Smart Investor: Understanding IPOs

Smart Investor – Getting Started, April 2011

An initial public offering – IPO, or float – is what happens when a company lists on the stock exchange for the first time. It happens when a company wants to raise money by selling shares in itself – and you, as an investor, can buy in.

Buying shares in an IPO is different to buying and selling shares that are already listed on a stock exchange. You won’t see a price on a screen telling you what the stock is trading at; you can’t press a button and get exactly the number of shares you wanted confirmed a few seconds later. An IPO involves a longer process.

To start with, you can find out what companies are planning to float by going to the Australian Securities Exchange website. Click on the ‘personal investors’ tab, and under the ‘prices, research and announcement’ heading you’ll see a section called ‘upcoming floats’.

This will show you a list of what’s coming up, along with the planned listing date if that’s been announced. Clicking on the company name will give you the company contact details, some information about what it does, the capital it hopes to raise, and some relevant dates and other information.

If you’re interested in knowing more about these, each company has to submit details of the float to the Australian Securities and Investments Commission (ASIC). This becomes a document known as a prospectus, or information memorandum, and it is for you to learn more about the business and to decide whether to buy in. You can usually get the prospectus from the company, from ASIC itself, or sometimes from your broker.

At the time of writing, all the upcoming floats were small commodities plays unlikely to be of interest to mum and dad investors. So instead, let’s take a look at a prospectus of a recent jumbo issue: QR National, the Queensland rail company, whose offer document you can find here: http://www.qrnational.com.au/investor/Pages/Reports.aspx

The opening pages of a prospectus like this typically tell you a bit about the company and tend to be glossy and colourfully pictured. Professional investors, who know what a company does well before they look at a prospectus, ignore this and turn to the financial information further back, but if you’re considering investing in a company it is of course important to understand what it does. Also near the front you’ll find a summary, in this case called Key Offer Information, telling you things like roughly what the company hopes to raise, some key financial ratios, and the dates for things like the open and close of the offer and the date it starts trading.

Once you’ve digested the basics of the company’s business, the next section usually covers details of the offer itself. This should tell you things like the structure of the offer (in QR National’s case, for example, there were different bits for employees, clients of selected brokers, and the general public); how much it is raising, and what for; and the pricing structure – important in this case because there was a discount for retail investors over big institutions, which is often the case in a big float where the company wants mum and dad investors to come in. A useful thing to look for here is allocation policy, in this case on page 34. Often there is more demand than there are available shares, which is known as oversubscription. If that happens, this section will tell you who gets priority, in what circumstances you are guaranteed an allocation and how much you will get if you don’t have such a guarantee.

In QR National’s case, lengthy and detailed sections then follow on the industry, the company, the regulatory environment, management, the relationship with the Queensland state, financials, and key risks. These are all useful things to know, of course, but many investors find themselves overwhelmed by detail and want a solid professional opinion. Often a broker will have published a view, and certainly the national press – particularly the Australian Financial Review – will be writing about it, canvassing fund manager opinion on the pros and cons of a new issue. In a huge issue like QR National, many thousands of words of opinion were printed, and this can be helpful in deciding whether to go ahead and apply. If you do nothing else, be sure that you read the key risks section – although in most prospectuses one tends to be swamped with obvious but legally required comments like ‘markets might go down’.

If you do want to invest, the next step is to fill in the forms – in QR National’s case, these come immediately after page 74 in the online prospectus. On a big float like this, the issuer wants to make it easy for you to participate, so you can even do so through BPAY. Alternatively, you can pay by cheque or money order. Fill in the dollar value amount of shares you want to apply for, your name and details, your CHESS number if you have one (you will have got this through your broker when you opened an account), and fill in your cheque, money order or BPAY accordingly. Send it in, and wait. (If you’re investing through your own broker, they will have their own procedure for you to go through.)

The next step can be confusing. Unless you’re investing in a float where the price is set from the outset, the final price won’t be decided and announced until the offer has closed. So it’s not until everyone has put their orders in that you know exactly how many shares you are going to get for your money. This is one reason many investors prefer to buy in the secondary market (on the exchange once something is already listed) where there is more certainty. Set against that is the fact that you don’t pay brokerage commission in an IPO, whereas you do when buying on the stock exchange. Anyway, once the price is set, you will also hear if your allocation has been scaled back; if it has, some of your money will be refunded to you.

Once all of that is done, the shares – with you as the legal owner of them – will start trading on the date stated in the prospectus, and from then on, you can sell them, or buy more, like any other share. The performance of a stock after listing tends to be choppy at first as speculative money comes in and out, before settling down. If you’re lucky, you’ve got in at the ground floor with a real long-term success story. If not… well, maybe next time.