IPO (Initial Public Offerings)
(Notes by "Ozzie Dilbert", 1999)
In my investing I had not had any reason to look at IPOs until
this year, when FIBR (in which I hold a
stock position as well as an emotional attachment) decided to
spin out its NetSilicon division, now trading as NSIL.
While following this process, I learned a lot about the IPO process,
and seeing how much mis-information is spread around on the bulletin
boards, I decided to share some of it.
Companies make initial public offerings for a variety of reasons,
and understanding the reason for a particular offering will help
set realistic expectations for how successful it will be.
Here are some reasons for IPOs:
Every public offering must be managed by an underwriter.
Usually, two brokerage houses are sharing this role, so that
there is a lead underwriter and a co-manager.
- To raise capital for product development
This is the traditional path for a technology company:
One or two bright people have a great idea for how some
new invention can be used to build great new products.
First they take their own money to try to build a demonstration
prototype. Typically they get about halfway. Then they use that to
get a venture capitalist to finance development of an actual
usable product. When they start shipping a product, they have an IPO.
At this point the venture capitalist gets paid back, and the
rest of the money is used to finance the production ramp-up.
- To settle power struggles, such as inheritance issues
A company may have been successful as a private company,
where the management team is the same group of people as the
owners/investors. Then circumstances change: One of
the principals wants to retire, or changes in the industry make it
clear to the management team that the comapany needs to change
direction, but they can agree in which direction. They need to
restructure the company to resolve these issues.
- To spin out a division in order to resolve a merger deal
A company with operating divisions in different industries
(or different geographical markets) may have had good synergy
between divisions, but when a merger is contemplated, it is found
that some parts of the old company compete with the new partner.
Sometimes this is resolved by merging those divisions with the
corresponding divisions in the other parent company; sometimes
investors or government regulators insist that the competing
divisions must survive under new ownership. An IPO is one
way to achieve that.
- To spin out a division to open new markets
AT&T found Sprint and MCI reluctant to buy AT&T's equipment,
and spun out LU to resolve the issue.
- To get media attention
Barnes and Noble spun out its internet business as a separate
company in order to ride the "dot-com" hype-fest.
- To free a viable subsidiary from the death shadow cast by an ailing
In the long run, the value of a publicly owned company
is determined by the business fundamentals: Earnings, growth,
etc. But in the short run, the perceptions of the public and of
the market may be manipulated by factors unrelated to the fundamentals.
One of the ways that management can try to shape perceptions
is by adjusting the structure of the company.
The underwriter acts as the company's agent on Wall Street.
The underwriter and the company agree on a number of shares and a price
per share, and the underwriter basically buys all the new stock
at the agreed price and sells it into the market. Generally, the
an estimated price range is determined a couple of months ahead
of time; the final price is set the day before trading begins.
At the time of pricing, the deal can still be scuttled by either
the company or the underwriter. Once the pricing is committed,
the underwriter carries the risk if the price is too high.
There are many steps to an IPO. Here I will focus on the financial
transactions happening in the brief period just before and after
the first trading days.
- Announcement of Intent
Generally, the intent to make a public offering will be
announced prior to making an SEC filing.
- Selecting an Underwriter
It is desirable to have a well-respected firm as the
underwriter. An underwriter's reputation depends on their
track record of prior IPOs in the particular industry sector.
A formal prospectus must be written and filed with the
SEC (Form 1). This will outline all the material facts about
the company, and if the facts change, a revision must be
filed (Form 1/A - A for Amended).
- Road Show
With the prospectus in hand, a representative of the underwriter
travels with company management to give presentations to people
in the brokerage industry to persuade them that this new
stock is a good investment opportunity, and to persuade them
to take an allocation of the new stock.
The newly created stock is sold by the company to the
underwriter at an agreed-upon fixed price. The underwriter
usually allocates a significant fraction of the stock
to other brokerages, who can either sell it for the house
account, or - more commonly - offer it to their best clients
at the fixed price. This opportunity to take IPO stock at the
issue price and sell it on the same day is one of the few
guaranteed ways to make money legally.
The underwriter's own employees are not allowed to take
allocations, but they can give them to their friends at
other brokerages, who will then return the favor next time
they manage an IPO.
After the road show and allocation negotiations, it
will be fairly clear if the brokerage houses in general agree
with the proposed price range.
The evening before the offering, the company management
and the underwriter's group will meet to finalize the price
... or kill (postpone) the deal "due to unfavorable market
They have to set the price below their assessment of a realistic
long-term price, in order to make sure that the underwriter won't lose
money as they unload their allocation during the quiet period.
- First Day
Before the open, the new stock symbol will have been
loaded on the NASDAQ computers, and brokerages will have posted
bids on behalf of investors who do not have allocations,
but have faith in the new stock. Around 11 AM, the first offers
to sell will be posted, and for the next hour, trading will
be frantic as the stock struggles to find its price.
At this time, the underwriters and the partners with
allocations will typically offer a trickle of shares at
twice the issue price. If there is a lot of demand, they
will then keep raising the price, if not, they will drift
downwards until the demand appears. Usually, the volume during
this hour adds up to between a third and half of the offered
stock. A stock with a lot of hype and great public interest
may continue to float up during the day; it may close at
three times the issue price and keep rising for the next week
or two. Note, that this represents a situation where the
underwriter is taking a huge profit that rightfully should
have gone to the company via a higher issue price.
More commonly, if the price was set right, the stock will
close the first day 40%-60% above the issue price.
- Unloading by Underwriter
Over the next week or two, the underwriter will slowly release
the stock offering into the market at a controlled rate.
During this period, the stock will often drift lower until
the underwriter finishes unloading and the market stabilizes.
For most investors, this is the best time to buy into the new stock.
- Quiet Period
In order to ensure a level playing field, the SEC insists
that the prospectus (as filed with the SEC) is the only information
from the brokerage houses to potential investors. This restriction
is relaxed after about 3 weeks. This period is known as "the quiet
- Regular Coverage
After the quiet period ends, analysts at the brokerage houses
can start recommending the stock in their newsletters etc.
This generally will lead to upward movement.
- Announcement of Intent and selection of Underwriter
??-Jun-1998 - Osicom chairman Par Chadha outlines intent
to spin off NetSilicon division during Osicom's quarterly
investor conference call. At this time, the intent is
to do a "rights offering" instead of a regular IPO.
Osicom's motivation is clearly to try to escape an aura of
doom-and-gloom that hung around the company that summer.
The management has led investors to believe that major orders
for DWDM equipment is right around the corner, but as the
orders keep slipping down the calendar, "the street" is
losing faith in Osicom and the stock is faltering.
The hope is to point out that NetSilicon is valuable, and
Osicom shares represent that value.
The concept of a rights offering represents Chadha's
resentment of the Wall Street brokerages. Just like he took
Osicom public by a reverse merger, he wants to give the
profits of the offering to loyal stockholders (including himself)
rather than the brokerage houses.
??-Jul-1999 - Tucker Anthony is named as the lead underwriter.
26-Aug-1998 - The
original S-1 proposes a "rights offering" whereby 6.2 million shares
will be issued at $5/share, of which 2.9 million will be offered to
current holders of Osicom stock.
- Modification of Intent - not announced.
Over the next months, it becomes obvious that "the street"
is not supportive of an offering that will not "pay its dues"
to the brokerage houses, and the loyal investors are not
ready to commit new money.
In late September, the stock reaches an all-time low, and
Osicom schedules an investor conference call to discuss
business strategies. Par Chadha announces an intent to
spin out both NetSilicon and GigaMux and distribute the
shares retained in both divisions to FIBR shareholders as a dividend.
After which, the mostly empty Osicom holding company may be sold
or liquidated. Osicom stock price starts recovering, eventually peaking
in April 1999.
- Revised Prospectus
11-Mar-1999 - A revised prospectus names Dain Rauscher Wessels as
the lead underwriter with Tucker Anthony as co-manager.
No more "rights offering": NSIL will sell 2 mio shares, FIBR will
sell 1 mio shares and retain 9 mio shares. Shares to be offered to
the public at $14/share.
21-Apr-1999 - Amendment: Pricing range drops to $10-$12. NSIL will now
offer 2.3 mio shares, FIBR only 700,000. FIBR will retain 9.3 mio shares.
- Selecting a new Underwriter
02-Jul-1999 - A revised prospectus names CIBC World Markets
as lead underwriter with Piper Jaffray as co-manager.
NSIL will now offer 3 mio shares, FIBER will sell 2 mio and retain
8 mio shares. Offering price range $8-$10.
- Road Show
A road show is undertaken in late July. In preparation for
the road show, the S-1 is updated on 20-July-1999 with more
current financial data. The IPO is set to go around 08-Aug-1999;
put the offering is rescheduled for September after the market
gets nervous about "internet stocks".
Without a full road show, allocations are negotiated,
and the IPO is set for 15-Sep-1999.
This time around, the brokerage houses are presenting NSIL
as a great opportunity, and the press is almost uniformly positive.
14-Sep-1999 - The offering is priced at $7/share. Since this is outside
of the range in the prospectus, the S-1 must be revised yet again.
- First Day
15-Sep-1999 - The first wave goes up to $15/share, but settles in around
- Unloading by Underwriter
Over the first week, the price keeps drifting slowly down
towards 11, until a press release naming 3 VPs of sales and
marketing with excellent credentials boosts it by $3.5/share in
a single afternoon.
- Quiet Period
We shall see.
- Regular Coverage
We shall see.