Reading about it here and their example of Morgan Stanley and FB:
https://www.investopedia.com/terms/g/greenshoe.asp
"The underwriting syndicate, headed by Morgan Stanley (MS), agreed with Facebook, Inc. to purchase 421 million shares at $38 per share, less a 1.1% underwriting fee. However, the syndicate sold at least 484 million shares to clients – 15% above the initial allocation, effectively creating a short position of 63 million shares.
If Facebook shares had traded above the $38 IPO price shortly after listing, the underwriting syndicate would’ve exercised the greenshoe option to buy the 63 million shares from Facebook at $38 to cover their short position and avoid having to repurchase the shares at a higher price in the market.
However, because Facebook’s shares declined below the IPO price soon after it commenced trading, the underwriting syndicate covered their short position without exercising the greenshoe option at or around $38 to stabilize the price and defend it from steeper falls."
A few questions:
1. I would assume MS is borrowing those 15% shares that it sells short from the issuer?
2. And when those shares are bought and delivered back to the issuer, they are effectively cancelled so that the outstanding amount of shares eventually ends up being 421m?
From what I ve studied I d say yes to both. But wait for other answers
Its not a literal short so much as a short position as the article notes.
The idea generally is that to build the IPO book, the syndicate is allotted some amount of shares, but the syndicate will oversell this amount (15% is the amount they'll oversell i.e. the greenshoe clause in the underwriting agreement). This leads to a "short position" because the bank has sold more shares than it initially purchased. The greenshoe clause will allow the bank to cover its short by purchasing more shares at the discounted underwriting price (in the event that the stock is trading higher than the public offering price). However, in the event that the share is trading below that price, the company can cover its short position by just purchasing the shares in the open market.
I'm not as sure about the legal mechanics, but that's the general idea.
This answer is spot on. Another mechanism to think about is delivery, while they typically do, IPO shares don't necessarily settle T+2 as if you were buying them in the open market. However, even if you have not received them you can trade them as you are essentially making a promise to provide shares at some point in the future. S&T mechanics can get weird here and its not worth going in to. But important to note - while IPO shares typically settle T+2, there are provisions here that can effect delivery and the one thing is constant, if the bank has signed an LOI, sold and billed for shares to a institutional client they have an obligation to deliver.
1. So if they buy back the shares in the market when the price is lower than the IPO price, their short position will get covered and the total amount of shares will be equal to the original amount excluding overallotment?
2. If the price is higher than the IPO price the bank buys shares from the issuer at the discounted underwriting price. In this case will more shares get issued so the total amount of shares outstanding will be the original amount + 15% overallotment?
Agreed on both points. The idea is to try to match supply and demand. If the stock is trading well, you want the option to go back and sell more
Ok, so it is only in the case where the price rises, and they sell 15% more shares which they buy from the issuer, that more capital is raised and the number of shares outstanding increases? And they can only do this if they have not already exercises the allotment option before it starts trading?
In case they have exercises the option and the price falls, they buy back shares in the market and their short is covered and the number of outstanding shares is constant?
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