How many times have you seen a stock go up 10, 20 or even 70
percent on its first day of trading?
Frankly, big first-day gains in IPOs are entirely routine.
Sadly, they don’t mean much for the vast majority of investors, because they
often can’t buy stock at its IPO price. Instead, they buy at the 10,
20 or 70 percent premium.
That’s a raw deal.
Who actually gets to buy a newly public stock
at its touted IPO price? And is it possible for retail investors to get in on
the action?
Here’s a look at the process, and the best
practices to be able to buy an buy an IPO at
its offer price.
Why are IPOs so
inaccessible to the little guy? Most high-profile IPOs
today raise hundreds of millions or even billions of dollars. That, after all,
is the main point of taking a company public – to raise money for the company
and allow insiders to cash out. If you want to raise $1 billion by selling 50
million shares at $20 apiece, how exactly do you do that?
You have to have underwriters – investment
banks that agree to sell a specific number of shares for you, and get you a
certain price for them as well. (And they don’t do it pro bono.)
These banks are typically allocated different
amounts of the offering. Let’s say five different underwriters get 10 million
shares apiece to sell. Most individual investors don’t have $200 million
sitting around, so these banks go around to their biggest, best, most
profitable clients and offer them the shares. This is why mutual funds, hedge
funds, pensions, endowments and other institutional investors get the first
call.
Often, the split between institutional and
retail investors is somewhere in the neighborhood of 90/10. That 10 percent
will be spread around to different retail-facing brokerages.
While the deck is stacked against them,
everyday investors still have a chance of getting in on an IPO – and a few
things they can do to increase those chances.
How to buy an IPO at its
offer price – without $200 million. First, search your
broker’s website for what requirements you need to meet and what hoops you’ll
have to jump through if you want to get in on an IPO. Rule No. 1 is know the
rules.
Second, your chances of getting in on the next
Alibaba Group Holding IPO – shares jumped 38 percent on their first day – marginally
increase with the size and prestige of your brokerage firm.
The bare-bones, do-it-yourself oriented online
brokerages might not get any allocation of shares, or may get very few to sell.
You won’t be getting in on the ground floor using Robinhood, for instance.
That means that if your aim is to buy
IPOs at their offer price, full-service brokers with larger amounts of assets under
management are your way to go.
Fidelity is one such option, and it has its
own requirements for potential IPO investors. For example, you must either have
$100,000 or $500,000 in household assets, or made at least 36 trades in the
last year, or be a Premium or Private Client Group customer.
The decision on whether to require $100,000 or
$500,000 in assets depends on the underwriter Fidelity sources the deal from,
according to Robert Beauregard, director of external communications at Fidelity
Investments.
“Fidelity strives to give customers the most
fair and equitable IPO allocation possible, based on the number of shares we
receive from the underwriter,” Beauregard says.
Just as underwriters dole out dibs on shares
to their biggest and best customers, eligible investors are evaluated “based on
their relationship with Fidelity.”
“This is informed by factors such as assets
held at Fidelity, customer tenure, frequency of trading and margin balances,”
Beauregard says.
This harkens back to the first rule of upping
your chances in buying IPOs before they skyrocket: know the rules.
They can vary from brokerage to brokerage.
Most brokerages have so-called share allotment
formulas, which help decide which clients get shares in a heavily subscribed
IPO.
Typically, they’re based on “assets, how long
you’ve been a client and trading history,” says Mike Laubinger, vice president
at Victoria Capital Management in Charleston, South Carolina.
“Often overlooked is the risk tolerance
assigned to your account,” Laubinger says. “If you selected ‘conservative or
moderate’ on your investment profile you will not be able to participate. IPOs
are considered ‘speculative or aggressive’ from a risk standpoint.”
You can easily change your preferred risk
profile through your online account.
That said, not every brokerage has the same
approach.
“We don’t focus as much on a profile. When the
indications of interest comes in, we try to work a lot with our clients to make
sure there’s a reasonableness around what they’re doing,” says Rich Messina,
senior vice president of investment product at E-Trade Financial (ETFC).
“You don’t want to discriminate from anyone
being able to participate in it. As long as you don’t have some sort of inside
ties to a company,” you can request shares, Messina says.
Exploit loopholes, weigh
supply and demand, consider derivative investments. Aside
from going with bigger brokers, knowing the particular rules and guidelines,
and adjusting your risk profile if necessary, there are still more tricks of
the trade to help your chances in IPO-world.
At Fidelity, for instance, you don’t necessarily
need $100,000 or $500,000 – or need to be rich enough to enjoy their premium
services. You could hypothetically make 36 trades in a year – and do so without
paying a penny in fees. Dozens of iShares and Fidelity ETFs, for example, are
commission-free to buy.
Another tip that increases your chances
regardless of brokerage is to focus on less-sexy issues. Obscure business types
like business development companies, master limited partnerships or real estate
investment trusts aren’t likely to garner the attention that, say, LinkedIn or
Twitter (TWTR) did on their first day.
“There are some initial public offerings that
are probably not having as much buzz, but are just as good companies to be
participating in in the future,” Messina says.
Finally, there’s an indirect way to buy IPOs
before they experience their Day One pop: derivative investments.
Sometimes, a hot new issue will debut with a
small percentage of its total shares offered to the public and the rest held by
a publicly traded parent company. For instance, when Match Group (MTCH) went
public in 2015, it sold 33 million shares to the public – but parent company
IAC/InterActive (IAC) still held an 80 percent stake in the online dating behemoth.
IPOs are high risk, high
reward. While Wall Street has advanced toward democratization over time,
the new issue market remains heavily stacked in favor of big money. While in
principle that seems wrong, it makes some sense due to the dynamics of raising
lots of money very quickly.
It’s unfortunate average Americans can’t do
everything big money managers can, but sometimes that keeps retail investors
out of trouble. IPOs are risky, after all, and often perform worse in their
first year than the broader market.
On the other hand, buying an IPO at its offer
price can be a huge advantage if you pick correctly; you need to do your
homework, read the prospectus and know the company well before deciding to try
to get in on the IPO.
But if, after homework and careful rumination, you want to take a shot at it, make sure you give yourself the best chances. Look at the rules and regulations surrounding IPOs at your brokerage. Follow the tips and tricks mentioned above. If you’re lucky and clever enough, you just might be able to operate your brokerage account like a mini hedge fund.
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