Timing the Market

A number of factors can affect the success of an initial public offering. A company may have some control over certain internal factors, such as product development or sales. Others may stand totally out of its reach.

Goldman, Sachs & Co., the venerable investment banking firm, offers a prime example. Goldman originally filed its Form S-1 on August 24, 1998, registering its IPO. A month later, Goldman announced that it was indefinitely withdrawing its planned IPO. What happened?

In the summer of 1997, the Asian financial markets started to unravel, beginning with the devaluation of the Thai baht. The financial crisis soon spread to other Asian countries as Hong Kong, Indonesia, Malaysia, the Philippines, Singapore, South Korea, and Taiwan all found their currency and stock market under attack. For example, in Japan, the Nikkei 225 slid 39% from a high of 20,815 to a low of 12,788 from June 1997 to October 1998. Likewise, in Hong Kong, the Hang Seng plummeted 60% from a high of 16,686 to a low of 6,644 from August 1997 to August 1998.

Domestically, the crisis left the American stock market largely untouched. In fact, from June 1997 to June 1998, the Dow Jones Industrials rose from a low of 7,245 to a high of 9,099, a respectable 26% climb. A month later, the Dow peaked at 9,408 and then proceeded to shed 20% over a period of six weeks, dropping down to 7,497 by early September. Among those companies hit hard were financial services firms. In September 1998, Goldman pulled its planned IPO off the table, citing instability in the financial markets. Goldman refiled its Form S-1 in March 1999 and finally went public that May, at which time the Dow had recovered to 11,031, a robust 47% above the September 1998 low.

Initial Offering Price

A company's initial offering price will be set based on the company's market value and the number of its shares outstanding. If the company and its underwriters want to lower or raise the share price, the company can split its shares or effect a reverse split. For example, prior to its initial offering, Akamai Technologies Inc. effected a 3-for-1 stock split of its common stock on January 28, 1999, another 3-for-1 stock split of its common stock on May 25, 1999, and a 2-for-1 stock split of its common stock on September 8, 1999.

The share price is considered important because it affects public perception of the company. Investors may view a low share price, as seen in penny stocks, as a sign of weakness. On the other hand, a high share price may price some investors out of the market. So, investment banks will target an initial offering price of around $15.

Example - IPO Price per Share

Goldman Sachs Group
Akamai Technologies Inc.
Insweb Corporation
Ariba Inc.
Phone.com Inc.
Webvan Group
AskJeeves Inc.
Delicious Brands Inc.

Because an IPO price is based on a company's market value, the price may change due to intrinsic or extrinsic factors any time before the initial public offering. If strong investor demand exists for a company's shares, the underwriters may price the shares higher. This final offering price will be set after the SEC review process has concluded and shortly before the initial public offering.

For example, Akamai Technologies Inc. filed Amendment No. 1 to its Form S-1 with the Securities and Exchange Commission on September 27, 1999, proposing a maximum offering price per share of $18. A month later, on October 28, 1999, Akamai filed Amendment No. 6 to its Form S-1, raising the proposed maximum offering price per share to $22. On the following day, Akamai filed its prospectus pursuant to Rule 424b(1), again raising the offering price per share to $26. Despite this price hike, Akamai opened trading at 110 and closed the day at $145 3/16.

So, why did Akamai leave $120 per share, or $10.8 billion, on the table? Well, the company and its underwriters may have had some difficulty valuing the company. After all, Akamai was founded in August 1998 and went public just six months after it began offering its services. As the risk factors disclosed, the company had "limited meaningful historical financial data upon which tobase planned operating expenses and upon which investors may evaluate [ the company] and [ its] prospects."

In addition, some underwriters are hesitant to price an initial offering at its full potential market value. Because successful IPOs are commonly viewed as ones producing an immediate share price run-up, underwriters often will price the shares at a slight discount.

Initial Offering Size

A number of factors will affect the offering size.

  • Capital requirements. How much capital does the company need to develop or expand its business? Such expenses may include costs to hire or retain personnel, lease office facilities, and purchase office equipment and supplies.
  • Shareholder dilution. If a company issues additional shares, the existing shareholders will end up with a lower percentage of the outstanding shares. So, how much do the existing shareholders want to dilute their ownership? Do they want to retain a majority interest in the company?
  • Market demand. How receptive is the investment community to the company's shares? If a strong demand exists, a company may consider increasing the offering size. For example, Akamai Technologies Inc. initially registered to sell 6,000,000 shares. It later raised its offering size to 9,000,000 shares.
  • Miscellaneous. To arrive at a certain initial offering price, a company may split its stock or effect a reverse split. Respectively, this will double or halve the number of outstanding shares, and likewise affect the initial offering size.
  • Liquidity. To achieve an active trading market, the company needs a large enough float.

Besides its initial offering, a company will usually make available to its underwriters an option to purchase additional shares, or a green shoe, at the IPO price if the offering is oversold. For example, in its underwriting agreement, VISX Inc. proposed to issue and sell 2.5 million shares of common stock to its underwriters. In addition, solely for the purpose of covering overallotments, the company proposed to issue and sell, at the underwriters' option, up to 375,000 additional shares of common stock. This option was exercisable on or before the thirtieth day following the initial public offering. These option terms are fairly standard.

Lockup Agreements

Before the offering, underwriters typically will secure 180-day lockup agreements with executive officers, other employees, directors, and certain existing stockholders of the company, restricting them from selling their shares during the lockup period.

The purpose of the agreement is to prevent a large number of shares from flooding the market at the time of the offering. This guards against a public perception that company insiders lack confidence in the company's prospects, and also avoids depressing the stock price.

Copyright 1999 Findlaw Inc.