A lesson from Facebook -- avoid IPOs - MoneyWeek Investment Tutorials

so in this week's video and following the Facebook flop frankly an embarrassment for Wall Street and all concerned let's take a look at what an IPO is an initial public offering for novices I'm going to go back one step and just explain how companies raise finance and then we'll get straight in to where an IPO fits in and they'll give you some guidance on whether I think you should try and join in an IPO even if you're given the opportunity now anyone who bought Facebook might say the answer to that question is pretty obvious with hindsight but actually I'm gonna give you a broader picture of why I don't think buying IPOs is a fabulous idea as a retail investor okay so you're a company you're looking to raise money alright where do you go well there are basically four places you can go to raise money you can do it yourself you can grow a company organically as it's called that is simply saying we make enough profits as a little private company we make enough cash flow we can just grow ourselves we don't need to ask anybody outside for finance and that's cheap that's fast and that's nice work if you can get it there's number one however sooner or later yet probably going to need to expand the business and get outside finance so a couple of other ways to do it a bank loan may be secured on assets that you own a bit like a mortgage for an individual okay or you can issue bonds and in another video I deal with bond basics part 1 and part 2 a bond is a tradable piece of paper it's effectively a loan broken up into chunks and sold to investors so you can do a bond market issue and do take a look at my videos if you don't sure about that so we've got organic growth we've got a bank loan we've got a tradable bank loan a bond if you like and finally and I mean finally because it's usually the most expensive way to do it you've got a share issue and that's where IPOs fit in all right now why do I say that's the fourth option not the first well because shareholders don't forget if you can write them in to your business new shareholders are taking quite a lot of risk that is because if your company goes bust they're the lowest in the queue to get money back and dividends are paid after interest on things like bank debt alright so normally raising money by issuing shares via an IPO is an expensive way to raise capital not just because of the fees you pay for the banks who advise you but also because your shareholders quite rightly are quite a demanding bunch of investors to keep happy once you've done it so IPOs ah the usually the first way a company approaches the equity market looking to raise fresh capital okay now what type of company are we talking about one of the reasons why people tend to pile into IPOs is there are not that many of them okay the public company as it's called which is the vehicle you use to raise money via an initial public offering is a kind of dying beast and there are many papers written about why that is and I won't try and cover that here right but let's just have a think about the types of company out there before we go into the pros and cons of an IPO alright you've got what are called public companies and you've got what are called private companies alright and in the UK they normally have the limited Ltd badge of the name alright so X Y Zed limited Morgan Cars Limited whatever happens to be now most companies are privately owned again they're owned by the directors the people who set them up and you and I can't normally buy shares in them unless those directors choose to sell okay so it's kind of a closed shop of your life and most companies are that by number the vast majority of companies privately owned some of them very small okay over here you've got public companies much fewer a number and you've got two types you've got the listed plc that's where an IPO fits in in just a moment and you've got just the completeness the unlisted plc public limited company now now don't get confused an IPO is a way of raising money if you are a listed PLC just be aware that out there there are unlisted PLC's now you're into football all right very quick example Arsenal Football Club is a public company but you won't find it shares at the London Stock Exchange okay um so what that means is Arsenal is owned by people who are not just the directors some fans have shares so it is a public company it's opened itself up to other investors but it doesn't have a listing I'll say the New York Stock Exchange in the London Stock Exchange the shares are relatively illiquid but in theory you can buy and sell them in the kind of over-the-counter market provided you can find someone else willing to do a trade with you all right so over here and companies move around by the way so if you're into football Arsenal is an unusual company it's an unlisted PLC this is UK football clubs the vast majority of clubs are privately owned all right by Russians and Americans on the whole these days all right and one or two sometimes find their way over here and become listed all right so a few years ago I could have put man United here a fully listed PLC look up the share price and London Stock Exchange and so on but since the Glazer family took it over it's migrated over there all right so now in order to buy shares Manchester United no point notes your stock broker and saying get me shares because they're on the London Stock Exchange they're not you'd have to phone the Glazer family hope they're any good mood and see if they'll slip you a few shares in a private deal all right so IPOs are all about this bit of the market all right and it's not very many companies in London we're talking just a few thousand companies out of a massive universe right so be aware the reason shares shareholders and investors get excited about IPOs and I have some sympathy with this is because they think well here's an opportunity for me to actually buy into one of the best companies in the country right true and there are not that many of them in reality but that's still not a reason to jump in my IPO shares as I'll explain in just a moment right now something else we need to know about IPOs all right we're saying that the companies that are involved in IPOs are public companies they're looking to list for the first time why because they want to raise money bring in new shareholders and they're prepared to put up with all the headaches that go with being a listed plc you're thinking why don't more companies do this why they're so few why a few thousand why not loads more the answer is it's kind of a pain listed companies have to breeze accounts more often they've got more regulations to follow they get more scrutiny in the press they get criticized when they pay the directors lots of money okay it's kind of a hassle all right so the quite a few firms listing is not the answer but clearly for a lot it is a good way to raise money so IPOs let's take a look I POS let's focus in on those after all that is the theme of this video so in principle if I'm looking to raise money as a company okay I can either do what you sometimes this is a bit of a jargon tor either do a placement or a public offer so once I've decided I want to make my shares available not just amongst my board directors but other people as well bring them in I can't do a placement of public offer all right and this is kind of where companies have a choice what's the difference well this one is what it sounds like this is making new shares available to the public all right you you issue a prospectus you so now lesson something you invite people to buy the shares and it's on their deadline to apply over here got the placement now what's the difference well the placement what the company is doing is approaching institutional investors only okay and normally I'll bring the bank to help it okay so if you're a company looking to do a placement you'll get some advisors on board JP Morgan Goldman Sachs whoever happens to be they'll help you with the pricing the timing the contact book you want to run okay that means going around talking to various potential clients who might be interested in buying shares so they'll be getting contact with pension funds life insurance companies fund managers and so on and doing a kind of Roadshow going round seeing how much interest there is in the shares in this new company and then when you get the deadline day if you like they will be placed with those specific institution does it sound like a bit of an old boys club okay nice cozy arrangement well that's exactly what it is okay the company or raise the capital it wants okay the institutional investors will get the block investment they want in the new company okay some of them may have to because they offer no index tracking and so on and of course the advisors the investment banks JP Morgan's is all take out a flat fee you get percentage of the amount raised very nice all right public offer now you can split this by the way you can do if you're a new company you could do 75% like that and 25% like that that's just me making up numbers or 90/10 or 5050 you can also offer shares to the public okay more of a hassle frankly the regulation is tighter because you're selling shares to the public okay um the administration is much more involved okay because you've got to deal with over subscriptions that's too many people applying for the shares or the popular offer and you got a deal in both cases with on the subscriptions that's not enough people applying to buy the shares the company wants to sell then what happens the answer is the adviser will normally underwrite the whole thing and that means the JP Morgan's of this world not only advise the company that's trying to sell these shares on the method the timing the price and so on but they also say if the public don't want the shares will step in and buy them at a pre-arranged price that's called underwriting okay so my point being the public offers are usually more hassle so unless a company's got a reason to approach the public to sell shares to it they'll often not bother and that gives you a clue as to what I think about IPOs alright because companies will sometimes say we we want to bring in the public when we sell our shares the first time they want to create a kind of shareholding democracy as a football club we want our fans to own shares as a telecoms company we want our customers to own shares okay as a social networking firm we want the world to own our shares okay it's all kind of marketing claptrap in a way it can be a sign I'd say a little bit desperation I mean if you can offload your shares this one why would you do it that way which is frankly more work costs more more hassle okay and the answers gotta be sometimes we're little bags just we want to get rid of the shares again maybe the retail investors out there will take them when other investors possibly we've got to work harder on institutions to get into a deal all right so what do I think of IPOs would I buy IPOs now people might say well obviously Tim Facebook's just happened when this video is being made okay so there's a clear example of where an IPOs got a bit wrong all right well that's not the only way to go wrong okay so my view is there are three or four reasons why personally I'd be very very very wary of buying shares in an IPO company even though it's tempting okay even though you want to get in on the first day of trading it so on number one okay when companies do IPOs that involve the public you have to ask the question are they getting a little bit desperate to raise capital why are they going through all these hoops I've just dealt with that just now number two how much do you know about this company it's the first time it raised money publicly as the first time it's had to you know probably published proper sets accounts to comply a regulation I mean how much you mean own about what was probably a privately owned company up to this point that you're prepared to commit your capital do it right now surely better to wait than it's been in the public domain for at least a few months and then decide if you want to buy the shares all right because otherwise you might get caught up in marketing hype about the latest mining for local social networking firm when you stand back and ask yourself what do I actually know about this thing and its business model the answer is probably not a whole lot so there's no other reason to at least wait okay next you get stock drops okay three or four months after an IPO you can find and this is true with Facebook often looks like it's gonna be true of Facebook Google group on LinkedIn the share price drops below the IPO price okay now it can be for various reasons okay maybe the IPO price was ridiculously optimistic or maybe maybe it's a combination of that and employees working for the firm that's gone public were locked in for a few months and then they dump all the shares which temporarily causes a price dip but the bottom line is often if you wait you'll get in at a better price on the pío price okay and finally when Wall Street and the media gets so excited about something all right that you seem to hear about it everywhere every time you pick up a newspaper you have got to think do I really want to part of this okay and some of the social networking firms there's huge frenzy it's like the dot-com boom all over again okay there's huge excitement lots of analysts coverage lots of media coverage all of it positive and as a slightly cynical contrarian investor you have to ask yourself the question do I want to go in on the back of all this hype okay so to wrap up what we said is companies have a range of ways of raising funds they don't always go for share issues but if they do the initial public offering is the buzzword that describes a company going to the public probably for the first time to raise capital okay next thing you need to be aware of is that people get excited about IPOs because not that many companies are public so they want a piece of the action but my advice is wait okay by all means get a piece of the latest action on Wall Street but my advice would be hold back for at least three or four months let the dust settle let the share price find a more sensible level than perhaps your IPO price and then if you want to go in okay get in at what I describe as a more valuable price than the one that perhaps day ones trading revealed

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Keywords: IPO, Share, issues, Underwriting, Facebook, Google, Investment, banks, placement, Offer, for, sale, Cheap, investing, Mark-to-market, JP, Morgan, Chase, Portfolio, valuation, Fund, successful, investor, Investing, tips, Dividend, stocks/shares, Working, Cashflow, Overtrading, market, firms, profit, loss, trading, Bid, offer, spreads, MoneyWeek, Tutorial, Currency, bank, credit, 'stock, market', investments, tutorials, Trading, Stocks, Analysis, Trade, Tim, Bennett, Economy, whiteboard, white, board, explained, Financial, Bloomberg

Id: 2wigPibiX_g

Length: 14min 54sec (894 seconds)

Published: Thu May 31 2012