPO to date. In 2014, the e-commerce-giant raised $25 billion. Visa Inc. floated in 2008, raising $19.7 billion (sixth largest). Facebook was perhaps one of the most anticipated and hyped IPO, but in terms of numbers it came just tenth, raising $16.01 billion. A final IPO of note is NTT DoCoMo. The Japanese phone operator went public in 1998, selling its shares for a total of $18.05 billion. This alone puts it as the ninth largest IPO in history, but when inflation is considered (over 20 years ago $18 billion would have been worth more than it is now), it puts the total money raised at the equivalent of $28 billion in today’s money. 


How to trade IPOs

Initial public offerings provide a unique opportunity to trade equities. How exactly to trade around them depends on sentiment towards the equity.

For example, if it’s believed an equity is going to kick on after its IPO and continue to grow and increase profits, it may be worth investing heavily on its opening day to take advantage of the low price. Of course, the price will be set and initially offered at a level that is thought to be representative of its market value, but if an investor feels that the shares are undervalued or the share price will soon increase, it could be worth investing heavily at that price. Furthermore, the markets have a general uptrend as time goes on, so often with an equity that’s performing well, its price is at one of the cheapest levels it will ever be during its IPO.

Alternatively, it may be worth seeing how the stock performs in its opening days on the market. Perhaps an investor believes the price will rocket but it instead falls after the float. At this point, the investor is getting an even better price on an equity that they believe will rise in the future.

One thing to note about trading around IPOs is that the share price of the equity is likely to fluctuate and experience volatility in its opening few days, as natural market forces (supply and demand for the equity) eventually allow the price to settle at something more reflective of its actual value.

A second consideration for anyone trading IPOs is the interest that surrounds them. For Uber’s recent IPO, search volume for the keyword ‘Uber’ was understandably significantly more than usual, with people interested in not only the IPO, but specifically interested in trading around it.

As a result, what is often seen with the larger IPOs is a large number of people interested and trading it in its early stages, but as ‘the hype’ somewhat subdues, that interest fades away. The influx of, what will mostly be, new traders looking to see whether money can be made from Uber’s IPO (incidentally a huge company that most people would have at least have heard of, if not used) is key. These traders will for the most part not be experienced and will be trading based on news they hear from the major outlets. Sentiment will be easily driven and influenced.

For instance, had Uber smashed its opening day, it may have driven a bullish attitude as news outlets would have reported its positive d but. This as well as the fact that for inexperienced traders, what they know about Uber is likely to only be positive in that it’s a revolutionary rideshare company that’s offering them cheap fares, adds to the positive sentiment snowball effect. If a lot of traders are opening long positions on Uber, its price will be driven up. This could be despite its actual market value being worth less that what its price gets to, with underlying issues that should be hindering its share value being overlooked.

Takeaways

  • An equity’s price is often its cheapest during its IPO, so value is often there to be had.
  • Pricing for an equity’s IPO can be wrong, thus the market may move considerably early on.
  • During an IPO, particularly for the more notable companies, there will be often an influx of new (inexperienced) traders who simply follow trends.
  • An equity’s price in the time after its IPO may not be reflective of its actual share price.

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