10-Minutes to understand [over-allotment option & stabilization] of IPO
Author: duitKWSPkita | Publish date: Sun, 24 May 2015, 08:44 PM
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publication is for general discussion only. It does not form part of
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Dearest Reader,
Welcome to June' 2015. Hope everyone doing great in the first half of 2015.
We shall see another 7 to 8 IPOs to be
called throughout this year. Since the debate about "Should or should
not chase IPO" and "How GREEN-Shoe works on IPO " remain hot. I would
like to share something based on my experience in IPO projects.
Under this 5 minutes reading article the contents shall cover:
- Definition of 1)over-allotment option 2)underwriting and 3)stabilization mechanism
- General rules of listing (mainly on Bursa Market)
- How stabilization mechanism works
- Stabilization impact to Balance Sheet
- Conclusion
1. Definition of 1)over-allotment option 2)underwriting and 3)stabilization mechanism
Over-allotment option:- An option for UNDERWRITER(S) to sell extra (15% max) shares than originally planned. All the 15% shares can be exercised (sell or buy) within 30 days from the listing day.
Underwriting:- One or few parties(usually banks) jointly to carry out the process to raise investment capital (IPO) from investors on behalf of corporation (listing company). When there is a big corporation's IPO project, it might involve several underwriters and shall be led by one Lead Underwriter. Underwriter(s) are responsilbe from draft, planning until the end of the listing event.
Stabilization: More commonly called as GREEN shoe option is a legal act for Underwriter to 1) SELL when share price UPPER than IPO price or 2) BUY up to 15% company shares when the price LOWER than IPO price to stabilize(reduce risk) the price structure.
Primary market: Primary market is a trading activfity whereby prime investors such as Banks, Private Equity, Big Corporation and Government buy securities direct from the IPO company. This primary market activity will affect cash flow to the issuer company.
Secondary market: The transaction does not affect cash flow in the company, usually it happens after the listing day. NOTE: Primary market involves the transaction in the listing while Secondary market involves the trading after listing.
2. General rules of listing ( Bursa Market):
Reference: http://www.mia.org.my/new/downloads/professional/regulatory/sc_bursa/knowledge/2012/Practical_Guide_to_Listing_SMEs.pdf
Estimated timeline for the entire listing process from start to finish
3. How stabilization mechanism works ; but before start ask yourself:
- Why GREEN shoe come into the game?
- How to exercise the 15% additional shares? To who?
- Who bear the cost when underwriter buy in shares to stabilize the price?
- ABOVE or BELOW IPO price, what impacts to the IPO company?
The term "greenshoe" came from the Green
Shoe Manufacturing Company (now called Stride Rite Corporation), founded
in 1919. It was the first company to implement the greenshoe clause
into their underwriting agreement. - See more at:
http://www.flame.org.in/KnowledgeCenter/WhatisanIPOgreenshoeoption.aspx#sthash.aA8SyhDC.dpuf
The term "greenshoe" came from the Green
Shoe Manufacturing Company (now called Stride Rite Corporation), founded
in 1919. It was the first company to implement the greenshoe clause
into their underwriting agreement. - See more at:
http://www.flame.org.in/KnowledgeCenter/WhatisanIPOgreenshoeoption.aspx#sthash.aA8SyhDC.dpuf
The term "greenshoe" came from the Green
Shoe Manufacturing Company (today called Stride Rite Corp.), founded in
1919 as it was the first company to adopt the greenshoe clause into
their underwriting agreement. GREEN SHOE IS TO BE IMPLEMENTED 1)TO AVOID
THE IPO COMPANY ENCOUNTERS SHARP DROP ESPECIALLY IN THE TURBULENT TIMES
PREVAILING IN THE MARKET PLACE and 2)TO MAINTAIN THE
REPUTABLE NAME OF THE UNDERWRITER FOR FUTURE IPO BUSINESS.
For example, a company named "Malcolm in the Middle Berhad" - MalMid Berhad (not relevant to Malakoff) plan to sell 300 million shares at RM1 for listing. Presumably it is OVERSUBSCRIBED by 14X (marketing say saje, you BUY you DIE) so now the underwriter sold in total of 345 million shares (300 million X 15%)
When share price up, underwriter exercise the over-allotment option to deliver those oversold shares to cover the over-selling. Underwriter OVERSOLD the shares at IPO price and exercise the option at IPO price too, hence, the additional equity will go to IPO company. Underwriters only gain from the underwriting fees and commissions on these shares, plus additional % of successful hit rate commission. Of course the underwriter gains reputation from the equity market.
When share price down, the underwriter shall support the stock with a view to not let it break the IPO price (theoretically) and fall below IPO price. The lead underwriter shall complete to buy back these shares from the market which helps to stabilize the price and suppress the selling pressure from the market (cut supply). Here involve more complicated technical strategies to stabilize the price(will not be covered in this write up).
4. Stabilization impact to Balance Sheet
Here are the impacts for that IPO company should the Underwriter call option to sell the shares above offering price.
Debit: Cash (increase asset)
Credit: Paid in Capital ( increase equity)
Any IPO’s or secondary offerings raise equity . It will be shown as shareholders equity. only debts will be shown as liability. assets = equity+liability.
5. Conclusion
IPO can be done either for the purpose of business expansion or to pay debt / improve working capital for business need. In order to achieve GREAT IPO performance a company can reduce(undervalue) the offereing price but it will not serve the purpose of fund raising. When an IPO counter performs adversely my friendly suggestion is to track its STABILIZATION records over the 30 days period to examine whether the rebounce is happened due to the REAL buying interest or GREEN SHOE effect.
Lastly, wishing everyone a wonderful trading in IPO.
Warmest Regards,
duitKWSPkita
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