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First in a four-part series The ABCs of IPOs: Speak the language

By Darren Chervitz, CBS MarketWatch Wed Jan 14 10:16:35 1998
SAN FRANCISCO (CBS.MW) -- In the sometimes mundane world of investing, initial public offerings hold an alluring mystique.

The world of newly public companies, after all, remains off limits for most individual investors. That might start to change as soon as 1998. (See related story.)

Apart from the sex appeal and the potential for big returns, however, investing in IPOs is risky business. One simple fact anybody interested in jumping in the new issue market should know: IPOs have historically underperformed the broader market.

In 1997, for example, IPOs gained about 14.3 percent from the offering price vs. a 31 percent gain for the Standard & Poor's 500 Index. And if you use an IPO's first trade price as the benchmark -- fuhgedaboutit. IPOs in 1997 rose only 8.9 percent above their opening prices.

Obviously, investors need to get beyond the allure and hype of IPOs and become educated about the facts.

To help toward that end, CBS MarketWatch is publishing a special four-part series on the IPO market entitled "The ABCs of IPOs."

We'll start off with definitions of common terms used in the IPO market.

Next, we'll take a look at the IPO process, followed by an examination of the all-important prospectus and then some possible IPO investment strategies.

American Depositary Receipts (ADRs) -- These are offered by non-U.S. companies wishing to list on a U.S. exchange. They are called "receipts" because they represent a certain number of a company's regular shares.

Aftermarket performance -- used to describe how the stock of a newly public company has performed with the offering price as the typical benchmark.

All or none -- An offering which can be canceled by the lead underwriter if it is not completely subscribed. Most best effort deals are all or none.

Best effort -- a deal in which underwriters only agree to do their best to sell shares to the public. As opposed to much more common bought, or firm commitment, deals.

Book -- a list of all buy and sell orders put together by the lead underwriter.

Bought deal -- an offering in which the lead underwriter buys all the shares from a company and becomes financially responsible for selling them. Also called firm commitment.

Break issue -- term used to describe when an newly issued stock falls below its offering price.

Completion -- an IPO is not a done deal until it has been completed and all trades have been declared official. Usually happens about five days after a stock starts trading. Until completion, an IPO can be canceled with all money returned to investors.

Direct Public Offering (DPO) -- an offering in which a company sells its shares directly to the public without the help of underwriters. Can be done over the Internet. Liquidity, or the ability to sell shares, in a DPO is usually extremely limited.

Flipping - when an investor buys an IPO at the offering price and then sells the stock soon after it starts trading on the open market. Greatly discouraged by underwriters, especially if done by individual investors.

Greenshoe -- part of the underwriting agreement which allows the underwriters to buy more shares -- typically 15 percent -- of an IPO. Usually done if a deal is extremely popular or was overbooked by the underwriters. Also called the overallotment option. Gross spread -- the difference between an IPO's offering price and the price the members of the syndicate pay for the shares. Usually represents a discount of 7 percent to 8 percent, about half of which goes to the broker who sells the shares. Also called the underwriting discount.

Indications of interest -- gathered by a lead underwriter from its investor clients before an IPO is priced to gauge demand for the deal. Used to determine offering price.

Initial public offering (IPO) -- the first time a company sells stock to the public. An IPO is a type of a primary offering, which occurs whenever a company sells new stock, and differs from a secondary offering, which is the public sale of previously issued securities, usually held by insiders. Some people say IPO stands for "Immediate Profit Opportunities." More cynical observers say it stands for "It's Probably Overpriced."

Lead underwriter -- the investment bank in charge of setting the offering price of an IPO and allocating shares to other members of the syndicate. Also called lead manager.

Lock-up period -- the time period after an IPO when insiders at the newly public company are restricted by the lead underwriter from selling their shares. Usually lasts 180 days.

New issue -- same as an IPO.

Offering price -- The price investors allocated shares in an IPO must pay. Not the same as the opening price, which is the first trade price of a new stock.

Opening price -- The price at which a new stock starts trading.. Also called the first trade price. Underwriters hope that the opening price is above the offering price, giving investors in the IPO a premium.

Oversubscribed -- defines a deal in which investors apply for more shares than are available. Usually a sign that an IPO is a hot deal and will open at a substantial premium.

Penalty bid -- a fee charged to brokers by the lead underwriter for having to take back shares already sold. Meant to discourage flipping.

Pipeline -- a term used to describe the companies which have filed an S-1 registration statement but haven't yet started trading.

Premium -- the difference between the offering price and opening price. Also called an IPO's pop.

Prospectus -- the document, included in a company's S-1 registration statement, which explains all aspects of a company's business, including financial results, growth strategy and risk factors. The preliminary prospectus is also called a Red Herring.
Quiet period -- the time period in which companies are forbiddn by the Securities & Exchange Commission to say anything not included in their prospectus which could be interpreted as hyping an offering. Starts the day a company files a S-1 registration statement and lasts until 25 days after a stock starts trading. Intent and effect of quiet period have been hotly debated.

Roadshow -- a tour taken by a company preparing for an IPO in order to attract interest in the deal. Attended by institutional investors, analysts and money managers by invitation only. Members of the media forbidden.

Selling stockholders -- Investors in a company who sell part or all of their stake as part of that company's IPO. Usually considered a bad sign if a large portion of shares offered in an IPO comes from selling stockholders.

S-1 -- document filed with the Securities & Exchange Commission announcing a company's intent to go public. Includes the prospectus and is also called the registration statement.

Spinning -- the practice of investment banks of distributing shares to certain clients, such as venture capitalists and executives, in hopes of getting their business in the future. Outlawed at many banks.

Syndicate -- a group of investment banks that buy shares in an IPO to sell to the public. Headed by the lead manager and disbanded as soon as IPO is completed.

Venture capital -- the pre-IPO process of raising money for companies. Done only by accredited investors.

IPO Market Year in Review Year in Review Individual access Internet IPOs Rambus' ride Venture capital ABCs of IPOs IPO Tables Glossary

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