An initial public offering (IPO) of a company's stock on an organized stock exchange often raises substantial cash for the firm that issues and sells the shares. The money raised is used for a variety of purposes including acquisitions, paying down debt, expansion, capital improvements, and for declaring dividends to shareholders, owners, partners and senior management, as well as for future use as incentive bonuses.
TUTORIAL: IPO Basics
Many legendary IPOs have produced billions in cash returns for the issuing company. However, for every high profile winner, there's another firm whose IPO was a flop, with some shares eventually even falling below the issue price.
From an investor's perspective, if the shares were not sold at a profit, near the market price top, then the IPO, while it may have been profitable for the issuing firm, might be a loser from the investor's point of view.
The average small investor seldom gets an opportunity to buy into an IPO offering from a major firm. Brokerage and financial firms which sell IPO shares typically reserve those shares for their biggest customers. Smaller investors can buy the shares after they come on the market, but not generally at the issue price, which is usually lower than the post IPO price.
Let's take a look at three high profile IPOs to see how they fared in the difficult economic climate of 2011. (For related reading, see How An IPO Is Valued.)
The initial public offering from Nielsen Holdings (NYSE:NLSN), which includes the international market research firm, Nielsen, Co., was the largest IPO ever in the U.S. offered by a private equity-backed group.
The IPO raised about $1.6 billion, with the stock closing at $23 a share, higher than the forecast of $20 to $22 a share. The firm is headquartered in Cincinnati.
ServiceSource International (Nasdaq:SREV), based in San Francisco, is a major global vendor of revenue management software and services for technology-based firms. The initial offering of 11.9 million shares was expected to sell at from $7.50 to $9 a share, but sold out at $10 a share. Net proceeds were about $22.4 million and were earmarked to pay down debt. (To learn more on IPOs, check out IPO Lock-Ups Stop Insider Selling.)
A West Lafayette, Indiana, drug development firm, associated with Purdue University, Endocyte (Nasdaq:ECYT) initially filed for an IPO at $13 to $15 a share, but ultimately dropped its offering to $6 a share. The firm, however, offered 14.4 million shares at the $6 price, more than double the projected IPO of 5.4 million shares. Analysts calculate that the Endocyte IPO raised $94 million.
The Bottom Line
IPOs that succeed get lots of press, especially when speculators bid up the IPO share price after the offering. Shares of LinkedIn (NYSE:LNKD), a professional social networking firm, for example, doubled its price in one day. The investing public may think that any such widely-publicized venture is an automatic winner for the issuing company. The issuing company may profit from the higher share price if it has additional shares to sell at market prices. Often, a firm has no additional stock to sell after a major IPO, and so the upward trending price of their stock does not impact their bottom line. A company may, however, issue additional shares, but by doing so, they dilute the value of outstanding shares. (For more information, read What Is Dilutive Stock?)
Some major firms, including Facebook, delayed planned IPOs for 2011 because of poor market conditions and accounting problems.
Remember, there are two criteria for measuring the success or failure of an IPO. First, from the issuing company's point of view: Did the issuing firm raise the amount of cash desired? Second, from the investor's point of view: Did the investor sell the stock at a profit, or did he or she wait too long, and see the share price drop below issuing price? This is what happened to Groupon (Nasdaq:GRPN), and should serve as a lesson for investors looking to profit from IPOs in 2012.