Thoughts on IPO’s and secondaries
Little companies that are doing IPO’s or secondary distributions get ripped off by the underwriter (investment bank). It’s not that investment banks are evil. You might as well call a wolf evil because he eats rabbits. It’s the nature of things.
Here’s why. Sure the investment bank gets a fee for sponsoring the IPO and arranging to sell all the shares. But it still has to get rid of all those shares, which normally it sells to its own clients. Now if it’s a big popular company like Facebook that is having the IPO, everyone wants shares, and all the investment banks compete for the prestige of taking part in the IPO. That gives the company having the IPO a lot of negotiating power.
However, if it’s a little company that no one has ever heard of that is having the IPO, how is the investment bank going get rid of all the shares? The answer is to convince the little company to sell its shares as cheaply as possible. Well below what they are worth. What matters to the investment bank is how its own clients who get the shares will do, not how the company who is having the IPO will do. And not only the investment bank’s clients! It will take some of the shares itself, for its own book, if the price is low enough.
The IPO company is a one-time customer. The favorite clients are there forever (hopefully) and the investment bank wants to keep them happy so that they will take IPO stock in the future too. That insures that they, the investment bank, can keep getting those IPO fees, etc. In addition, if the favored customers can make instant money on the IPO, that gives them a good reason to keep their banking and investing relationships at the investment bank.
So that’s why you’ll hear of stocks going up 30%, 40% or more on the day of the IPO. The underwriter (think Goldman Sachs, Morgan Stanley, etc.), succeeded in getting a great deal for its clients by pricing the stock very low. Remember that the underwriter’s customers don’t know anything about the company. They just know they are getting a stock cheap and that they will be able to sell it at a profit almost immediately. Pretty good deal for them, isn’t it?
Sometimes the underwriter is able to sweeten it further and package a couple of shares with a warrant to buy at some price in the future. (That seems to be what happened with PN, but Alert! I don’t know for sure, I’m just writing this as a generic explanation, I didn’t go back and try to figure for sure where those particular warrants came from.) That makes it an even better deal for the underwriter’s clients.
Usually, it’s a warrant to buy at an average price over a period of time, but for PN, they managed to slip in a clause saying the “lowest” price instead of the average price. But since the IPO was at $13.50 and went up from there, the company probably felt “How low could the price be a year from now? $12? $14? $16?” Well they found out how a thinly traded company can have its stock manipulated down for a short time. It got to $3.65! It only had to close that low for a day, you remember, (as I understand it, anyway).
Here’s a post I wrote a couple of years ago on this board about a company having a secondary (slightly edited, I removed the name of the company to make it more generic).
Here’s what’s going on: They are offering 6.0 million shares, 4.5 million by the company and 1.5 million by stockholders. With a standard over allotment of 15% or 900,000 shares. The extra 900,000 shares will ALL come from stockholders, and will be non-dilutive. The Company expects to receive net proceeds of approximately $16,430,000 after deducting underwriting discounts and commissions.
Why are they selling it so cheap? - They are a tiny company and they are getting ripped off by the underwriters of the sale. They have no pull so the underwriters can force them to sell cheap if they want to raise cash.
Why are the insiders selling some of their stock? - Because they own almost all of it, and want to diversify, or buy a house, or send their kids to college, or buy a Tesla.
Why do the underwriters force them to sell cheap? - First so they can buy a part of the shares cheap for themselves. Second so they can give their own favorite clients a bargain, and keep them happy.
Why is the price down today, the day before the secondary? - The underwriters’ clients, who are promised cheap shares, don’t know beans about the company and don’t care. Joe Blow, who is promised 20,000 shares tomorrow at $4.00, sees a price of $4.60, or $4.50, or whatever, and sells his 20,000 shares short at that price, knowing that he’ll cover his short tomorrow with the shares he gets at $4.00. So he makes a fast profit of 50 or 60 cents in one day. Probably EVERY ONE of the underwriters’ clients is doing that, which is why the volume is so high.
Why then, doesn’t the price go right down to $4.01 or $4.02, with all these guys selling their shares short? I see that it’s at $4.25. - Because lots of intelligent investors like you and me, seeing what’s going on, and knowing that $4.25 is a bargain price and that in a week or less the price should be way back up, are buying at $4.25.
I hope that this was useful.
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