Initial Public Offerings
IPO = Initial Public Offering
SEO = Seasoned Equity Offering
Two types of Underwriting Contracts
1. Best Efforts – Underwriter can return any unsold shares to the issuer – Smaller issuances
2. Firm Commitment – Underwriter buys the entire issue as a set price – Most well-known issuances
Steps in the process
1. File a Registration Statement with the SEC in accordance with the Securities Act of 1933.
aka – The Disclosure Statement – discloses everything about the company.
Part of it is used as the Initial Prospectus – aka – The Red Herring
Underwriters are responsible for making certain everything is truthfully revealed in the Registration Statement – called Due Diligence
2. Cooling off period – usually about 20 days during which SEC reviews registration statement
3. Road show – time (usually during cooling off period) when underwriters and company officers tout the stock to investors at meetings held in different cities
Offer range – The underwriters usually give an expected price range of $3 -$4 rather than a specific offer price. This range can be revised as new information comes in.
Indications of Interest – obtained during road shows. These are not legal obligations to purchase shares, but are indications based on various offer prices.
4. Typically, the SEC requests changes or clarifications in the registration statement. This may go several rounds.
5. Once accepted by the SEC, the red statement on the side of the front cover comes off and we have a prospectus
6. Agreement Among the Underwriters (The Underwriting Syndicate) – becomes an amendment to the registration statement
Members of the syndicate
Lead Manager (Book Manager)
Underwriters
Selling group – no capital commitment
How sales will be conducted
Remuneration for different members of the syndicate
Lead Manager’s responsibilities
7. The underwriting spread is set – the difference between the offer price and the proceeds the underwriters pay the issuing company – note that this is typically about 7%
8. The offer price is set – often not finalized until after markets close the day before issuance. May be in the middle of the range, below the range, or above the range
9. Calls are placed to those who indicated interest and shares are sold. When over-subscribed, investors won’t get as many shares as they requested.
10. Overalotment Option (Green Shoe Option) – Underwriters can sell an additional 15% at their option
11. Initial Return (degree of underpricing) – Difference between the offer price and the first-day closing price. Most of this occurs during the first few trades on the secondary market
12. Price Support (Stabilizing the market) – Underwriters may stand ready to purchase shares at or slightly above the offer price to legally support the price for 5-10 days
13. Tombstone – an ad placed on the effective date of the offering announcing the sale and listing the underwriters alphabetically by groups.
14. If trading OTC, many of the underwriting firms may become market makers in the stock
Shelf Registration – file with the SEC and wait for the optimal time to sell. Firm can wait up to 2 years. Rarely done with IPOs – more often with SEOs or bond issues
Private Placements – non-public offerings made to “sophisticate investors”
May not be sold to the public for two years
By Rule 144A, may be traded among institutions on PORTAL
No SEC registration needed
More common with bond issues
Number of IPOs Categorized by the LTM Sales (in 2005 $), 1980-2015IPOs with an offer price below $5.00 per share, unit offers, small best efforts offers, ADRs, closed-end
funds, REITs, bank and S&L IPOs, limited partnerships, and firms not listed on CRSP within six months
of the offer date are excluded. Five companies with missing sales (Last Twelve Months) are also excluded
for the LTM Sales columns. MV is the post-issue market value valued at the first closing price. Sales and
MV are in millions. PSR is the price-to-sales ratio. There has been 24% inflation since 2005.
Number of IPOs / Percentage of IPOs
L TM Sales $2005 / L TM Sales $2005 / Medians, $2005
Year / <$50mm / >$50mm / <$50mm / >$50mm / Sales / MV / PSR
1980 / 38 / 33 / 54% / 46% / 44 / 83 / 2.5
1981 / 140 / 52 / 73% / 27% / 28 / 73 / 2.9
1982 / 54 / 23 / 70% / 30% / 21 / 68 / 3.1
1983 / 286 / 165 / 63% / 37% / 28 / 93 / 3.2
1984 / 99 / 73 / 58% / 42% / 39 / 55 / 1.6
1985 / 95 / 92 / 51% / 49% / 47 / 69 / 1.4
1986 / 199 / 194 / 51% / 49% / 49 / 78 / 1.6
1987 / 137 / 148 / 48% / 52% / 53 / 99 / 1.6
1988 / 42 / 60 / 41% / 59% / 86 / 126 / 1.5
1989 / 47 / 66 / 42% / 58% / 61 / 124 / 2.4
1990 / 44 / 66 / 40% / 60% / 56 / 131 / 2.2
1991 / 118 / 168 / 41% / 59% / 69 / 144 / 1.8
1992 / 191 / 221 / 46% / 54% / 58 / 133 / 2.0
1993 / 230 / 279 / 45% / 55% / 61 / 124 / 2.1
1994 / 216 / 187 / 54% / 46% / 46 / 98 / 2.1
1995 / 257 / 204 / 56% / 44% / 39 / 161 / 3.5
1996 / 411 / 266 / 61% / 39% / 32 / 159 / 4.5
1997 / 273 / 201 / 58% / 42% / 41 / 149 / 3.3
1998 / 146 / 135 / 52% / 48% / 47 / 224 / 3.6
1999 / 342 / 135 / 72% / 28% / 19 / 550 / 30.2
2000 / 279 / 102 / 73% / 27% / 14 / 638 / 40.6
2001 / 25 / 54 / 32% / 68% / 146 / 507 / 2.9
2002 / 16 / 50 / 24% / 76% / 263 / 560 / 2.3
2003 / 15 / 48 / 24% / 76% / 173 / 392 / 2.7
2004 / 70 / 103 / 40% / 60% / 87 / 352 / 4.2
2005 / 46 / 113 / 29% / 71% / 133 / 347 / 2.7
2006 / 54 / 103 / 34% / 66% / 105 / 353 / 3.9
2007 / 58 / 101 / 36% / 64% / 83 / 471 / 6.7
2008 / 4 / 17 / 19% / 81% / 172 / 468 / 3.9
2009 / 4 / 37 / 10% / 90% / 239 / 622 / 2.0
2010 / 22 / 69 / 24% / 76% / 132 / 379 / 2.8
2011 / 24 / 57 / 30% / 70% / 131 / 747 / 5.6
2012 / 19 / 74 / 20% / 80% / 126 / 503 / 4.4
2013 / 58 / 99 / 37% / 63% / 93 / 551 / 5.4
2014 / 99 / 108 / 48% / 52% / 60 / 351 / 9.1
2015 / 62 / 55 / 53% / 47% / 42 / 399 / 12.6
1980-2015 / 4,220 / 3,958 / 52% / 48% / $47 / $178 / 3.3
Mean First-day Returns, Categorized by Sales, for IPOs from 1980-2015
Sales, measured in millions, are for the last twelve months prior to going public. All sales have been converted into dollars of 2003 purchasing power, using the Consumers Price Index. There are 8,178 lPOs, after excluding IPOs with an offer price of less than $5.00 per share, units, REITs, SPACs, ADRs, closed-end funds, banks and S&Ls, small best efforts offers, firms not listed on CRSP within six months of the offering, and natural resource limited partnerships. Sales are from Thomson Financial's SDC, Dealogic, EDGAR, and the Graeme Howard-Todd Huxster collection of pre-EDGAR prospectuses. The average first-day return is 18.0%.
1980-1989 / 1990-1998 / 1999-2000 / 2001-2015Return / N / Return / N / Return / N / Return / N
Ossalescs lOm / 10.3% / 420 / 17.2% / 741 / 68.9% / 331 / 10.1% / 316
$1 Om~sales<$20m / 8.7% / 243 / 18.7% / 393 / 81.4% / 138 / 14.0% / 71
$20m~sales<$50m / 7.8% / 500 / 18.8% / 791 / 75.0% / 155 / 14.6% / 205
$50m~sales<$ 100m / 6.3% / 356 / 12.9% / 589 / 6l.8% / 87 / 20.5% / 264
$1 00m~sales<$200m / 5.1% / 234 / 1l.8% / 454 / 35.8% / 56 / 17.0% / 224
$200m~sales / 3.4% / 290 / 8.7% / 645 / 25.0% / 91 / 11.6% / 584
All / 7.3% / 2,043 / 14.8% / 3,613 / 64.5% / 858 / 13.9% / 1,664
Average 3-year Buy-and-hold Return
Number / Average / Market- / Style-
Year / of IPOs / First-day Return / IPOs / adjusted / adjusted
1980 / 71 / 14.3% / 89.8% / 37.0% / 18.5%
1981 / 192 / 5.9% / 12.3% / -27.0% / 10.3%
1982 / 77 / 11.0% / 37.5% / -31.5% / -12.0%
1983 / 451 / 9.9% / 15.9% / -37.7% / -4.4%
1984 / 172 / 3.6% / 49.5% / -28.9% / 27.2%
1985 / 187 / 6.4% / 5.6% / -41.3% / -12.3%
1986 / 393 / 6.2% / 16.9% / -22.6% / -1.3%
1987 / 285 / 5.6% / -2.6% / -19.1% / -11.2%
1988 / 102 / 5.7% / 58.5% / 10.5% / 37.1%
1989 / 113 / 8.2% / 49.6% / 14.9% / 12.2%
1990 / 110 / 10.8% / 9.7% / -35.9% / -38.4%
1991 / 286 / 11.9% / 31.2% / -1.8% / 5.8%
1992 / 412 / 10.3% / 37.4% / -0.2% / 11.1%
1993 / 509 / 12.7% / 44.5% / -8.3% / -8.8%
1994 / 403 / 9.8% / 78.1% / -5.7% / -1.2%
1995 / 461 / 21.2% / 28.9% / -57.8% / -24.6%
1996 / 677 / 17.2% / 25.2% / -56.8% / 7.0%
1997 / 474 / 14.1% / 58.3% / -1.9% / 21.9%
1998 / 281 / 21.9% / 24.1% / 6.4% / -4.3%
1999 / 477 / 71.1% / -47.8% / -32.7% / -60.8%
2000 / 381 / 56.3% / -60.2% / -30.9% / -56.8%
2001 / 79 / 14.2% / 17.8% / 14.4% / -28.1 %
2002 / 66 / 9.1% / 68.6% / 39.0% / -0.4%
2003 / 63 / 11.7% / 34.0% / -7.7% / -11.2%
2004 / 173 / 12.3% / 51.4% / 6.9% / -7.0%
2005 / 159 / 10.3% / 14.6% / 3.1% / -2.5%
2006 / 157 / 12.1% / -28.8% / -11.1% / -4.5%
2007 / 159 / 14.0% / -16.5% / -0.5% / 0.5%
2008 / 21 / 5.7% / 11.4% / 8.1% / 5.1%
2009 / 41 / 9.8% / 37.0% / -5.1% / -18.3%
2010 / 91 / 9.4% / 36.4% / -9.6% / -18.5%
2011 / 81 / 13.3% / 38.6% / -8.7% / -11.7%
2012 / 93 / 17.8% / 74.9% / 26.1% / 24.2%
2013 / 157 / 21.1% / 27.2% / 3.9% / 0.2%
2014 / 207 / 15.4% / 12.6% / 6.2% / 9.5%
1980-1989 / 2,043 / 7.3% / 22.5% / -22.6% / 2.2%
1990-1994 / 1,720 / 11.2% / 46.2% / -6.4% / -1.7%
1995-1998 / 1,893 / 18.1% / 34.1% / -34.1 % / 1.3%
1999-2000 / 858 / 64.5% / -53.2% / -31.9% / -59.1 %
2001-2014 / 1,547 / 13.6% / 21.1% / 3.7% / -2.7%
1980-2014 / 8,061 / 17.9% / 22.1% / -17.8% / -6.3%
Panel A: IPOs from 1980-2014 categorized by venture capital backing
Average / Average 3-year Buy-and-hold ReturnNumber / First-day / Market- / Style-
VC-backed or not / ofIPOs / Return / IPOs / adjusted / adjusted
VC-backed / 2,974 / 27.0% / 25.3% / -9.6% / 1.9%
Non VC-backed / 5,087 / 12.6% / 20.3% / -22.6% / -11.1%
All / 8,061 / 17.9% / 22.1% / -17.8% / -6.3%
The average first-day return on IPOs has consistently been above 10% for several decades. In 1999 it was 67%. Why do companies leave so much money on the table?
1. The Winner’s Curse – Informed investors will only invest in “good” IPOs. Thus, uninformed investors, who would invest in any IPOs, will receive a disproportionate number of shares of the bad ones. Seeing this, the underwriters need to underprice all IPOs in order to keep the uninformed investors in the ball game.
2. Payment for Information – During the road show, investors need incentive to truthfully reveal how much they like the IPO. Otherwise, they would lie if they think the IPO is great, because then the underwriters would cut the price. By underpricing, and then giving investors no more shares than they request, investors will be shut out of the good IPOs if they don’t let the underwriters know how good they are.
3. Lawsuit Avoidance – It is hard for investors to complain that they were misled in the prospectus and suffered financially when they made 15% in one day.
4. Investor Interest and the Partial Adjustment Phenomenon – during the road show, as underwriters learn more about the level of interest, they do not fully adjust the offer price – either up or down. This leads to the upward adjusted prices having the most underpricing and the downward adjusted offer prices having the least underpricing.
5. Information momentum and the SEO – Issuers only issue a fraction of the number of shares they want to issue during the IPO. If they underprice, it is viewed as a success, there is increased publicity, increased trading volume, increased analyst coverage, and the stage is more effectively set for a larger SEO which will come within the next year.
6. Payback – Underwriters need to underprice (on average) to get investors to buy into all IPOs – even the dogs. If an investor opts out of the cold IPOs, he/she will be left out of the hot ones.
7. Pay It Forward – Underwriters will underprice as a tool to give stocks with sure high returns to decision-makers at firms who have business they want in the future. This is called spinning.
8. Limits to arbitrage – Normally, prices reflect the weighted average of optimistic views (buyers) and pessimistic views (sellers and shorters). IPOs can’t be sold or shorted prior to the issue date, and are expensive to short immediately after issue, so the pessimists are shut out of the market, causing the price to go above equilibrium.
9. The Lottery Theory – No investor wants to miss a chance to invest in the next Microsoft, so even though they know that IPOs do poorly on average, the skewness of the distribution is too tempting to resist.
Underpricing Around the World
Country / Sample Size / Time Period / Ave. Initial ReturnAustralia / 266 / 1976-89 / 11.9%
Austria / 61 / 1984-95 / 6.5
Belgium / 28 / 1984-90 / 10.1
Brazil / 62 / 1979-90 / 78.5
Canada / 258 / 1971-92 / 5.4
Chile / 19 / 1982-90 / 16.3
China / 226 / 1990-96 / 388.0
Denmark / 29 / 1989-97 / 8.0
Finland / 85 / 1984-92 / 9.6
France / 187 / 1983-92 / 4.2
Germany / 170 / 1978-92 / 10.9
Greece / 79 / 1987-91 / 48.5
Hong Kong / 334 / 1980-96 / 15.9
India / 98 / 1992-93 / 35.3
Israel / 28 / 1993-94 / 4.5
Italy / 75 / 1985-91 / 27.1
Japan / 975 / 1970-96 / 24.0
Korea / 347 / 1980-90 / 78.1
Malaysia / 132 / 1980-91 / 80.3
Mexico / 37 / 1987-90 / 33.0
Netherlands / 72 / 1982-91 / 7.2
New Zealand / 149 / 1979-91 / 28.8
Portugal / 62 / 1986-87 / 54.4
Singapore / 128 / 1973-92 / 31.4
Spain / 71 / 1985-90 / 35.0
Sweden / 251 / 1980-94 / 34.1
Switzerland / 42 / 1983-89 / 35.8
Taiwan / 168 / 1971-90 / 45.0
Thailand / 32 / 1988-89 / 58.1
Turkey / 138 / 1990-96 / 13.6
United Kingdom / 2,133 / 1959-90 / 12.0
United States / 13,308 / 1960-96 / 15.8