The Good, the Bad, and the Ugly of IPOs

Markets aren’t functioning as well as they used to. Although they had a strong start to the year, they struggled to return to recent levels. Over the first quarter, stocks have dropped more than 4 percent. Yet, when companies go to register new issues, and other technical finance, things go smoothly. Lots of new issues are getting filed every day.

How? It’s called IPOs. They are split into companies that have recently gone public (i.e., they are well established) and under-prepared corporations that are brand new to the public. All forms of new corporate growth are fully underwritten with a variety of financial instruments and obligations. Because investors are willing to buy new securities, money can flow toward companies with modest histories. But because more risks are taken, indexes of these companies, which use a handful of SEC rules (namely reporting period, record date, and record year), are established, and create a price based on public health.

I bought a “company” called Trademark/Groupon on the same day as WorldCom, providing some nice examples of risk and rewards of financial globalization. Have a look at the charts of the upcoming iShares Dow Jones U.S. Broad Index ETF (DIA) and the Facebook (FB) IPO, below.

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iShares Dow Jones U.S. Broad Index ETF

It’s simple. WorldCom tried to raise $1.56 billion in an IPO. The price was between $15-$16, but at the end of the first day the share price wasn’t anything significant. So $15 is how much stock the company offered investors, up to a maximum of 464,500 shares.

The company came up with a phony revenue figure to make the IPO a success. It claimed it had sales in 1999, but had in fact no profits that year (10% of 1999 sales $12,129,000). So for the first day only, it could offer investors 464,500 shares. If anyone bought it, they were guaranteed to lose money (and keep their shares). On the second day, on Wednesday, February 21, 2000, the share price did not top $15, and changed hands all the way down to about $8. So unless you had a couple of dozen people’s money in this IPO, you would have lost money on a guaranteed guarantee.

The iShares Dow Jones U.S. Broad Index ETF (DIA) tracks the performance of the Dow Jones U.S. All-Cap Index and so will usually outpace its competitors with periods of strength and lesser amounts of weakness (at least historically). If you think that this is something that could happen again, that’s fine! If not, you can invest elsewhere (some would say, in bonds).

Facebook, of course, was just acquired by Facebook Inc., and will be listed on the Nasdaq Stock Market. It is also the most valuable company in the world today, with a market capitalization of $421 billion. I didn’t have any personal shares in the company, but Google did own 5 percent of it, and last year held a pre-IPO liquidation to break up the company.

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