By Matt Dundas & Thomas Connelly
Chinese e-commerce giant Alibaba Group (NYSE: BABA) made its explosive Wall Street debut on September 19th, as shares of the firm were sold to public investors for the first time ever in an initial public offering (IPO). The company, its executives, and early investors sold a combined 13 percent stake in the firm for $21.8 billion, valuing the company at $167.7 billion. Shares were offered to IPO investors at $68 a piece and vaulted 38.1 percent higher in their first day of public trading to close at $93.89 – a dazzling one day return that would make even a payday lender blush. BABA shares’ performance is consistent with research that shows that IPO shares often clock double digit returns the first day they hit public markets. That begs the question: are IPOs a sure thing investment?
An IPO usually takes place when a privately-owned company decides to sell a piece of itself to public investors in exchange for cash to help grow the business. Company executives and other shareholders often tag along and use the IPO as an opportunity to “cash out” of a block of their own shares in the firm. The company hires (and generously compensates) investment bankers to promote shares to potential investors as being perhaps the greatest investment of all time. In the days leading up to the IPO, the bankers take orders for shares from jazzed-up investors and home in on a price per share they believe will maximize IPO proceeds without being too greedy. Just before the official IPO date, the bankers distribute stock to the IPO investors. Finally, the shares are listed on a stock exchange, begin trading, and typically spike in price as investment becomes open to everyone.
At this point, you are probably wondering why anyone would waste time fiddling around with boring old mutual funds and ETFs. Clearly IPOs are where the action is! Sadly, investment bankers do not want your money. Bankers would much rather sell large blocks of IPO shares poised for a quick pop to their institutional client cronies for the sake of efficiency, and of course, palm-greasing. Those institutional clients include brokerage companies that may choose to pass shares on to individual investors looking to get in on the IPO, but again, shares are likely to be allocated to the most lucrative clients. If an individual is able to get IPO shares, it may simply be because none of the larger players want them (hint: not a good sign… IPOs don’t always pop). Further, brokers may discourage clients who receive IPO shares from selling right after they pop to avoid putting downward pressure on the shares when they begin trading, exposing the client to more risk. And forget about waiting to buy shares until after they start trading – research shows that IPO shares typically underperform the market during their first year. The average IPO is exaggerated by a very small percentage of IPOs (less that 5 percent) that doubles during their first month. Be careful if you think you can cherry-pick from the top — you might end up with one of the roughly one third of IPOs that plunge below their initial offer price by the end of their first month.
While IPOs are fun to watch and their exclusivity oh-so-enticing, they are usually out of reach for most people and are still not necessarily a sure thing. Indeed, the sexiest investments are not always what they’re cracked up to be. Evidence actually shows that the less-sexy investments, such as shares in smaller, lesser-known companies and companies with distressed valuations, have historically been much stronger performers as a group. Beware of headline-grabbing investments promising fast money. For most investors, trying to get in on the latest IPO is yet another one of Wall Street’s siren songs.
Sources cited: Bloomberg News Alibaba Seeks to Raise Up to $21.1 Billion in U.S. IPO; Reuters Alibaba IPO prices at top of range, raising $21.8 billion; The European Financial Management Association Which, why and for how long do IPOs underperform?; The Journal of Finance The Variability of IPO Initial Returns.
This is intended for informational purposes only and represents the views and opinions of Versant, which are subject to change. Information is based on data Versant deems reliable. Neither the information, nor any opinion expressed herein constitutes investment advice or a solicitation to make an offer, to buy or sell any securities. This report is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person. Investments involve numerous risks including, among others, market risk, and are subject to loss of principal. Past performance is not indicative of future results.
