Initial Public Offering

From Financial Literacy Wiki

An initial public offering (IPO) is the first sale of a company's common shares to investors on a public stock exchange. The main purpose of an IPO is to raise capital for the corporation. While IPOs are effective at raising capital, but being listed on a stock exchange imposes heavy regulatory compliance and reporting requirements. The term only refers to the first public issuance of a company's shares. If a company later sells newly issued shares (again) to the market, it is called a 'Seasoned Equity Offering'.

When a shareholder sells shares it is called a "secondary offering" and the shareholder, not the company who originally issued the shares, retains the proceeds of the offering. In distinguis them, it is important to remember that only a company which issues shares can make a "primary offering". Secondary offerings occur on the "secondary markets", where shareholders (not the issuing company) buy and sell shares with each other.

Reasons for Listing

When a company lists its shares on a public exchange it will almost invariably look to issue additional new shares in order to raise extra capital at the same time. The money paid by investors for the newly-issued shares goes directly to the company (in contrast to a later trade of shares on the exchange, where the money passes between investors). An IPO therefore allows a company to tap a wide pool of stock market investors to provide it with large volumes of capital for future growth. The company is never required to repay the capital, but instead the new shareholders have a right to future profits distributed by the company.

The existing shareholders will see their shareholdings diluted as a proportion of the company's shares. However, they hope that the capital investment will make their shareholdings more valuable in absolute terms.

In addition, once a company is listed it will be able to issue further shares via a rights issue, thereby again providing itself with capital for expansion without incurring any debt. This regular ability to raise large amounts of capital from the general market, rather than having to seek and negotiate with individual investors, is a key incentive for many companies seeking to list.

Another reason why company makes a listing is that, in the future, when they found a suitable acquisition target, the company can use its shares as a currency to purchase the acquisition target. As we have seen in the case of Singtel purchasing Optus Australia.

Pricing

Historically, most IPOs in Singapore have been underpriced. The effect of underpricing an IPO is to generate additional interest in the stock when it first becomes publicly traded. This can lead to significant gains for investors who have been allocated shares of the IPO at the offering price. However, underpricing an IPO results in "money left on the table" - lost capital that could have been raised for the company had the stock been offered at a higher price.

The danger of overpricing is also an important consideration. If a stock is offered to the public at a higher price than what the market will pay, the underwriters may have trouble meeting their commitments to sell shares. Even if they sell all of the issued shares, if the stock falls in value on the first day of trading, it may lose its marketability and hence even more of its value. This is because stocks that are first traded receive a lot of media attention.