High-Profit IPO Strategies E-Book

Tom Taulli

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Bloomberg Professional
• Sprache: Englisch
• Veröffentlichungsjahr: 2012

Seitenzahl: 425

Beschreibung

A detailed guide to the new era of IPO investing Typically generating a great deal of interest, excitement, and volatility, initial public offerings (IPOs) offer investors and traders with opportunities for both short-term and long-term profits. In the Third Edition of High-Profit IPO Strategies, IPO expert Tom Taulli explains all facets of IPO investing and trading, with a particular emphasis on the industries that are fueling the next generation of IPOs, from social networking and cloud computing to mobile technology. In the past year alone, many of these types of IPOs have provided enormous opportunities for nimble traders as prices have fluctuated widely for several months following the offering. This new edition reflects the new IPO environment and presents you with the insights needed to excel in such a dynamic arena. * Discusses more sophisticated IPO trading strategies, explores the intricacies of the IPO process, and examines the importance of focused financial statement analysis * Contains new chapters on secondary IPO markets, reverse mergers, and master limited partnerships * Provides in-depth analysis of other major industries generating worthwhile IPOs * Covers IPO investing from basic terms to advanced investing techniques Comprehensive in scope, the Third Edition of High-Profit IPO Strategies offers investors and traders with actionable information to profit in this lucrative sector of the financial market.

Leseprobe

Contents

Foreword

Introduction

Part I: IPO Fundamentals

Chapter 1: Getting IPO Shares

Risk

The Calendar

Online Brokers

Build Relationships with the Syndicate Firms

Dutch Auction

Buy on Secondary Markets

Private Placements

IPO Mutual Funds

Directed Share Program

Follow-On Offerings

Direct Public Offerings

IPOs to Avoid

Conclusion

Chapter 2: IPO Basics

Why Do Companies Go Public?

Reasons Not to Go Public

JOBS Act

Cast of Characters

Conclusion

References

Chapter 3: IPO Process

Laws That Impact IPOs

Steps of the IPO Process

Conclusion

Part II: IPOs for Investors

Chapter 4: Finding the Best IPO Information

Information to Get Your Feet Wet

In-Depth IPO Information

Other IPO Information Resources

Conclusion

Chapter 5: Making Sense of the Prospectus

Getting a Copy of the Prospectus

Main Sections

Front Matter

Graphic Material

Qualification Requirements

Prospectus Summary

Risk Factors

Letter from Our Founder

Market Data and User Metrics

Use of Proceeds

Dividend Policy

Capitalization

Dilution

Selected Consolidated Financial Data

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Business

Management

Executive Compensation

Certain Relationships and Related-Person Transactions

Principal and Selling Stockholders

Description of Capital Stock

Shares Eligible for Future Sale

Index to Consolidated Financial Statements

Miscellaneous Sections

Conclusion

Chapter 6: Balance Sheet

Some Fundamentals

Balance Sheet Overview

The Assets

The Liabilities

Conclusion

Chapter 7: Income Statement

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Conclusion

Chapter 8: Statement of Cash Flows

Background

Focus on Operating Cash Flows

Free Cash Flow

Stock Options

Factoring

Footnotes

Fraud and Misrepresentation

Conclusion

Chapter 9: Risk Factors

Inexperienced Management Team

Need for More Financing

Legal Proceedings

Market and Customer Base

Going Concern

Competition

Dual-Share Structure

CEO Dependence

Reliance on the Government

Unproven Business Model

Limited History of Profitable Operations

Small Market Potential

Cyclical Businesses

Conclusion

Chapter 10: IPO Investment Strategies

Neighborhood Investing

Invest in What You Know

Study Mutual Fund Holdings

Strong Backers

Analyst Coverage

IPO Rules of Thumb

Buy on the Opening or Wait for the Lockup to Expire?

Buying on Margin

Options

Conclusion

Chapter 11: Short Selling IPOs

How Short Selling Works

Risks of Short Selling

Taxes

Finding IPOs to Short

Conclusion

Part III: IPO Sectors

Chapter 12: Tech IPOs

The Cloud

Social Networking

Mobile

Marketplaces

Security

Big Data

Evaluating a Tech IPO

Conclusion

Reference

Chapter 13: Biotech IPOs

FDA Approval

Analyzing Biotech IPOs

Conclusion

References

Chapter 14: Finance Sector IPOs

Banking

Asset Managers

Private Equity Firms

Online Brokerages

Insurance

Specialized Online Financial Services

Conclusion

References

Chapter 15: Retail Sector IPOs

Brand

Disruptive Threats

Major Consumer Changes

Timing

Check Out the Store

Financial Metrics

Narrow Base

Conclusion

References

Chapter 16: Foreign IPOs

Advantages of Foreign IPOs

Risks

IPO Process for Foreign Deals

American Depositary Receipts

Direct Investments in Foreign IPOs

Conclusion

Chapter 17: Energy IPOs

Crude Oil

Natural Gas

Coal

Alternative Energy

Types of Energy Companies

Evaluating an Energy Company IPO

Master Limited Partnerships

Conclusion

Chapter 18: REIT IPOs

Trends in the Real Estate Market

Basics of REITs

Conclusion

Part IV: Other IPO Investments

Chapter 19: IPO Funds

Types of Funds

Mutual Funds

Exchange-Traded Funds

Closed-End Funds

Hedge Funds

Fund Strategies

Conclusion

References

Chapter 20: Spin-Offs

The Basics

Investing in Spin-Offs

Conclusion

References

Chapter 21: Fad IPOs

Spotting the Fads

Knowing When to Get Out of Fad IPOs

Conclusion

References

Chapter 22: Secondary Markets, Angel Investing, and Crowd Funding

Pre-IPO Funding Process

Accredited Investor

How to Become an Angel Investor

Angel Deal Structures

Strategies for Angel Investing

Due Diligence and the Term Sheet

Secondary Markets

Crowd Funding

Conclusion

Chapter 23: The 100x IPO

The Amazon.com IPO

Conclusion

Conclusion

Appendix A: The Underwriting Process

Appendix B: Analyzing the Financial Statement Items

Glossary

About the Author

Index

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Copyright © 2013 by Tom Taulli. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

The second edition of Investing in IPOs Version 2.0 was published by Bloomberg Press in 2001.

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Library of Congress Cataloging-in-Publication Data:

Taulli, Tom, 1968-

High-profit IPO strategies : finding breakout IPOs for investors and traders / Tom Taulli. — 3rd ed.

p. cm. — (Bloomberg financial series)

Rev. ed. of: Investing in IPOs. c2001.

Includes bibliographical references and index.

ISBN 978-1-118-35840-5 (cloth); ISBN 978-1-118-42033-1 (ebk); ISBN 978-1-118-43418-5 (ebk); ISBN 978-1-118-41697-6 (ebk)

1. Going public (Securities). 2. Investments. I. Taulli, Tom, 1968- Investing in IPOs. II. Title.

HG4028.S7T38 2013

332.63'2042—dc23

2012030210

Foreword

Most any small private company that has a vision to become a major influencer in its industry also has a vision to go public. The seeds of an initial public offering (IPO) are often sown as the company starts up, providing a framework that guides business evolution over the ensuing years. That was certainly the case with NetSuite when we launched in 1998, at the height of the Silicon Valley dot-com boom, with the vision of delivering a business management application over the Internet. An IPO was in our DNA from the start.

I met Tom Taulli as we enjoyed an Oakland Athletics baseball game shortly before we went public. At that game, which I’m sure the A’s won (full disclosure: A’s General Manager Billy Beane is on NetSuite’s board), Tom told me about his forthcoming book to demystify the IPO process for individual investors. This Foreword, which I was honored to be asked to contribute, appears in the third edition of that groundbreaking book. Having read it, I would say it is not only incredibly useful to the individual investor, it is also a must-read for those CEOs facing their first trial in the public markets.

In 2007 when we decided the time was right to go public, we viewed the IPO as a way to satisfy three main objectives: as a marketing strategy to raise our profile and credibility among customers, prospects, and industry influencers; as a validation for our employees that their hard work was paying off; and as a way to raise capital to fuel further growth. Our IPO in December 2007 was remarkably successful. We’d set an offering price of $13 to $16 per share, but market demand drove the price to more than $26—a figure that was the largest jump in initial-to-final pricing since the Google IPO a few years earlier.

Some of our IPO ideas were considered trendsetting in 2007 but have since become far more prevalent (and of course, this book does a great job of explaining the ins and outs of these various choices). For instance, we conducted a true Dutch auction rather than a traditional IPO sale, and we believe that approach raised more cash for the company than a more common approach to the IPO would have. We raised $175.9 million, and though we didn’t realize it at the time, that capital would prove useful when the financial crisis of 2008–09 unfolded. It was a key factor in our ability to grow the business during the global slowdown, even as companies in technology and other industries shrank or folded.

We also sold a very small percentage of the company—just 10 percent, far less than the norm at the time—to raise adequate capital while not diluting the company. And we decided to list on the NYSE rather than on the NASDAQ. We were one of the few technology start-ups listed on the NYSE at the time, and since then, we have been joined by many others, including LinkedIn and SolarWinds. In the final analysis, the goals we had for our IPO to enhance our customer success, employee pride, and cash on the balance sheet were met with flying colors.

Successfully executing an IPO—and meeting the demands for transparency and compliance that attend a public company—is a rite of passage that leverages the management skill and processes developed during the private years. The IPO is a major milestone for a successful company that fosters even greater discipline, focus, and leadership, and ultimately strengthens our great engine of capitalism. Conversely, history has shown that ill-prepared companies can stumble and fail at the IPO and in the harsh light of public scrutiny. Helping investors understand the risk and rewards of an IPO and apply their own due diligence is what this third edition of Tom Taulli’s High-Profit IPO Strategies is all about.

Zach Nelson, CEO

NetSuite Inc. (NYSE: N)

Introduction

I’ve been involved in the initial public offering (IPO) market since the mid-1990s, which was certainly a great time to get involved. Netscape sparked the Internet revolution with its massive IPO on August 19, 1995. On its first day of trading, the stock soared from $14 to $57 and then ended the day at $58.25. The company sported a market value of $2.9 billion even though revenues were meager.

During this time, I got Internet fever and co-founded a company called WebIPO. It was an early player in the industry to allocate IPO shares to retail investors. All in all, it was a tremendous experience, but I also realized how difficult it was to break through the walls of Wall Street.

Of course, the IPO market today is much different from IPOs during the dot-com boom. It’s rare to see an IPO double or triple on the first day of trading. In fact, the volume of deals is much lower today. Whereas the late 1990s may have had 500 to 600 a year, the number is now about 100 to 150.

But this is not necessarily a bad thing. The fact is that the IPO market provides a vetting process. That is, it makes it tough for a flaky company to hit the markets. Don’t expect to see crazy deals like Pets.com.

The IPO market remains a great place to find tremendous investment opportunities. Even though the past decade has seen two recessions and a horrible financial crisis, there have been standout public offerings, such as Google and Salesforce.com.

Many of the top deals were not necessarily tech companies, either. Just look at the successful IPOs from Chipotle Mexican Grill and Buffalo Wild Wings.

The good news is that the IPO market will continue to be the place to catch companies that are trailblazing the next big thing. Without a doubt, the tech sector already has promising megatrends like cloud computing, mobile, social networking, and big data.

But we’ll also see much progress in other categories like biotechnology, new forms of energy, and transportation. There may even be advances in space exploration. Consider that SpaceX launched a rocket that docked with the International Space Station in May 2012. The company’s ultimate goal is to reduce the costs of space exploration by a factor of 10. Oh, and the company has plans to go public.

Now, as of this writing, there is still a lot of skepticism. The U.S. economy is sluggish and unemployment is too high. Europe is having severe troubles, and even China is experiencing a slowdown.

Yet such things will not blunt innovation. After all, Bill Gates started Microsoft in the mid-1970s, when the U.S. economy was mired in a terrible recession. It didn’t matter much to him.

So in my book, I want to help make your IPO investing a success and catch the next big waves of innovation. To this end, there are four main parts. Part One covers the fundamentals, such as the IPO process and how to obtain shares. Next, we do a deep dive into strategies and research. This includes covering online resources like EDGAR and RetailRoadshow. We also look at how to interpret the S-1 document—spotting the risk factors and analyzing the financial statements.

There’s even coverage of short selling. Unfortunately, there are still many lackluster IPOs, but you can short them to make a tidy profit.

Part Three covers the many sectors of the IPO market. These include technology, biotech, financial services, retailers, energy operators, and real estate investment trusts (REITs). We also look at how to invest in foreign companies. Let’s face it—there are many growth opportunities in global markets.

The final part of the book looks at specialized transactions, such as spin-offs. There is also coverage of the emerging area of secondary markets. Essentially, these allow you to buy shares in pre-IPO companies.

Throughout the book, I cover a variety of short-term investment strategies. While they can be good for decent gains, I think these can miss the big picture, though. Getting the big gainers often means holding on to a stock for several years. Just imagine if you had sold Amazon.com or Microsoft in the early days. If so, you would have missed out on massive profits.

It’s true that IPOs are unpredictable. But then again, buying the no-brainer blue-chip stocks can be risky, too. Just look at what happened to companies like Eastman Kodak and Lehman Brothers.

As with any effective investment strategy, the way to deal with risk is to diversify. You might, for example (depending on your risk profile), invest 5 percent of your net worth in IPOs. You can then allocate the rest of your funds to other asset classes, such as stocks, bonds, and perhaps a little bit of gold.

In fact, chances are that you have already participated in the IPO market and don’t realize it. How is this possible? The reason is that mutual funds are the biggest purchasers of IPOs.

But again, if you want to get the big gains, you’ll need to do some research and buy the stocks. And in this book, I give you all the information you need to get going.

So let’s get started.

Part I

IPO Fundamentals

Chapter 1

Getting IPO Shares

The most common question I get from investors is: How do I get shares in a hot initial public offering (IPO)? After all, many IPOs have strong gains on the first day of trading. During the dot-com boom of the late 1990s, there were many that more than doubled. The environment got so crazy that Barbra Streisand offered free concert tickets to get allocations of hot IPOs.

But even as things have calmed down, there are still IPOs that surge. And yes, they get lots of headlines.

Unfortunately, it is extremely difficult to get shares at the offering price. Instead, often individual investors have no choice but to buy the stock once it starts trading, which can be risky. If anything, it is usually a good idea to wait a few days until the trading activity subsides.

For the most part, the investors who get IPO shares at the offering price are large players—like wealthy investors, endowments, mutual funds, and hedge funds. They have the ability to buy large chunks of stock. Plus, these investors may be more willing to do heavy trading with other investments. In a way, IPOs are a nice reward for top clients.

Seems unfair? Perhaps so. But it is legal, and the Securities and Exchange Commission (SEC) actually encourages it. This is from the agency’s website at www.sec.gov:

By its nature, investing in an IPO is a risky and speculative investment. Brokerage firms must consider if the IPO is appropriate for you in light of your income and net worth, investment objectives, other securities holdings, risk tolerance, and other factors. A firm may not sell to you IPO shares unless it has determined the investment is suitable for you.

Interestingly, though, even some large investors fail to get allocations of hot deals. The process can be hit-or-miss. In fact, it is often the case that a big investor will get only a portion of the shares requested. This is actually a way for the underwriters to create a sense of scarcity. After all, if you got all the shares you wanted, might this indicate there is not much demand for the IPO?

Despite all this, there are still ways to get in on the action. Let’s take a look.

Risk

Even if you can get shares in an IPO, this is no guarantee of getting profits. These types of deals are always risky. For example, on August 11, 2005, Refco went public, with the stock increasing 25 percent on its first day of trading. The company was a top broker for futures and options. It also had top-notch private equity investors, such as Thomas H. Lee Partners.

Unfortunately, Refco’s CEO, Phillip R. Bennett, had been cooking the books for at least 10 years and failed to disclose as much as $430 million in debt. By October 17, the company was bankrupt and the stock was worthless.

True, this is an extreme case. But it does happen, although a more common event is a broken IPO. This is when the stock price falls on the first day of trading. This is often a bad sign and may mean further losses down the road as institutional investors try to bail out.

Yet there is still a lot of opportunity when getting shares in an IPO. So in the rest of the chapter, we’ll look at some key strategies.

The Calendar

Before investing in IPOs, you need to track the calendar. This is a list of the upcoming IPOs. A good source is Renaissance Capital’s IPO Home at www.renaissancecapital.com, shown in Figure 1.1. It will show the upcoming IPOs for the next month or so. This gives you time to check out who the underwriters are so as to perhaps get an allocation of shares, as well as to do research on the companies.

FIGURE 1.1 Renaissance Capital IPO Calendar

Source: Renaissance Capital, Greenwich, CT (www.renaissancecapital.com)

As you follow the calendar, you’ll notice some things. First, there is seasonality to the IPO market. Generally there are no more IPOs during mid-December, and the market does not get started again until mid-January. The IPO market is also closed in August and does not get going again until mid-September.

Moreover, there will usually be five to 10 deals in a normal week. But when there is lots of instability in the market, there may be none. Keep in mind that during the fourth quarter of 2008—when the world was ensnared in the financial crisis—there was only one IPO.

Some deals may be postponed. And yes, this is not a good sign. A company will usually blame “adverse market conditions,” but the real reason is probably that investors are not interested in the deal. In many cases, a postponement will turn into a withdrawal of an offering.

Online Brokers

In the IPO market, there has been resistance to the changes in technology, and there are still many elements of the old boy network. However, the Internet has certainly made a huge impact.

A key was the emergence of Wit Capital.

In 1995, a beer company called Spring Street Brewery, a microbrewery that sells Belgian wheat beers, needed to raise money. Unfortunately, the company was too small to interest a Wall Street underwriter, and venture capitalists wanted to take too much control of the company.

So the founder of the company, Andrew Klein, decided to sell shares of the company directly to investors. One option was to sell directly to his growing base of customers—by putting a notice of the offering on the beer bottles.

Because Klein had considerable experience in finance (he was once a securities attorney at one of the most prestigious Wall Street firms, Cravath, Swaine & Moore), he decided to take another, more sophisticated, route. He organized the prospectus, made the necessary federal and blue-sky filings, and prepared to sell the offering over the Internet. He posted the prospectus online, and Spring Street raised $1.6 million from 3,500 investors. Overnight he became a celebrity, as the Wall Street Journal, the New York Times, CNBC, and many other media covered the pioneering IPO.

However, Klein did not stop with the Spring Street Brewery IPO. He recognized the need for a mechanism to buy and sell stock on the open market for companies such as Spring Street that are not on a regular stock exchange. So he created a trading system where buyers and sellers could make their transactions commission free.

The SEC stepped in and suspended trading, but to the surprise of many, within a few weeks, the SEC turned around and gave conditional approval of the online trading system. From there, Klein decided to build an online investment bank, called Wit Capital. It would be a place where individual investors had access to IPOs at the offering price and to venture capital investments. Before that, such services had been provided mostly to high-net-worth individuals and institutional investors.

But of course, a big driver for Wit Capital—as well as other IPO digital brokers—was the dot-com boom. Investors had a huge appetite for new issues, and the market exploded.

Yet after the market fell apart, so did many of the online brokerages. As a result, the main players in digital IPOs are the larger players, such as Fidelity, E*Trade, and Charles Schwab.

So it is worth checking out these firms and seeing what deals are available. But they all have eligibility requirements; take Fidelity (see Figure 1.2).

FIGURE 1.2Fidelity.com IPOs

A customer must have a minimum of $100,000 in assets with the firm, or must have placed 36 or more stock, fixed-income, or option trades during the past 12 months. Also, there must be at least $2,000 in cash in the account.

Then there is the following process:

Alerts

. This is an e-mail system that will indicate when an IPO is available. There will also be e-mails for when offers are due, the effectiveness of the offering, the pricing, and the share allocation.

Q&A

. A customer must answer a variety of questions (which are based on securities regulations). Essentially, these are meant to flag a so-called restricted person, a customer who has some type of connection to the financial services industry that may forbid him or her from participating in the IPO.

Review the preliminary prospectus

. This is done by downloading the document.

Enter an indication of interest

. This is the maximum number of shares to buy in the offering. You will not be able to indicate a price since it has yet to be determined. Instead, the deal will have a price range, such as $12 to $14.

Keep in mind that you may not get the amount of shares requested—or any shares. The offer is not binding.

Effectiveness

. On the day the deal is declared effective, you will get an e-mail to confirm your indication of interest. You can also withdraw the offer before the transaction is priced, which usually happens within 24 hours.

Allocation

. You will receive an e-mail showing the number of shares you have purchased. In the case of Fidelity, the allocation is based on a propriety system that evaluates a customer’s relationship, such as the level of trading and other activities with the firm. According to the website at

www.fidelity.com

:

The allocation methodology is done as fairly and equitably as possible. The size of a customer’s indication of interest is not considered during allocation other than the fact that we will not allocate more than the customer requested. Therefore, you should only enter an indication of interest for the amount of shares you are interested in purchasing as entering a larger number will not help you receive additional shares and there is always the possibility that you could be allocated everything you ask for.

Check your account

. Make sure you received the allocation. Mistakes do happen.

There will also be a link to the final prospectus.

Trading

. You can sell the shares at any time. But again, you may be penalized for flipping them. According to Fidelity:

If customers sell within the first 15 calendar days from the start of trading in the secondary market, it will affect their ability to participate in new issue equity public offerings through Fidelity for a defined period of time.

Build Relationships with the Syndicate Firms

A company will usually have two or more underwriters. They manage the offering. But they also form a syndicate of many other brokerage firms to sell the deal. You’ll find these firms in the prospectus. Interestingly, you will often see many boutique operators.

So a good idea is to contact them and learn about these firms. How do they allocate IPOs? Do they like to have a certain level of assets in your account? By building a relationship, you are likely to get allocations in IPOs. You may also get some deals for secondary offerings.

Dutch Auction

More and more, auctions are becoming a popular way for people and companies to do business on the web. It was the Nobel Prize–winning economist William Vickrey who developed the ingenious auction system. It’s the same system that the U.S. Treasury uses to auction Treasury bills, notes, and bonds. Why not use it for IPOs?

Actually, a firm called WR Hambrecht + Co does have an auction system set up for IPOs. It is called, appropriately enough, OpenIPO. The founder of the firm is William R. Hambrecht, who is also the founder of the traditional investment bank Hambrecht & Quist. He started the firm because he wanted to “balance the interests of companies and investors.” OpenIPO allocates IPOs to the highest bidders. However, the auction is private, and all winning bidders get the same price. Consider that top companies such as Google, Morningstar, and NetSuite have used the system.

Here’s how it works: Suppose that XYZ wants to go public and has offered to sell one million shares. Its investment bankers have performed the necessary due diligence and have established a price range of $10 to $14. Anyone can go to OpenIPO—rich or poor, individuals or institutions—to place a bid on the shares.

Let’s say you want to bid for 1,000 shares of XYZ at a price of $14 a share. Before you can make the bid, you must first establish an online OpenIPO brokerage account for a minimum of $2,000. Keep in mind, though, that when bidding on an IPO you will need to have enough cash to cover the maximum IPO bid price. It is important also to take note of the fee schedule listed on the website. What’s more, you cannot buy IPO shares on margin, and the minimum bid is for 100 shares, although there is no maximum. You can submit multiple bids, say 2,000 shares at $13 and 1,000 shares at $11, and so on. If you have second thoughts, you can withdraw any of the bids.

Let’s say there is a lot of action for the XYZ IPO, and many bids come in (the auctions typically last between three and five weeks before an IPO is declared effective). The OpenIPO proprietary software processes these bids. It determines that at a price of $13 per share, 1.1 million shares will be purchased. This is known as the clearing price.

Since there are more shares demanded than have been offered for sale, XYZ has two choices. First, it can have the IPO at $13 per share, in which case you will get 91 percent of your bid. (This is calculated as 1.0 million divided by 1.1 million, or 0.91. As a result, you will get 910 shares, which is 91 percent of 1,000.) Or second, XYZ can decide to lower the price below the clearing price. Suppose it lowers the price to $12. At that price, there is demand for 1.3 million shares, which means a 77 percent ratio. Thus, you will get 770 shares (77 percent of 1,000).

There are certainly successful Dutch auction IPOs. Perhaps the most notable was the offering of Google, which was on August 19, 2004.

Actually, the company used a modified Dutch auction. That is, Google reserved the right to set the final price, not a computer.

So for the IPO, the company priced its shares at $85, which was at the bottom of the range of $85 to $95. But on the first day of trading, the stock closed at $100.34.

In a true Dutch auction, this first-day pop would probably not have happened since the demand would have equaled the supply of shares. But perhaps Google wanted to provide a nice return for its shareholders.

However, it would not have been smart for shareholders to take this quick profit. By October 2007, the shares would go over $700.

Despite the success, Dutch auction IPOs are fairly rare. The reason is likely that Wall Street investment banks prefer the traditional approach, which gives them more power over the process and often results in higher fees.

Buy on Secondary Markets

Secondary markets in IPOs have seen tremendous growth over the past few years. Two of the top operators are SharesPost and SecondMarket.

These firms have platforms that allow investors to purchase pre-IPO shares. This is done by purchasing stock from employees and venture capitalists. No doubt the hottest trading to date was in the shares of Facebook.

But there are some drawbacks. First, the fees can be high and it can easily take several months to pull off a transaction. Besides, the companies may never go public, making it difficult to get a return on the investment. In Chapter 22 we’ll go into much more detail on secondary markets.

Private Placements

A secondary market involves buying shares from existing shareholders. In a private placement, you buy shares directly from the company. For the most part, the buyers tend to be venture capitalists and private equity investors.

But this is starting to change. Over the past few years, there have emerged some marketplaces for private placements. One is actually SharesPost.

In late 2011, the firm helped with the private placement of TrueCar, an online service to buy cars. The company raised $200 million in debt and equity.

In the process, investors received a document called a private placement memorandum (PPM). It is like an IPO prospectus but is usually not as in-depth. In the case of TrueCar, there was an online video of a presentation from the CEO.

A private placement will also usually involve one or more investment bankers. They will perform due diligence as well as put together the investor materials.

But to participate in private placements, an investor must be accredited. This means he or she must have made over $200,000 for the past two years (or more than $300,000 for married couples).

Even if you meet the criteria, you still may not get shares in a private placement. Keep in mind that the company will often want certain types of investors in its company—that is, those who have demonstrated a long-term focus.

IPO Mutual Funds

There are a variety of mutual funds, closed-end funds, and exchange-traded funds (ETFs) that focus on IPOs. Examples include the Global IPO Fund, Direxion Long/Short Global IPO Fund, First Trust U.S. IPO Index Fund, and GSV Capital Corp.

Because of their scale, they can get shares at the offering price. In fact, some even purchase shares in the secondary market. For example, GSV Capital has invested in pre-IPO shares of companies like Groupon, Twitter, and Facebook.

These funds also have the advantage of professional management. In Chapter 19, we’ll take a closer look at IPO funds.

Directed Share Program

A directed share program (DSP) is when a company sets aside a certain number of shares for friends and family. These usually account for about 5 percent of the offering. So yes, if you know someone at a company that’s going public, it’s worth asking if there are shares available. A DSP must be disclosed in an IPO prospectus.

In many cases, DSP shares are not subject to the lockup (this forbids an investor from selling shares for a period of time, which is usually a six-month period after the offering). But companies are starting to change this.

In some situations, a company may have a DSP for employees, customers, and suppliers. This was the case for the General Motors IPO. Actually, with the Dunkin’ Donuts offering, the company had a DSP for its franchisees.

But this type of program is not without its risks. For example, when Vonage had its IPO in 2006, it set up a DSP for customers to purchase at the offering price of $17.

Unfortunately, the stock price plunged, hitting $6 within a couple of months. As a result, many of the DSP investors failed to pay for the shares!

Follow-On Offerings

After a company has an IPO, it may have other offerings of stock. These are known as follow-on offerings, but many investors also call them “secondaries.”

A follow-on offering is similar to the process of an IPO in many ways, such as with disclosures. In other words, there will be a new prospectus filing, and management will have a road show.

It is fairly common for a company to have a follow-on offering within six months to a year after the IPO. In many cases, it is a way for executives, venture capitalists, and private equity firms to sell off shares. It tends to be better to have a follow-on offering than for them to start dumping stock. Interestingly, though, a follow-on offering may require these holders to extend the lockup on the rest of their shares.

To generate demand in a follow-on offering, a company will price the shares below the market price—say by a few percentage points. Thus, buying follow-on shares can mean a nice short-term profit. But like getting an IPO, you need to establish a relationship with an underwriter. Or you might want to check out some top online brokers. Consider that Fidelity provides access to follow-on offerings.

Direct Public Offerings

A company using a direct public offering (DPO) does not use an underwriter. Instead, the company offers stock directly to the public. In many cases, these investors are customers or friends of the company. The company, in a sense, is leveraging its goodwill to do an IPO and avoiding the costs of hiring an underwriter.

Small companies seeking less than $5 million in capital usually pursue DPOs. Often, companies going the DPO route have had trouble getting financing from venture capitalists or underwriters.

Until 1995, DPOs were quite rare. In most cases, when a company did a DPO it sold its stock only to its established customers, known as an affinity group. Perhaps the best-known DPO was Ben & Jerry’s selling its IPO stock at its ice cream stores. The offering was announced on the bowls of ice cream.

But not all companies have such loyal affinity groups. As a result, DPOs were scarce. Then the Internet arrived and offered companies a huge, cost-effective distribution channel to sell stock directly to investors.

The simplicity and low costs of putting up a web page make it enticing for companies to engage in securities fraud. And yes, there have already been numerous cases of DPO fraud.

One such case involved Interactive Products and Services, of Santa Cruz, California. The company raised $190,000 over the Internet from 150 investors. Unfortunately for those investors, the company was a complete sham, and the investors lost everything. Netcaller, the company’s only product, was a figment of the founder’s imagination, based on a rejected patent application. Interactive Products made false statements in its web prospectus, and the founder spent the money it raised on personal items such as clothing, stereo equipment, and groceries.

Interactive Products’ Netcaller was described in its prospectus as a “hand-held cordless Internet appliance which enables the user to browse the World Wide Web, send and receive e-mail messages, have real-time communication through the Internet, and two-way voice communications using Internet telephone software.”

Interactive Products actually placed extensive web banner ads, many of which stated: “The next Microsoft is offering its stock to the public over the Internet.” When you hear such inflated claims for a product that is seemingly too good to be true, stay far away.

There are other concerns with DPOs, including lack of liquidity. There is usually no market for buying and selling shares in a DPO. One company, Real Goods Trading, did a DPO and allowed its investors to trade their Real Goods stock from its website. In such cases, the transaction is then cleared through an escrow agent. But even this approach does not guarantee a good price for your stock. According to the Real Goods website, there was very little trading activity.

To get more liquidity, a DPO will often try to list on a national exchange like the New York Stock Exchange or NASDAQ. No doubt this will create much more liquidity and exposure for the stock.

In some cases, it has happened. But as an investor, it is not a good idea to count on it. DPO companies tend to be niche operators that do not have the growth ramp required for a national listing.

Another chief concern with DPOs is the absence of an underwriter to chaperone the deal. This means that vital tasks such as due diligence, research, and deal structuring, which ordinarily fall to underwriters, are left largely unmonitored and without expert assistance.

IPOs to Avoid

Sometimes you will get offers for IPOs that may seem too good to be true. It’s probably best to avoid these.

Here’s a look:

Spam

. It has become a huge business, primarily because it is so easy and cost-effective to send simultaneous messages to millions of people. Some look very personalized, and others look as if they were sent to you accidentally. But keep in mind that spam is never accidental. It’s a marketing tool, not objective information. Some spam will offer you the “opportunity” to buy into IPOs or investments. It’s a good idea to stay away. It is common to see these kinds of messages, like “Get the next Facebook.” Unfortunately, they are scams. Keep in mind that a Wall Street firm would never use spam to sell a deal. It would be illegal.

Unsolicited mail

. If you sign up for magazines or online journals, you are likely to be put on a variety of mailing lists. In order to promote their IPOs, small companies will purchase these lists and send out very professional-looking, glossy marketing materials. In most cases, a company has hired a public relations (PR) firm that knows how to hide the negatives and hype the positives. These may actually be pump-and-dump offerings—when a company’s officers issue large amounts of stock to brokers, creating the illusion that the stock has done a successful offering as the price soars. The brokers, in turn, will dump the stock on clients.

Cold calls

. Cold calls are a key part of the brokerage business. It’s called “dialing for dollars.” These brokers are playing a numbers game. The more calls they make, the more people they reach who may put their money into the supposedly hot investments they are selling. Cold calling is by far the most cost-effective means of marketing. To be successful, there needs to be only a 1 to 2 percent closure rate.

In most instances, you simply don’t want to buy what cold callers are selling. Remember this: If it were such a hot investment, they wouldn’t be selling it unsolicited over the telephone.

But cold callers can be very convincing. They spend hours every day making the same calls, using the same script. If you want to reduce the number of calls you receive, ask the broker to put you on the Do Not Call list, or write a letter to the compliance officer of the firm.

Crowd funding

. In 2012, the U.S. government passed legislation that made crowd funding legal. Essentially, this allows small companies to issue shares using the Internet. But keep in mind that these investments will likely not reach the IPO market for many years, if ever. In Chapter 22, we’ll take a closer look at crowd funding.

Conclusion

While it may seem tempting to get IPO shares for the opening day, it can be risky. Even Facebook fell over 20 percent within a few days of its offering. A better approach—at least for long-term investors—is to wait a quarter or two before jumping in. The hype will subside and the stock will get seasoned in the market.

Chapter 2

IPO Basics

It’s a common misconception that initial public offerings (IPOs) are a guaranteed road to riches. Although there are many IPOs that do extremely well—like Google, NetSuite, Salesforce.com, Starbucks, and Chipotle—the fact is that IPOs are like any other investment: there is always risk. Before considering IPO investment strategies, it’s important for investors to understand what IPOs are and how they work.

Anyone reading this book probably knows that an initial public offering is the first sale of stock by a company to the public. It’s when a company makes the transformation from being privately held to becoming publicly traded, complete with its own ticker symbol. However, there’s probably a lot of other, more advanced IPO terminology that most people don’t know. For example: What does it mean when an IPO goes “effective”? What is the registration statement? What is the “red herring”? What exactly do the underwriters do? These questions—plus a great deal more about investing in IPOs—are covered in this book.

This chapter takes a look at what motivates a company to launch an initial public offering as well as a look at the drawbacks. We will also meet the major players in the IPO process.

Why Do Companies Go Public?

There is no single answer to that question. It’s a major decision that will surely change the character of a company and mean many sleepless nights for management. What’s more, an IPO is very expensive. The company will need to hire attorneys, accountants, printers, and many other advisers described later in this chapter.

But first, let’s look at the main reasons a company might decide to go public.

Prestige

An IPO is a major accomplishment. Wall Street will suddenly begin to take notice. Analysts will start following the company; so will the media. And hiring new employees will become easier, because publicly traded companies are generally perceived to be more stable than private companies.

Since a public company must meet rigorous compliance requirements as well as provide periodic financial reports, this helps to create more trust for investors, customers, and suppliers. This can certainly be an important competitive advantage, especially for those companies that focus on large customers. It’s never easy for a private company to snag a contract with a mega player like IBM or Coca-Cola.

Yet an IPO may turn into a public relations (PR) nightmare. This happened with the public offering of BATS Global Markets, the number three stock exchange operator in the United States. The company attempted its IPO on its own platform and the IPO was supposed to be a showcase of its abilities. But on the day of the transaction, the BATS computers malfunctioned and the stock price plunged to 4 cents per share. The glitch even impacted the trading in the shares of Apple, which plunged by 9 percent. BATS had no choice but to cancel all trades and withdraw its IPO. The company’s CEO wrote in an e-mail: “On Friday we were under the brightest spotlight imaginable, opening our own stock on our own exchange for the first time ever. It doesn’t get much more public than that. It shouldn’t have failed, but it did, and the timing couldn’t have been worse.”

Getting Rich

Staging an IPO is one of the best ways for company principals to get rich. An example is Mark Pincus, who founded a variety of Internet companies in Silicon Valley and was an early-stage investor in companies like Twitter and Facebook.

In 2007 he got an inspiration for a new-style online gaming company. At the time, he was having trouble beating other gamers and was certainly willing to pay money for extra help to win. Mark thought others would feel the same way. So he created Zynga, which produced hit games like FarmVille, CityVille, and Zynga Poker. He also was smart to focus on developing these titles on the fast-growing Facebook platform.

By 2011, the company had generated $1.1 billion in revenues and had 240 million average monthly active users across 175 countries. Zynga went public in December of that year and raised $1 billion. But before this, Mark had already sold $109 million of his stock. This type of transaction has become a big business over the past few years with the emergence of secondary marketplaces like SharesPost.

However, it’s not just the founders who get rich; a company’s employees can, too. In the case of the Facebook IPO, it minted over 1,000 millionaires. One was David Choe, who painted murals for the company. Instead of taking cash compensation, he got stock options. They ultimately became worth over $100 million.

Cash Infusion

An IPO will typically raise a lot of cash for a company. This money does not have to be paid back. It can be used to build new facilities, fund research and development, and float the acquisition of a new or expanded business. But in some cases, all or a portion of the cash from the public offering will not go to the company. Instead, it will be used to purchase existing holdings from executives and investors.

For the most part, an IPO will raise about $100 million to $200 million. But in some cases, the amounts can be staggering. Here’s a list of the biggest IPOs in history:

Company

Date

Amount (in billions)

Visa

03/18/08

$17.8

ENEL SpA

11/01/99

$16.4

Facebook

05/18/12

$16.0

General Motors

11/17/10

$15.7

Deutsche Telekom

11/17/96

$13.0

AT&T Wireless Group

04/26/00

$10.6

Kraft Foods

06/12/01

$8.6

France Telecom

10/17/97

$7.2

Telstra

11/17/97

$5.6

Swisscom

10/04/98

$5.5

United Parcel Service

11/09/99

$5.4

Lower Cost of Capital

For the most part, the public markets offer the lowest cost of capital. A key reason is that there is a larger pool of investors. This means it is easier to find those who are interested in the opportunity. And because there is lots of volume in the stock, the transaction costs are low.

In fact, the cost of capital can be extremely low during bull markets. Just look at the dot-com bubble of the late 1990s. During this period, companies were able to raise hundreds of millions of dollars by issuing small amounts of stock since the valuations were extremely high.

Easier to Raise More Capital

Once a company becomes public, it is usually easier to raise additional capital—in terms of either more stock issuances or debt financing. Keep in mind that since the company has a trading record, it allows investors to make quicker investment decisions. Besides, it has already been issuing ongoing financial reports.

Some companies will actually put together a so-called shelf registration. This means that there can be a sale of stock at almost any time. So if there is a bullish move in the price, a company can get additional capital at a relatively low cost.

Stock as Currency

Publicly traded stock is almost like cash. As a result, a company can use it as payment for acquisitions. This can be attractive when the stock price is at a high valuation. In a sense, this can be a way to buy a company on a cheap basis.

However, there may still be restrictions. For example, the buyer may require that the current management team stay on board for a year or more until being allowed to sell the shares. This can be an effective way to create an incentive for the managers to continue to perform on behalf of the company—and generate more value.

Liquidity for Investors

Except in rare occasions, a company that goes public will usually have institutional investors, which may include private equity funds or venture capital firms. While they tend to hold on to their investments for the long term—say five to 10 years—they will ultimately want to sell their positions. Often, an IPO will generate the highest returns.