What is Alibaba? If you’ve turned on the business news anytime in the last two weeks, you’ve probably heard this name. Alibaba is China’s largest eCommerce company. It hosts millions of merchants and allows them to connect with millions of consumers. And last week, it became the largest IPO in history. This led me to the idea of writing about IPOs, or Initial Public Offerings, and how and why companies go public. (It actually led my assistant to the idea which she suggested to me. Thanks Bre!)

An initial public offering is how a company begins trading as a public company. Let’s take a step back. A public company is one that trades shares on a stock exchange or over-the-counter market. Examples can be found in the world’s largest corporations such as Microsoft (MSFT), Apple (AAPL) and Boeing (BA). Any company you can buy stock in is a public company. You cannot buy stock in a privately held company. They are owned by a small number of people or entities. Examples of privately held companies are Mars, Inc. (maker of Snickers, M&M’s, and Twix, among others), Enterprise Holdings (car rental behemoth) and very recently, computer maker Dell.

So, how does it work? When a company starts out, the founders and/or any financial backers own the entity. As it grows, more people may become owners by investing money into the company, employees may be given ownership stakes in lieu of salaries or bonuses, etc. When the company decides to go public, they will hire an investment bank to put a value on the shares of the company and in essence, the company as a whole. This is the IPO price. They will decide how many shares they are going to sell at the IPO and who will get them. Typically speaking, these shares primarily go to large institutional investors such as mutual funds, hedge funds and pension funds. Once the shares are priced and allocated they start trading on the secondary market. The price they start trading at is determined by a designated market maker (DMM).  This is done by matching all the buy orders for the stock with shares that are for sale. In cases where there is very high demand in the secondary market, there can be a large gap between the IPO price and where the stock starts trading publically. This was true for Alibaba (BABA).

Let’s take a look at the Alibaba IPO. The original range for the IPO price was $62-66 per share. However, because of the apparent high demand for the shares in the secondary market, they eventually priced at $68. This happened on Thursday, September 18th, so the shares would start trading publically on the 19th. The DMM spent the morning of the 19th, collecting buy orders and trying to match them with shares that were being offered to sell. The initial indication was that the shares would open in the low to mid 80’s. However, because the demand was so high, the DMM had to raise the open price several times. (the higher the price, the more people would be willing to sell). After nearly 2 ½ hours, the shares opened at $92.70. Nearly 100 million shares traded hands in the first five minutes alone.

Alibaba ultimately raised $25 billion and at the IPO price had a market value of $168 billion.

So, why go public? The obvious answer is to raise money. And that’s true. As companies grow, they may need money to expand further, or pay off debt. But there are other reasons. Going public gives a value to your company and therefore, to the shares of all the owners. Until there is a value on your company, any ownership stake is ambiguous dollar-wise. Going public rewards the early investors, and people who have taken shares of the company instead of salary. It also gives your company a currency, so to speak. Once the shares have a value, a company can use its own stock to purchase other companies. Instead of giving up cash, the company will give up partial ownership to buy another company. And with a valuation based on a stock price, it may be easier for a company to access the debt markets.

There are drawbacks, however. As a public company you are subject to the quarterly reports of earnings, revenues, and growth. Shareholders can now scrutinize the finances of the company and the decisions of management. They are also able to vote on certain things, such as the board of directors. In some situations, this may make it too onerous to be public. This was the case with Dell Corporation. Last year, the company was taken private by its founder, Michael Dell, in an attempt to avoid the “89 day shot clock” (quarterly reports) that afflicted the company and enact a long term turnaround plan that could take five years.

The IPO system is not perfect and it definitely favors large institutional investors and super wealthy individuals. Letting the investment banks control where the shares go, they will naturally lean towards their largest clients. Because it is almost impossible for regular retail investors to get shares at the IPO price, we are relegated to the secondary market to get shares of new companies. That being said, there is no guarantee that an IPO will go up. Be very careful to do your research and don’t just invest in the flashy new name in the news.

 

*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. (“CFS”), a registered broker-dealer (Member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. Verity Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.

 

Gavin Chinn, CFS* Financial Advisor

Check the background of this investment professional on FINRA’s BrokerCheck.

An Investment Advisor registered through CUSO Financial Services, L.P., Gavin has 22 years of experience as an advisor in the Puget Sound area.

“I believe every client is unique and deserving of a personalized financial plan that will help them reach their individual financial goals. Before I make any recommendations, I like to get to know my clients. By asking the right questions, and developing an honest, trusting relationship I can really get a sense of what’s going to work best for them.”

Gavin graduated from the University of Washington with a BA in Business Administration and started his financial career with US Bank in the Investment Department. Prior to joining Verity in 2006, he spent eight years with Piper Jaffray.

So what is Gavin’s vision for his dream retirement?

“My dream retirement would be absolutely worry free: financially, emotionally, and in every aspect of life. My finances would be in order so expenses for travel, luxuries, and gifts for the kids, grandkids, and great-grandkids would be taken care of. My kids would be financially sound, so I would be confident in their prosperity. This would give me the freedom to travel and play and do whatever it is I want to do.”

When Gavin’s not working, he enjoys spending time with friends and family, watching Husky football, and taking weekend trips around the Northwest.

Gavin is registered to transact securities business in the states of WA, OR, CA, AZ, FL, HI, ID, IL, MN, NM, NY and VA.

*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. (“CFS”), a registered broker-dealer (Member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. Verity Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.

Comments are closed.