10 December 2021

Spotlight on: IPOs

by the FMA editorial team

What is an IPO?

An IPO is an Initial Public Offering. It’s the first time new shares in a company are offered to investors in the wider public. These shares are then listed on a stock exchange, such as the NZX or ASX.

An IPO can be riskier than other sharemarket investments, because there isn’t any past history on the stock exchange. However, it’s also possible that the lack of historical share price provides a buying opportunity.

Shares bought in an IPO are just like all the other shares on the exchange – so can then be bought and sold once it is listed.

Why do companies have IPOs?

A company might be about to expand, grow into new markets or buy a competitor or new business. Raising money in an IPO allows it to head down a new — and hopefully successful — path. This could lead to a good investment, but if the expansion fails, or it is over-valued at listing, it could mean you lose money.  

Other IPOs happen when the owners of a private company use it to ‘cash out’ by selling their stake to a wider group of investors.  Private owners might have built up a company over decades, then use the IPO to realise their investment. Other groups, such as private equity investors might have shorter-term plans to buy a business, re-organise or expand, then cash out through an IPO after a few years.

How do I find out about IPOs?

Companies running an IPO will often use a merchant bank or broker to act as ‘joint lead managers' to promote the sale to the public. Share investing platforms will also advertise to their clients about new IPO opportunities.

IPO shares can be sold to a small group of invited investors or pitched more widely. Some companies run big marketing campaigns to get everyday investors interested, while others might only offer the new shares to the clients of big brokers or merchant bankers.

Companies with a well-known brand might tap into their customer base to look for new investors in their shares.

How can I find out more about the company and its risks’?

The company running an IPO has to publish a lot of information about its plans, projections and finances. These must comply with certain requirements, but remember there has been no requirement for this kind of information for most of its history, so you won’t have as good a picture of how the company has performed up till now.

A lot of information is contained in a Product Disclosure Statement (PDS). A PDS explains how the investment works, gives an overview of the company and importantly includes risks to the company’s financial performance or plans. It’s important to read the entire PDS and get professional advice where you need it. See our Guide to Product Disclosure Statements.

How are IPOs priced?

IPOs are often promoted widely to achieve a higher price for the owners selling their shares. The company running the IPO is trying to sell a pre-determined number of shares at the best price. Commonly, a ‘bookbuild’ process is used where the joint lead managers invite institutional investors to submit bids for the number of shares they wish to purchase across a range of prices to determine an appropriate issue price for the IPO.

Share prices can change dramatically after an IPO. Some of this will depend on how the shares were priced in the first place by the company and its bankers.

If shares are issued to new investors in an IPO for example at $1 each — and this is viewed as a real bargain — then the share price will jump as new investors scoop them up on the open market. If that price is set too high, then the price will fall below $1 in later trading, as new owners offload them.

There’s been varying levels of performance of IPOs when their new shares are traded. Think of buying shares in an IPO like any other investment – do your research. An IPO might mean you can buy shares in a company that resonates with you, or in an industry you don’t have much exposure to – but remember, you can always buy its shares on the open market after the IPO.

IPOs – tips from the NZ Shareholders Association

The New Zealand Shareholders’ Association has these ‘assessment points’ which it recommends as useful when you’re thinking about investing in an IPO:

  • The nature of the underlying business – what industry is it in, what is its strategic story?
  • What share of the business is being retained by existing shareholders? This could be an indicator of future confidence
  • What is the company doing with the money raised?  Is it to pursue growth, retire debt or simply pay out the existing owners?
  • The cost of listing the company on a stock exchange– as a %, how much of the money raised is going to fund underwriters, lawyers and/or investment bankers? 
  • Pre-IPO financials and post-IPO forward looking financial information. Do they look better or worse?

(It can be hard to focus on forward-looking prospective financial information, as it can be of lower quality – but understanding pre and post is critical.)

Watch out for ‘pre-IPO’ scams

Many companies may have the prospect of an IPO in their long-term plans. These might get delayed due to market volatility, or personal circumstances. ‘Pre-IPO’ scams are when a fraudster says they can get you in the queue for when shares in a particular company are eventually released.

This scam will often use well-known, but privately held successful companies as bait to get money out of people with the false promise that they will get early access to shares in any future IPO. Remember, in New Zealand, it’s illegal to sell shares through an unsolicited offer.

Ignore uninvited investment offers – it’s illegal in New Zealand to sell financial products such as shares through an unsolicited meeting, for example a ‘cold call’ or uninvited email.

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And check out others in our Spotlight series: