NEW YORK In the most anticipated stock debut of the year, millions of Twitter shares will change hands later this week after the New York Stock Exchange's opening bell.
But how will each share move through Wall Street to the mutual funds held by investors? It's a complex process that comes down to one veteran trader at a workstation on the floor of the New York Stock Exchange, who must sift through thousands of orders and dozens of yelling traders to determine the right price for Twitter's opening trade.
The process of an initial public offering begins when a company decides it needs more money -- and turns to the investing public to raise the cash. The company hires an investment bank to guide it through the process. The company opens its books to regulators and the public, takes its business plan on the road, and pitches itself to big, professional investors. Finally, it sets a preliminary stock price and date for the first day of trading.
The Night Before the IPO:
- The company has finished making it case to potential investors. Its investment banks have taken orders from their biggest clients. In Twitter's case, investment banks Goldman Sachs, Morgan Stanley and JPMorgan Chase are handling orders for the 70 million shares offered in the company's IPO.
- Large institutional investors, such pension funds, mutual funds, and hedge funds, will get first priority, followed by brokerage houses and individual investors, who get a very small percentage of the shares at this point. The banks try to place shares with investors who plan to hold onto the stock.
- The company decides on a final stock price based on demand from investors and advice from its investment banks. Twitter's stock is expected to start trading between $23 and $25 a share. But it could go higher if demand continues to rise. Twitter has already raised its projected price range from an earlier $17 to $20 a share.
- The company approves the price and issues the shares to its investment banks. Twitter is expected to set the price late Wednesday.
- The investment banks, or underwriters, immediately sell the IPO shares to clients, based on the orders it took earlier. The shares mostly go to big investors. Only a small percentage of individual investors will get shares in the IPO at this point.
- New shareholders start preparing orders for the next day. Some shareholders want to sell all or part of their newly-acquired stock. Some want to add to their holdings if they didn't get as much stock as they hoped.
- Twitter will have made its money. When the stocks starts trading the next day, company executives will ring the opening bell and applaud as trading opens on the floor of the NYSE. But all the hoopla, buying and selling, and changes in the stock price won't change the amount raised by Twitter. The 70 million shares will be owned by public investors, who can trade them among each other.
The Day of the IPO:
- Before the stock market opens, a "designated market maker" arrives on the floor of the NYSE and starts processing orders from the night before. The DMM is like a conductor for a company's stock. He or she is an experienced stock trader in charge of ensuring the buying and selling goes smoothly. If trading becomes volatile, the DMM can step in and buy shares using his firm's own money. It's good to have this safety net if things go wrong with the IPO. DMMs, who used to be called specialists, are unique to the NYSE.
- Around 9:15 a.m., 15 minutes before the market opens, traders get a first taste of the public demand for a company's shares. Twitter's DMM will work through any initial orders to get a price quote for newly-issued shares. The price quote is typically in a range.
- At 9:30 a.m. company executives ring the bell to open the NYSE.
- Twitters' stock is expected to start trading Thursday morning, when traders will gather around the DMM. The traders, who represent dozens of clients and hundreds of investors who may buy or sell, start placing their own orders. The area can become crowded as dozens of traders compete for the attention of Twitter's DMM.
- Company executives head down to Twitter's location on the NYSE to observe the first trade.
- The NYSE's floor traders shout their orders to the DMM. Some investors want to buy the IPO, some are clients who got shares in the IPO overnight and want to sell a portion of their holdings. The DMM's job is to find that right price for a company's newly-offered shares.
"We're trying to give an opportunity to everyone to get into the stock," says Matt Cheslock, a DMM for Virtu Financial who works at the NYSE.
- The DMM, floor traders and underwriters work to find the right starting price for newly-issued shares. This is called price discovery. For example, Twitter's price range of $23 to $25 may narrow to $23.50 to $25, if demand is high enough.
- Price discovery may take a few minutes or an hour once the market opens. It depends on how the underwriters and DMM want to handle a company's first trade and how much demand exists for an IPO stock, says David Ethridge, who heads up the IPO business for the NYSE. For example, Chinese tech company 58.com went public last week and it took roughly 20 minutes from the opening bell to start trading. Mortgage insurance company Essent Group, which went public the same day, took about 35 minutes to begin trading.
"When you're getting close to that first trade, you can really feel the energy in the room start to rise," says Jonathan Corpina, a NYSE floor trader with Meridian Equity Partners.
- Once the DMM thinks the company's stock is priced correctly, he or she will "freeze the book," saying that that no more stock orders can be placed. The accepted orders are processed, and the stock opens to trading. If problems arise, the NYSE can bypass the electronic system and use humans to trade Twitter's stock, Cheslock said.
- Once the stock starts trading, any investor can start buying and selling the shares. Individual investors often buy new shares of a company at this point. IPOs are very risky though. Even if the company is considered a good investment, its shares can struggle once the enthusiasm for the IPO fades. For example, Facebook's shares had an IPO price of $38, but fell as low as $18 each in the months after it went public.