Investing Series: What is an Initial Public Offering or IPO?

This is a part of the Investing Series.

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An Initial Public Offering or IPO is kind of like a debutante in high society showing herself on the social scene for the first time.

They’re coming out into society!

They’re ready to be married off [to the right investor / husband]!

They’re beautiful, young and fresh!

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You get the idea.

It just means a company that was previously private (that is, not traded on the stock exchange where investors like you and me could grab a piece of them, not necessarily that they were introverts), decide to go “public”, and allow investors like us to buy a piece of their company no matter how small.

*waves at Starbucks (SBUX)* Hi! I own 10 stocks of your company! *wave*

Ahem.

WHY WOULD A COMPANY WANT TO GO PUBLIC?

Money. It’s always for money. Or for love.

(But in this case, it’s 100% for the love of money.)

It’s kind of like the company getting to use other people’s money without a clear debt.

If a company needs money, it can go to a bank where it can get a loan, and then pay interest on the loan.

Otherwise, they can IPO, and get money from investors like us, where it can use our money, in return for our hopes and dreams that they will grow from a $2.00 stock to a $200 one.

We’re basically gambling our money on this company, lending it to them to grow their business and make money for us.

If we lose money that we invested in the company, then it’s gone. We’ve lost the game.

Unlike getting money from the bank, the company doesn’t have to pay us back. We just hold these shares worth half or less than half what we originally paid for them, and suck it up as a loss.

Even if the company goes bankrupt, it basically pays everyone else first (banks, etc), before the common (lowly) shareholder, but in return, you get to say you own a piece of the company.

This is why it’s important to look at what a company is worth at the sum of its parts.

• Read: Calculating fair book value for a company

What’s that you say? Sounds like a bum deal? Well this is where most people should invest their money.

WHAT’S THE GENERAL PROCESS OF AN IPO?

So an IPO usually gets shopped around to big investment banking firms who look at your company, your rivals, and they basically guess (for lack of a better word) what you might be worth.

They then set a price for the stock they think it’s worth, and the number of stocks they want to issue (usually common shares, not preferred ones).

They decide how much debt they want to owe to shareholders, then based on the price set per share, they divide it by the number of shares they want to issue and let people buy.

They then take this IPO around like a caravan or a carnival, and they do what they call a “roadshow” to let everyone know with big signs, bells and whistles, that an IPO for a company is coming.

Then.. they IPO. That’s it.

They set a date, they ring the bell at the stock exchange (if they’re big enough), they pop some champagne (or beer, depending on how rich you are), and eat some celebratory cake while watching your stock either plummet or shoot up like a star.

EXAMPLE:

A very major IPO that happened in my time that I can always recall is Facebook, which was on May 18 2012.

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Do we all remember Facebook?

(Does anyone even use it any more?)

Well for those of you not in the know, the Initial Public Offering (IPO) basically flopped and did not meet anyone’s (unrealistic) expectations.

He had paid gobs of money to this firm called Morgan Stanley (oh a small outfit, you wouldn’t know them.. not really a household name :P).

Morgan Stanley chose a price at $38.

The stock shot up to $45 within the first day, and then ended at $38.23.

It was then that they realized (Morgan Stanley) that the price THEY HAD CHOSEN to be too high for the market, and they had bitten off more debt than they could chew by offering too many shares.

Anyway, the story ends sadly, with the stock losing more than half its value in 3 months following its IPO in May (around August).

WOMP WOMP.

It now sits at $23.31 at the time of writing this post in mid-June.

Basically, investors shat on it at $38 and was not confident this company was worth as much as they all said it was.

To me, it’s worth $10 at best per stock, because frankly, I don’t see the point of the platform. Never did, never will.

Now companies instead of looking at Silicon Valley IPOs as the way to go to show how big you’ve become, they’re now shying away from them, and looking for other ways to raise capital to grow.

An IPO used to be the one mark of success for a new technology company, but as regulations have increased and more private investors have signaled interest in the sector, the prestige and financial necessity of an initial public offering has waned.

High profile IPO disappointments like Facebook (FB.O) and Zynga (ZNGA.O) have not helped the case for public markets.

SUMMARY

• An IPO just means an Initial Public Offering
• IPOs are offered by companies because they want to raise more money (e.g. take on debt from investors) to grow
• Not all companies in the world are traded on the stock market (some are “private”, like YKK Group that deals in practically all the zippers in the world)
• Public companies (or ones that come out and debut on the stock market), are the ones we can buy
• Not all IPOs are rosy stories