ShmoopTube

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principles of finance a la shmoop. the IPO checklist. short operating

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history .no dividends, often no earnings. so why do investors love IPOs so much? [checklist shown]

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and because so often the stock prices of IPOs are under priced dramatically on

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purpose. the shares zoom upwards that first day of trading in a few cases eBay

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Yahoo LinkedIn Tesla and others the stock price is way more than doubled in

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the first day or three of trading. that's the good the bad is that most IPOs are [charts]

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actually terrible, but investors love lottery tickets and they'll keep putting

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5 bucks on red 32 on the roulette wheel until somebody forces them to you know

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stop. so why do i POS zoom? well a lot of it is about unknowns. investment banks

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technically owned the entire company for a brief moment in time and they don't

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like to take a risk before they turn around and sell it to the public. think

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about it. works like this. the bank is taking the company public and they buy [flow chart]

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all the shares it's selling to the public for let's say 15 dollars and 50 cents a

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share, and like five minutes later they turn around and dump them at sixteen

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bucks. 50 cent spread their got it if the bank has done a great job marketing the

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IPO to mutual funds and hedge funds and private investors buying them

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well then demand for those shares is often a multiple of the supply of those

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shares available to buy. got it ?demand higher than supply so stock prices go up.

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alright and this is not done by accident or out of the banks kindly goodwill. by [man gives presentation]

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having demand 3 for 20 times the supply the certainty that the bank will be able

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to fully sell out all of its shares that it bought for 15 .50 or whatever the

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price was will be very high. and in most IPO deals there is what's called a

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greenshoe option, or over allotment option for the bank. that is if the bank

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is supposed to be selling 10 million shares of a given company.com in an IPO [flow chart]

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well the bank has the option to sell 12 million shares if the demand is there to

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give it price. meaning they could sell 2 million more and that's why you'll read

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about here about or see on CNBC initial red herring whisper prices that always

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start out it's crazy low number like 10 bucks a share

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and then magically seemed to creep upwards toward 15.50 well banks start low [definitions on a white board]

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gain interest from early adopter investors and if demand is for well 80

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million shares on a 10 million share base at 14 bucks while the bank likely

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has little risk in raising the final IPO offering price to 15.50 and

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having some cheapskates go away so that there is a ventral demand for 60 million

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shares at the higher 15.50 going on $16 price and at that price. the bank can

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sell 12 million shares instead of 10 million shares and on the margin that's [definitions on screen]

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a big deal to the banking team who brought public the company. they're

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making 50 cents a share spread on the shares right so on 10 million shares

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they make 5 million and well for almost no extra effort or at least very little

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extra effort they make an additional million bucks selling 2 million more

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shares at 50 Cent's spread in the green shoe effort. and the companies love this [equations]

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because they raise more capital at a higher price gives a little more cushion

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a little more dough to go by that water fountain with the cores neon sign thingy

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in the lobby. alright well note that IPO teams usually

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comprised four or five individuals who tap into many resources along the way

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mostly in the form of lawyers and accountants and other suit-wearing [man in suit frowns]

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bureaucrats. so an extra million bucks goes a long way toward paying the

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bonuses of the group at the end of the year, like if you think if you could do

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one of those each month yeah that'd be grand. well being able to sell more

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shares rather than less is a good thing for the company as we've noted. the [equations]

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company has more shares trading in the public market which adds liquidity

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making it easier for buyers to buy and sellers to sell the stock. and the big

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investors love that. well that liquidity lowers the

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transaction costs of trading in the stock, that is like there's lots of

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shares so you don't need five cents Commission to keep everyone happy per [flow chart]

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share it could be like four cents or three cents but you got a lot of shares

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trading it's a lot of spread it's good for all the traders and that transaction

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cost is essentially a tax on the trade and lower taxes are always good for

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commerce. I'm looking at you Congress. all right well the heat the bank generates

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is good for another reason as well the company had originally budgeted to spend [fire in a pit]

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based on a raise ten million chairs at ten bucks are a

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hundred million dollars of new capital, but for only modestly more dilution well

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they'll have sold 12 million shares at 15.50 net to them -remember the bank sells

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it at sixteenth of company keeps fifteen fifty. or said another way they've just [equations]

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raised a hundred eighty six million instead of a hundred million and that's

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a good thing it'll be a really nice holiday party in year one as a public

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company so that's the reward. all right what about the risk ?well there's lots of

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it you can imagine a situation where a company is only marginally

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oversubscribed like demand for twenty million in their supply of 15 million.

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and the bank is unable to raise prices along the journey of its IPO marketing [flow chart]

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Roadshow. the bank could in theory find itself holding 10 million shares of

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piece-of-crap.com when skittish investors 8 minutes before the IPO

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decide to call in sell at any price orders to their traders in many deal

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cases. in order to win the IPO the bank has to agree to buy and hold the set of

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number of shares itself like as a proprietary trading in its own coffers

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the bank's money is at risk. so if the deal was bought by the bank at 10 bucks [flow chart]

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a share and it sold down to 5 bucks a share and by the way people that's about

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what happened to Amazon on its IPO. while the bank could be left holding a heavy

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lead filled bag in the ocean and oh by the way that's also not good for the

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clients of the bank who rely on it to only give them "good deals" in quotes and

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we chuckle at that. a few piece-of-crap.coms and while most banks capital [man gives presentation]

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markets teams are out of business.

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