This report will be analyzing the operating procedure and the returns getting from the IPO’s.
EXECUTIVE SUMMARY
This report originated as requirement of thesis program of Business Administration curriculum of Stamford University, Bangladesh. The intern has take Dhaka Stock Exchange to complete the requirement, “IPO: An Appraisal of Operating Procedure and Recent Performance”
The main focus of this report will be analyzing the operating procedure and the returns getting from the IPO’s. The aim of the report is to give a general situation of IPO’s in Bangladesh for the sample period 2003 to 2008 and this report provides an overall situation of IPO’s in Bangladesh from the sample period of 2003 to 2008
The present study provides a comprehensive analysis of the initial return and long term performance for the initial offering in Bangladesh. A total of 63 new issues are included in the sample, from the sample period 2003 to 2008. The initial return on IPO’s was especially higher for the firms during 2003 to 2008 in most of case the analyzing result, we can conclude that the initial return of IPO’s were much higher, in most of the case than the subsequent retune over the person from 2003 to2008, during 2004 and 2005 period most higher average return than other period. Exceptionally, very few companies were performing badly where investors got poor and negative return. The IPO’s are overprice in Bangladesh because price decrease overtime during the period 2003 to 2008 in our analysis. When price decrease, initial returns have been deteriorating over the period, because the shares are over price. In that case the issuer receives more than it should have from issuing the share. We will see next whether these companies were performing will or not after IPO’s (where we will analyze their post IPO’s performance in the letter section. We have to look forward to see what the long term performance of those IPO’s. We have scrutinized the long performance of those IPO’s. From our analysis, we have seen many IPO did will initially. But, they failed to perform to keep their price stability. From our observations, we saw that few companies (like insurance companies in the year 2005. see table) did will after the IPO though their initial return were lower than other companies ,which have initial higher return They should be aware that firm’s do not perform as will after going public. The weak performance of IPO‘s was partially attributed to irrational valuation at the time of IPO, which were connected over time. In addition it was partially attributed to the firms managers, who spent excessively and less efficient in managing the firms fund than they were before the IPO.
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An analysis of the cost of going public is also done in the present study. Furthermore the sequence of event leading to the rise and fall of the IPO market in Bangladesh are also described in details from the period 1991 through 1999 and despite the spectacular growth during the early to mid 1990s the market for new issues in Bangladesh is currently stagnant.
Overall state (Analysis) of IPO market in Bangladesh-The most of the companies comes for IPO are overvalued. The IPO’s are from unfamiliar and unexamined companies, which give initial return much higher from there offer price. In most case, investors are buying that share more than the offer price. By the analyzing most of investors characteristic, we can sat that they have a tendency to buy the new IPO by selling the existing shares of reputed companies to get the initial high return. For capitalization the initial IPO return, they invest in the unfamiliar company’s shares by withdrawing money from the secondary market. As result, market capitalization and price index have been a declining tendency after the immediate IPO offer.
Several inferences are developed in this study. Such as lack of investor’s knowledge, Market: drains of IPO are in the share, risks of investing in IPO’s and SEC’s Vigilance, Timing of IPO’s and paying dividends. so that the recommendation part try to gives certain suggestion regarding inferences and various problem that are very often confronted by related parties in the capita market with a view to overcome those tribulation are rejuvenate the capita market.
Introduction
This project paper is an effort to appraise the functioning of the initial public offering (IPO) in Bangladesh in terms of operating procedure and performance analyses. The intention is to provide readers with the true picture of the current scenario regarding IPO that is prevailing in the marketplace.
1(a) Origin of the report
As per for the completion of my BBA degree, require to prepare a final project paper on a related topic. It is from this inspiration and according to my instructor…………….Advice, chose to prepare my project on initial public offering (IPO) in the name of “IPO: An Appraisal of Operating Procedure and Recent Performance” . this is a very lucrative topic to learn about the real life implementation of new issues of stock in Bangladesh and I found the topic very interesting and appealing.
1(b) Objective of the report
The main focus of this report will be analyzing the operating procedure and the returns getting from the IPO’s. The aim of the report is to give a general situation of IPO’s in Bangladesh for the sample period 2003 to 2008.
Our objective is to provide a formal report on the IPO’s in Bangladesh to implement the theoretical knowledge learned in the class on real life perspective.
Our distinct objectives are:
- To find out the initial return of IPO’s.
- To analyze the long term performance of IPO’s.
- To provide the procedure of going public.
- To find out background of IPO.
1(c) Scoop of the report
This report provides an overall situation of IPO’s in Bangladesh from the sample period of 2003 to 2008. Its finds out the reason behind why initial returns of IPO’s are higher rather than succeeding return. While talking about the performance of IPO’s, the report also highlight the process of IPO Operation in Bangladesh, the historical background, problem of IPO operation etc.
1(d) Methodology of the report
this report has been prepare on the basis of related articles, individuals interviewee, personal studies, data collected from different source, expert opinion. In the preparing the report, primary and secondary data have used. A total of 63 stocks (IPO) were issued during the period 2003to 2008. Hoover the present study covers 63 IPO’s. The offering price each of IPO , its first trading price and its closing price subsequently five month after IPO’s in the secondary market at the end of each month were collected from the DSE library. Prospectuses for the IPO’s were collected from the SEC library in Bangladesh.
1(e) Limitation of report
Target was to prepare exact report delivering the condition of IPO operation in our country. But unavailable of information prove to be the most disturbing constrain in preparing the report. face some problem from the source because of their no cooperation. Data collection was proven to be most hazardous. This was not readily available. have gathered data from the DSE & CES library by visiting so many times. This was an exciting topic to prepare a standard term paper but there were not enough studies on this topic. But, have tried level best to prepare this paper with sincerity. Effort will be a successful one when this paper will approach readers desired level.
Chapter one
Literature Review and Theoretical Background
IPO Mean The first sale of stock by a private company to the public. IPO’s are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded.
In an IPO, the issuer obtains the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), the best offering price
and the time to bring it to market. IPO ( www.investopedia.com)
An initial public stock offering (IPO) referred to simply as an “offering” or “flotation,” is when a company issues common stock or shares to the public for the first time. They are often issued by smaller, younger companies seeking capital to expand, but can also be done by large privately-owned companies looking to become publicly traded.
In an IPO the issuer may obtain the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), best offering price and time to bring it to market.
An IPO can be a risky investment. For the individual investor, it is tough to predict what the stock or shares will do on its initial day of trading and in the near future since there is often little historical data with which to analyze the company. Also, most IPO’s are of companies going through a transitory growth period, and they are therefore subject to additional uncertainty regarding their future value. (www.ipostocks.com/ – Cached – Similar)
Investopedia explains Initial Public Offering – IPO’s can be a risky investment. For the individual investor, it is tough to predict what the stock will do on its initial day of trading and in the near future because there is often little historical data with which to analyze the company. Also, most IPO’s are of companies going through a transitory growth period, which are subject to additional uncertainty regarding their future values. (www.RenaissanceCapital.comIPO)
Prospectuses: Publication of a prospectus is not a recommendation by ShareBuilder Securities Corporation that any particular investor should purchase the securities described or that the securities are a suitable investment for any particular investor. (www. sharebuilder com/ sharebuilder/).
Dual-class IPOs; Long-Run Underperformance; Firm Valuation; Corporate Governance Mechanisms; Sweden– This study analyzes the effects of a dual-class share structure on firm long-run underperformance following an IPO. The sample consists of 204 IPO firms during 1998-2007, whereof 86 had a dual-class share structure and 118 had a one-share one-vote structure. When testing for long-run IPO underperformance we use Cumulative Abnormal Returns (CAR), mean Buy-and-Hold Abnormal Returns (BHAR) and the Calendar-Time approach. When using CAR we use value-weighted returns whereas when using the two latter methods we use both equally-weighted (EW) and value-weighted (VW) returns for our calculations. In line with what earlier has been found on the US equity market, we find no support that dual-class IPOs should perform worse than single-class IPOs in the long-run; however, we find some indications of the opposite relationship. In addition, regression results on price-to-book indicate that the Swedish market seems to take into account the positive long-run performance of dual-class IPO firms.( Author: Elisabet Åkesson; Tomi Lakkonen; -2008 )
IPO; Long-run underperformance; Private Equity backed;
S This thesis examines the long-run underperformance of IPOs on the Swedish equity market during 1992-2005 and hence includes the post IT-era. We also investigate whether there is a difference in long-run performance between IPOs that are backed by professional private equity investors and those that are not. We use a sample of in total 271 IPOs of which 89 are private equity backed. In order to investigate the abnormal performance we use two different approaches; the event-time approach as well as the calendar-time approach. Under each of the approaches we use different measuring techniques as well as weighting methods, and control for size and book-to-market ratios. Our main contribution is that we introduce the Fama-French three factor model in determining long-run IPO underperformance on the Swedish equity market. Our findings suggest that Swedish IPOs do underperforms during this time period when returns are equally weighted. However this performance disappears when returns are value weighted. A deeper analysis point to the fact. (Gustav Björcke; Michael Menzel; 2007)
IPO s; long run underperformace; measurement problem underpricing; Behavioural Explanations;
The literature on IPO’s, in particular, its primary underlying reasons on long-run underperformance. The aim is to review theories regarding the long-run underperformance, and evaluate whether or not these theories can explain this phenomenon. A case study of Deutsche Telekom serves to assess the explanatory supremacy of the existing theories regarding the long-run underperformance of IPO’s. We find that one could not argue separately that the theories stated are the only explanation of the IPO characteristics; one has to take into consideration the potential affection of the measurement problem highlighted by Fama among others. However, the theories we conclude to be best applicable are the ones based on heterogeneous expectations, as illustrated with the case. We argue that the reality regarding the long-run underperformance of IPO’s is somewhere in between these to points of views and that it is important to have both of them in mind when examining any case. (Mustav Björcke; Michael Menzel; -2007)
THEORETICAL BACKGROUNDN
This part is designed to provide readers with the necessary understanding (definition reasoning types etc) of the term and languages that are related with IPO (initial public offering).after going through this part ,the readers hopefully be able to c0omprehend and relate the further proceeding of the paper relating to the fact of IPO.
1.1 Definition & Notes
1.1. 1 what is financial market?
The term financial market refers to conceptual “mechanism” rather than a physical location or pacific organization or structure. The financial market is being described as a system comprise of individual and institution, instrument and procedures that begin together borrows and savers, no market location. Above all, market in which financial asset or security such as bonds or stocks are traded is called financial market.
The financial markets in which funds are borrows or loaned for short periods (generally less than one year) or market which facilities the flows of short term funds are called money market.
The financial market in which funds are borrows or loaned for short periods (generally longer than one year) or market which facilities the flows of long term funds are called capital market.
The primary market Are market where security are initially issued or in which corporation raise funds by issuing securities or it is a market in which new issues of securities are first offered to the public. These first offering go directly the issuer. Our consideration is on IPO, which h is under the jurisdiction of primary market.
Secondary market are market in which securities and other financial assets are traded among investor after they have been issued by the corporation and public agency such as municipalities or it is market in which an investor purchase a security from another investor rather than the issuer. Subsequent to the original issuance in the primary market. It also called after market.
1.1. 2 What is stock exchange?
A stock market is a palace where stocks (shares) can be bought and sold .An stock exchanges facilities the trading of stocks and shares. A quoted company’s shares can traded on the stock exchanges. In Bangladesh we have two exchanges Dhaka stock exchanges (DSE) and Chitagong stock exchanges (CSE).stock exchanges can be traditionally divided two types 1) Organized Stock exchanges (2) Over the counter exchanges (OTC).
Organized Stock exchanges: It is formal organization with Physical Location where auction markets are conducted designated (listed) securities.
Over the counter exchanges: It is a large collactio0n of brokers and dealers , connected electronically by telephones and Inter net that provides for trading in securities not listed on the organized exchanges or securities exchanges commission
Both the exchanges in our considered as organized as organizes exchanges, but chitagong exchanges are considered more or less as OTC.
1.1.3 What is securities and exchanges commission (SEC)?
Securities and exchanges commission is a regulatory body that regulates the issuance and trading of stocks and bonds. The securities and exchanges commission was established on 18th June ,1993 under the securities exchanges commission Act, 1993.The chairmen and member of commission are appoint by the Government and have overall responsibility to administer securities legislation .The commission ,at present has three full time members ,excluding the chairman .The commission is a Statutory body and attached to the ministry finance.
Member Perform Following Function:
a. serves as the member of the commission and supervise its management.
b. Provide policy direction to industry and stuff and promulgate legally binding rules.
c. Act of administrative tribunal for decision on t6he capital market..
Mission of the SEC is to:
- protect the interest of the securities investor
- Develop and maintain fair, transparent and efficiency of the security markets.
- Ensure proper issuance of securities and compliance with security law.
Commission main functions are:
Commission’s Main Functions are:
1. Regulation the business of stock exchange and any other security market
2. Registering and regulating the business of stock-brokers share Transfer agents, merchant bankers and managers of issues, trustee of Trust deeds, registrar of issue, underwriters, portfolio managers, Investment advisers and other intermediaries in the securities market..
3. Registering, monitoring and regulation of collective investment scheme including all from of mutual funds.
4. Monitoring and regulating all authorities’ regulatory organization in the securities market.
5. Prohibiting fraudulent and unfair practices relating to the securities trading in any Securities markets.
6 promoting investor, education and providing for intermediary of the securities market
7. Prohibiting insider trading in securities.
8. Regulating the substantial acquisition of share and take-over of companies.
9. Undertaking investigation and inspection, inquiries and audit any issuer or dealer of securities, the stock exchanges and intermediaries and any self regulatory organization in the securities market. Beside these conducting research and publishing information.
1.2 What is IPO?
“IPO” stand for an “Initial Public Offering” of securities. IPO is the first time a company sale its stocks to the public. A company that has previously been owned privately issues IPO in order go to public or in other words, we can say IPO is the first sale securities by a privet company go to public.
IOP are often desired by smaller, younger companies seeking capital to expand their business. A common first step for a going firm is to obtain privet equity funding form venture capitalist firms, which seek to invest in firm that offer high potential for growth over time. This venture capitalist firm typically prefers an investment period of two to five years.
Therefore an IPO is commonly used not only to obtain new funding but also to offer ventures capitalist firms a very to cash in their investment. Many venture capitalist firms sell their shares in the secondary market between 6 and 24 month after the IPO. IPO also sometimes knows as” growing public”. Generally in our country IPO are associated with huge first day gains.
A public offering can be hugely complicated affair. it is usually something that is not undertaken by a company until.
The company has had change to prove itself and profitability model that will scale to much operation no a regional, nationwide or international level.
The company must also have a strong business plan in place with clear objective why it wants to go public. This objective may include raising million of dollars / TK of capital to found an expansion and growth of a very profitability business model. The very first sale of stock to the public is call initial public offering (IPO), and occurs on the primary market.
If a brand new company or a company already in existence, but with no shares listed on the stock exchange, decides to invite the public to buy its shares, it is called an Initial Public Offering or an IPO.
Since it is the first time the company is approaching the public for money, it is also referred to as ‘going public’.
If a company that is already listed (its shares are available for buying and selling on the stock exchange) is coming out with a fresh lot of shares, it is called the new issue.
Here are six terms commonly associated with an IPO that you, as an investor, must be aware of.
1.2. 1 Why go public?
Basically going or participation in an IPO is the process in which a business owned but several or one individual is converted into a business owned by many. It involves the offering part of ownership of the company to the through the sale of debt or more commonly equity securities (stock). Going public raising cash and usually a lot of it. Being publicly traded also open many financial doors.
Because of increased securities and competitive environment in capital market., public company very often have to pay better rates where they issue debt. As long as there a market demands, a public company can always issues more stock. Beside these, the most common reason for going public is that capital raised through an IPO does not have to be repaid, whereas debt securities such as bond must be repaid with interest. Thus mergers and acquisition are easier to do because stock can be issued as apart of deal.
Thus the primary reason for a company going public is to raises money, usually for capital to funds growth of the business or to pay down existing debt. Usually, the companies owners have invest there personal funds in the company up to this point, and its portions of there personal stock that will sold in the public.
But there is trade-off for this way of raising money. After issuing as IPO, the company is subject to the demands of its shareholder and board director. It must also adhere to the strict roles and regulation of the Securities and Exchange Commission and endure public security.
Again being on a major stocks exchange carries considerable amount of prestige. In the past, only privet companies with strong fundamentals could qualify for an IPO and it wasn’t easy to get listed.
1.2. 2 Advantage and Disadvantage of IPO:
An initial public offering (IPO) is the first sale of stock by a company. Small companies looking to further the growth of their company often use an IPO as a way to generate capital nodded to expand fund. Although further expansion is a benefit to the company, there are both advantages and disadvantages that arise when a company goes public. The decision take a company public in the initial public offering should not be considered lightly. There are several advantage and disadvantage to being a public company, which should thoroughly be considered. This memorandum will discuss the advantage and disadvantage of conducting an IPO and will briefly discuss the steps to be taken to register an offering for sale to the public. The purpose of this memorandum is ton provide a thumbnail sketch of the process. The reader should understand that the process is very time consuming and complicated and companies should undertake this process only after serious consideration of the advantage and disadvantage and discussions with qualified advisors.
1.2. (2). (A) Advantage:
There are many advantages for a company going public. As said earlier, the financial benefit in the form of raising capital is the most distinct advantage. Capital can be used to fund research and development, fund capital expenditure or even used to pay off existing debt. Another advantage is an increased public awareness of the company because IPO’s often generate publicity by making their products known to a new group of potential customers. Subsequently this may lead to an increase in market share for the company. An IPO also may be used by founding individuals as an exit strategy. Many venture capitalists have used IPO’s to cash in on successful companies that they helped start-up. Even with the benefits of an IPO, public companies often face many new challenges as well. One of the most important changes is the need for added disclosure for investors. Public companies are regulated by the Securities Exchange Act of 1934 in regard to periodic financial reporting, which may be difficult for newer public companies. They must also meet other rules and regulations that are monitored by the Securities and Exchange Commission (SEC). More importantly, especially for smaller companies, is the cost of complying with regulatory requirements can be very high. These costs have only increased with the advent of the Sarbanes-Oxley Act. Some of the additional costs include the generation of financial reporting documents, audit fees, investor relation departments and accounting oversight committees. Public companies also are faced with the added pressure of the market which may cause them to focus more on short-term results rather than long-term growth. The actions of the company’s management also become increasingly scrutinized as investors constantly look for rising profits. This may lead management to perform somewhat questionable practices in order to boost earnings. Before deciding whether or not to go public, companies must evaluate all of the potential advantages and disadvantages that will arise. This usually will happen during the underwriting process as the company works with an investment bank to weigh the pros and cons of a public offering and determine if it is in the best interest of the company.
(1) Increased capita:
A public offering will allow a company rise to capital to use for various corporate purposes such as working capital, Company expansion, acquisition, research and development, expanding plan. New equity may be available in an amount greeter than, or at cost less than to private financing. Moe fund are available for expansion, to repay debt and interest, working capital, acquisition of business or technology and other purpose. Potentially higher valuation is there than available in private offering, increasing net worth of the compound facilities future debt and equity financing. It helps to get future access to public markets. If a company needs to raise capital, it can sell stock or it can issue bonds. An initial equity offering can bring impeded proceeds to a company. Once public, a company’s financings alternatives are increase. A public traded company can return to the public markets for additional capita via a bond or convertible bond issue or secondary equity offering, a public status can also provide favorable terms for alternative financing from public and private investor. Besides these growing companies constantly access to new capital. Going public is one way to obtain that capital but it take time and money quite a lot of both IPO some strategic advantages.
(2) Liquidity:
To sell the stock of private company, a stockholder must find other individuals that are interested in owning shares. This is very difficult, especially for the minority position. By going public, creates a market for its stock in which buyers and seller participation. In general stocks in a public company are more liquid than private enterprise. Liquidity is created for the investor, institution, founder, owners and venture capital professionals. Investor of the company may be able to buy or sell the stock more readily upon completion of the public offering.
This liquidity can elevate the value of the corporation. The stock liquidity is contingent on a Varity of factors including registration rights, lock-up restriction and holding periods. A public company has a greater opportunity to sell shares of stock to investor. Liquidity can also provide an investor or company owner an exit strategy, portfolio diversity and flexibility of asset allocation. On of the important benefits of public offering is the fact that the company’s stock eventually becomes liquid, offering reward and financial freedom for founders and employees.
A public market for the stock also provides a potential exit strategy and liquidity to the investor. A psychological sense of financial success can be added benefit of going public. A going public can enhance the personal net worth of a company’s shareholder
(3) Increased prestige and Image:
Public companies often are better known and more visible than private companies, this enables them obtain a large market for their good and services. Public companies are able to access larger pools of capital. Public companies can help a company gain prestiges by creation a perception of stability. A company’s founders and managers gain an enormous amount of personal prestige from being associated with a client that go public. Prestige can be very helpful in recruiting key employees and marketing products and service. When sharing ownership with the public, you spread the company’s reputation and increase its business opportunities. By selling stock on an exchange your company can gain additional exposure and become batter known. This exposure may lead to improved recognition and business operations.
(4) Valuation:
Public trading of a company’s shares sets a value for the company that is set by the public market and not through more subjective standards set by a private valuation. This is helpful for a company that is looking for a merger or acquisition. It also allows the shareholder to know the value of the shares. Once a company is public and the market for its stock established, the stock can be considered as valuable as cash when acquiring other business. A successful IPO can have a dramatic effect on a company’s profile, perceived competitiveness and stability.
(5) Increased wealth:
The founders of the company often have sense of increased wealth as a result of the IPO. Prior to the IPO these shares were illiquid and had more subjective price. These shares now have an ascertainable price and after any lockup period these shares may be sold public, subject to limitation of the country’s law. Beside theses, it gives the ability to use stock incentive plans to attract and retain key employees. The newly created value can become part of an estate providing value not only for the founders but also for the generations to come.
1.2. (2). (B) Disadvantage:
(1) Time and expense:
Conducting an IPO is the consuming and expensive. A successful IPO can take up to a year or more to complete and a company can expect to spend several hundreds of thousand of taka on attorneys, account, and printers. In addition, there are considerations for underwriter’s fee which are a substantial part of the value of the offering. Due to the time and expense of preparation of the IPO many companies simply cannot afford the time or spare the expense of preparing the IPO. There are expenses like underwriters discount and commission and offering expenses, including legal and accounting fees, printing costs, transfer agent fees, stock exchange listing fees. Compliance with SEC reporting requirements will increase significantly the company’s general and administrative costs. Management will spend significant time in public relations and in informing the investment community about the company may have to expense outlays incurred prior to termination of the offering. Such outlays may be substantial depending on when the decision to terminate is made.
(2) Disclosure:
The SEC disclosure rules are very extensive. Once a company is a reporting company it must provide information regarding compensation of senior management, transaction with parties related to the company, conflict of interest, competitive position, how the company intends to develop future products, material contracts, and lawsuits. In addition, once they offering statement is effective, a company will be required to make financial disclosures required by the securities and exchange rules 1987. It requires public companies to file non audited financial statements and audited financial statements periodically. These statements must also contain updated information regarding no financial matters similar to information provided in the initial regarding statement. This usually entails retaining lawyers and auditors to prepare these statements. In additional, a company must report certain material events as they arise. This information is available to investors, employees, and competitors. He offering prospectus and SEC filing will reveal information about the company that would not otherwise be available, giving competitors potential advantages.
(3) Falling stock price and market pressure:
If the shares of the company’s stock fall, company may lose market confidence, decreased valuation of the company may affect lines of credits, secondary offering pricing, the company’s ability to maintain employees, and the personal wealth of insiders and investors.
Beside these, marketplace pressure may cause the company to focus too much on short-term results to maintain stock prices, forgone risks necessary for future success. Public shareholders may demand dividend, even though management believes reinvestment of earnings is better.
(4) Regulatory review and restriction on management:
The Company will be open to review by the SEC to ensure that the company is making the appropriate filings with all relevant disclosures. The company may not be able to act as quickly as it when it was private because of the need to comply with SEC proxy rules when obtaining shareholder votes. Insiders and others are subject to civil and criminal liability if they trade company stock on the basis of material nonpublic information. Management must exercise extreme caution in dealings with the investment community to ensure no selective disclosure of material nonpublic information.
(5) Vulnerability:
If a large portion of the company’s shares are sold to the public, the company may become a target for takeover, causing insiders to lose control. A takeover bid may be the result of shareholders being upset with management or corporate raiders looking for an opportunity. Defending a hostile bid can both expensive and time consuming.
(6) Others:
The current shareholders percentage ownership of the company will be diluted in a public offering. Control of the company may shift and the company could face an attempted unfriendly takeover. The market may view certain a takeover devices as unacceptable in an initial public offering. Earning per share will be diluted. The public marker for new securities can be fickle. An understanding of the “window” of opportunity is critical. There may be urgency of the need for additional funds and the availability and cost of alternative sources of financing. Besides there, going public may require organizational structure change – e.g. from a partnership to corporation.
So, there are the advantages and disadvantages of IPO’s. Before investing in IPO’s investors should understand the different dimensions of IPO’s thus proceed further.
1.3 IPO Basics
The process of IPO: Relevant notions
In the sometimes mundane world of investing, initial public offerings are shrouded in mystique. The world of newly public companies, after all, remains off limits for most individual investors, although that is slowly beginning to change. Apart from the potential for big returns, however, investing in IPO’s risky business. Obviously, investors need to get beyond the allure and hype of IPO’s and become educated about the facts.
Following are some definitions of terms commonly used in the IPO market.
Once the company determines how much money it wants to raise and the type of securities it will sell, the next step is to find an underwriter who guarantees the money by buying the stock offered and then reselling it to the public.,
The details of the offering are disclosed in an underwriting agreement. The underwriter also files a registration statement with the Sec, along with a statement on how the company will use the money raised in the IPO – individuals can being buying stock in the company.
The internet is a great place to learn about conducting an IPO, risks for investors, and current stock price for IPO’s progress. One can also find consultants who will help structure once company in the beat manner to facilitate an IPO. But in Bangladesh this process is still not popular.
Underwriting:
Underwriting is the process of insuring someone or something. It is an act of guaranteeing a specific price to the initial issuer of securities or in other words, we can say that underwriting is a way of placing newly issued securities. Should they not be able to find enough investors, then they end up holding some securities themselves.
The process of bringing a new security issue to the market, by reselling the issue to the public for a profit, underwriting is one of the main activities of an investment banker.
When a corporation decides that it is time to go public, issuing stock to investors, it must hire an investment banking firm to help sell the corporation’s stock. Basically, what happening is the investment banker is acting as the middle-man between the public and the corporation. Now in most cases, the underwriter will buy the stock from the corporation and sell it at a higher price to the public. The difference between the price that the underwriter pays for the stock and the price the public pays for the stock is known as the underwriting spread. Also, because some corporations are selling huge amount of shares at the IPO they will from an underwriting syndicate, which is other investment bankers who co-purchase the stock in a set in a set of allotments. This reduces some of the risk that the investment banker takes from buying all of the shares; the underwriting process is really complicated because of all the rules and regulations imposed by the SEC. Another thing that syndicates can do is bid on the stock price during the offering in order to “stabilize” the stock price. Basically, the stabilizing process is to secure the syndicates purchase and to allow the price of the stock to rise due to demand. When the syndicate bids on the stock price it must be less then or equal to the offering price, this regulates the syndicate from making the price too high and then selling it off quickly. He syndicate must also notify the public that it is bidding on the stock, that way the public is aware the syndicate is trying to stabilize the stock. Moreover, the SEC also requires that the underwriter investigate that company who is going public. This protects the public from buying shares of a company that has no intention of making money, but that just wants to profit on the offering of its stock price. The process of investigation the company going public is referred to as due diligence.
Underwriting refers to the process that a large financial service provider (bank, insurer, investment house) uses to assess the eligibility of a customer to receive their products (equity capital, insurance, mortgage or credit). The name derives from the insurance market. Financial bankers, who would accept some of the risk on a given venture (historically a sea voyage with associated risks of shipwreck) in exchange for a premium, would literally write their names under the risk information that was written on a Lloyd’s slip created for this purpose.
Risk, exclusivity, and reward:
Once the underwriting agreement is struck, the underwriter bears the risk of being able to sell the underlying securities, and the cost of holding them on its books until such time in the future that they may be favorably sold.
If the instrument is desirable, the underwriter and the securities issuer may choose to enter into an exclusivity agreement. In exchange for a higher price paid upfront to the issuer, or other favorable terms, the issuer may agree to make the underwriter the exclusive agent for the initial sale of the securities instrument. That is, even though third-party buyers might approach the issuer directly to buy, the issuer agrees to sell exclusively through the underwriter.
In summary, the securities issuer gets cash up front, access to the contacts and sales channels of the underwriter, and is insulated from the market risk of being unable to sell the securities at a good price. The underwriter gets a nice profit from the markup, plus possibly an exclusive sales agreement.
Also, if the securities are priced significantly below market price (as is often the custom), the underwriter also carries favor with powerful end customers by granting them an immediate profit (see flipping), perhaps in a quid pro quo. This practice, which is typically justified as the reward for the underwriter for taking on the market risk, is occasionally criticized as unethical, such as the allegations that Frank Quattro acted improperly in doling out hot IPO stock during the dot com bubble.
Types of Underwriting:
There are many types of underwriting arrangements in which a stock can be done. One is where the underwriter acts as an agent and tries to sell as much of the stock it can at the current market price. This is known as the best effort arrangement. In a best effort arrangement, the investment banker does not guarantee that the securities will be sold or that the company will get the cash it needs. Another type of arrangement is called firm commitment arrangement where the underwriter is compelled to buy the unsold securities. There are also many other types of arrangement is called firm commitment arrangement where the underwriter is compelled to buy the unsold securities. There are also many other types of arrangements when issuing stock. The main thing to know is that the terms in which stocks are issued are usually a contract between the company going public and the investment banker/ syndicate that is bringing the stock to the market. The most important thing to know about the underwriting process is that it is highly regulated by the SEC and that it can be an opportune time to for young investors to research good companies and make long-term investments.
Underwriting spread: It is the difference between the price at which an investment banking firm expects to sell securities and the price it is willing to pay to the issuing firm. The difference between an IPO’s offering price and the price the members of the syndicate pay for the shares. Also called the underwriting discount.
Securities underwriting-
Securities underwriting is the way business customers are assessed by investment houses for access to either equity or debt capital.
This is a way of placing a newly issued security, such as stocks or bonds, with investors. A syndicate of banks (the lead-managers) underwrite the transaction, which means they have taken on the risk of distributing the securities. Should they not be able to find enough investors, they will have to hold some securities themselves. Underwriters make their income from the price difference (the “underwriting spread“) between the price they pay the issuer and what they collect from investors or from broker-dealers who buy portions of the offering. When a Deale
Sponsorship underwriting-
Underwriting may also refer to financial sponsorship of a venture, and is also used as a term within public broadcasting (both public television and radio) to describe funding given by a company or organization for the operations of the service, in exchange for a mention of their product or service within the station’s programming.
Aftermarket Performance-
Used to describe how the stock of a newly public company has performed with the offering price as the typical-benchmark.
All or none-
An offering which can be canceled by the lead underwriter if it is not completely subscribed. Most best-effort deals are all or none.
Book-
Lists of all buy and sell orders put together by the lead underwriter.
Break issue-
Term used to describe a newly issued stock that falls below its offering price.
Completion-
An IPO is not a done deal until it has been completed and all trades have been declared official. Usually happens about five days after a stock starts trading. Until completion, an IPO can be canceled with all money returned to investors.
Direct public Offering (DPO)-
An offering in which a company sells its share directly to the public without the help of underwriters. Can be done over the internet, thought in Bangladesh it is not popular. Liquidity or the ability to sell shares, in a DPO is usually extremely limited.
Indications of interest-
Gathered by a lead underwriter from its investor clients before an IPO is priced to gauge demand for the deal. Used to determine offering price.
Offering price-
The price that investors must pay for allocated shares in an IPO. Not the same as the opening price, which is the first trade price of a new stock.
Opening price-
The price at which a new stock starts trading. Also called the first trade price. Underwrites hope that the opening price is above the offering price, giving investors in the IPO a premium.
Oversubscribed-
Defines a deal in which investors apply for more shares then are available. Usually it is a sign that an IPO is a hot deal and will open at a substantial premium.
Penalty bid-
A fee charged to brokers by the lead underwriter for having to take back shares already sold. Meant to discourage flipping.
Pipeline-
A term used to describe the stage in the IPO process at which companies have registered with the SEC and are waiting to go public.
Premium-
The difference between the offering price and opening price. Also called an IPO’s pop.
Proxy-
An authorization, in writing, by a shareholder for another person to represent him/ her at a shareholder’s meeting and exercise voting rights.
Quiet period-
The time period in which companies in registration are forbidden by the Securities and Exchange Commission to say anything not included in their prospectus, which could be interpreted as hyping an offering. The intent and effect of a quiet period have been hotly debated.
Road show-
A tour taken by a company preparing for an IPO in order to attract interest in the deal. Attended by institutional investors, analysts, and money managers by invitation only. Members of the media are forbidden.
Selling stockholders-
Investors in a company who sell part or their entire stake as part of that company’s IPO. Usually considered a bad sign if a large portion of shares offered in an IPO comes from selling stockholders.
Syndicate-
A group of investment banks that buy shares in an IPO to sell to the public. Headed by the lead member and disbanded as soon as the IPO is completed.
Private placements-
A private placement is an offering in which the company sells to private investors and not to the public. Private placements do not have registration fees. It is a process in which a corporation sells new securities directly without using underwriting service.
Preemptive Right-
When a public company issues more of its stock, it must first offer that stock to existing shareholders; that is their preemptive right. A stand by is the public sale of whatever stock the existing shareholders have not yet purchased.
The lock up period-
When a company goes public, the underwriters make company officials and employees sign a lock up agreement. Locks up agreements are legally binding contracts between the underwriters and insiders of the company, prohibiting them from selling any shares of stock for a specified period of time. The period can be anything from 3 to 24 months. But the lock up specified by underwriters can last much longer.
Flipping-
Some investors who know about the unusually high initial returns on IPO’s attempt to purchase the stock at its offer price and sell the stock shortly afterward. This strategy is referred to as flipping. Investors who engage in flipping have no intention of investing in the firm over the long run and are simply interested in capitalizing on the initial return that occurs the market price of the stock to decline shortly after the IPO. Thus underwriters are concerned that flipping may place excessive downward pressure of the stock price.
Prospectus-
Prospectus is a pamphlet that discloses relevant financial data on the firm and provisions applicable to the security. It is a formal legal document describing details of a corporation. The prospectus is generally created for a proposed offering (especially in case of IPO), but it can still be obtained from existing businesses as well. The prospectus includes company facts that are vitally important to potential investors. The prospectus includes all financial data for a company for the past five years, information on the management team, and a description of a company’s target market, competitors, and growth strategy. There is a lot of other important information in the prospectus, and the underwriting team goes to great lengths to make sure it’s all accurate.
In other word’s we can say that prospectus can be a formal summary of a proposed venture or project or it can be document describing the chief features of something, such as a business, an educational program, or especially a stock offering for prospective buyers, investors, or participants. But here we are concerned with prospective relating to IPO. The information that is required in the prospectus is monitored and set by the SEC. The company has to abide by the rigid requirements imposed by the market regulating authority. In our country, generally prospectus is consists of on average 40-50 pages. For a new company prospectus requires five years projected financial statements and in case of an existing company last five years financial statements are required. Subsequent part of this paper will provide us with detail requirement that are inflicted by the SEC.
Best effort — A deal in which underwriters only agree to do their best to sell shares to the public, as opposed to much more common bought, or firm commitment, deals.
Bought deal — An offering in which the lead underwriter buys all the shares from a company and becomes financially responsible for selling them. Also called firm commitment.
Green shoe — Part of the underwriting agreement which allows the underwriters to buy more shares — typically 15% — of an IPO. Usually done if a deal is extremely popular or was overbooked by the underwriters. Also called the over allotment option. Gross spread — The difference between an IPO’s offering price and the price the members of the syndicate pay for the shares. Usually represents a discount of 7% to 8%, about half of which goes to the broker who sells the shares. Also called the underwriting discount.
Initial public offering (IPO) — the first time a company sells stock to the public. An IPO is a type of a primary offering, which occurs whenever a company sells new stock, and differs from a secondary offering, which is the public sale of previously issued securities, usually held by insiders. Some people say IPO stands for “Immediate Profit Opportunities.” More cynic it’s Probably Overpriced.”
Lead underwriter — the investment bank in charge of setting the offering price of an IPO and allocating shares to other members of the syndicate. Also called lead manager.
S-1 — Document filed with the Securities and Exchange Commission announcing a company’s intent to go public. Includes the prospectus; also called the registration statement.
Spinning — The practice by investment banks of distributing shares to certain clients, such as venture capitalists and executives, in hopes of getting their business in the future. Outlawed at many banks.
Venture capital — Funding acquired during the pre-IPO process of raising money for companies. Done only by accredited investor.
All-hands– A company that is thinking about going public should start acting like a public company as much as two years in advance of the desired IPO. Several steps experts recommend include preparing detailed financial results on a regular basis and developing a business plan. Once a company decides to go public, it needs to pick its IPO team, consisting of the lead investment bank, an accountant, and a law firm. The IPO process officially begins with what is typically called an “all-hands” meeting. At this meeting, which usually takes place six to eight weeks before a company officially registers with the Securities and Exchange Commission, all the members of the IPO team plan a timetable for going public and ass