Hot IPO
Refers to initial public offerings (IPOs) with high demand
What is a Hot IPO?
An initial public offering (IPO) with high demand is a hot IPO. As a result, these initial public offerings are well-liked, generating significant interest from investors and the media even before they are released to the public.
Following the company's IPO, share prices often increase considerably due to publicity and enthusiasm. However, these IPOs can be significantly dangerous if you invest in businesses without a track record of success.
When a private company wants to go public, they frequently issue shares through an IPO. This is because they can raise a sizable sum of money quickly, especially if the issue garners attention from the public and develops into a popular IPO.
A private corporation can benefit from the public's demand for its shares by going public. The company's initial step is finding at least one investment bank to serve as an underwriter. Then, the underwriter(s) assist the business in determining the per-share price by marketing the IPO.
Banks anticipate that they will offer a certain number of shares to their purchasers, who might be institutional or individual investors. The underwriting spread is a charge paid to the underwriting banks out of the IPO revenue.
Understanding Hot IPOs
IPOs are deemed hot if they receive a lot of media coverage, which may spark investor interest. In addition, companies can quickly obtain a large amount of cash through a hot IPO, settling their obligations, covering their operating costs, and saving money for potential future expansion.
Soon after the stock starts trading, the price of the stock frequently increases significantly due to the increased demand for shares in a hot IPO.
This sharp rise in share price is often unsustainable, ultimately resulting in a price decline. Moreover, this trend may significantly impact the market itself. After trading begins on the secondary market, sudden price changes may affect the original stockholders.
When offering shares in an anticipated IPO, underwriters may give high-value customers preferred treatment, risking overpricing the stock. Due to the commotion around an IPO, investors are not guaranteed to profit from it as they may hope.
Price Action of Hot IPOs
Investors who believe there will be greater demand for shares than available are drawn to hot IPOs.
Oversubscribed IPOs have greater demand than supply, making them targets for short-term speculators and those who see long-term potential in keeping the shares.
Companies frequently let their underwriters extend the offering size to accommodate more investors and maximize their profits because a hot IPO is likely to be oversubscribed.
The underwriters must balance the size of the IPO and the excellent price for the degree of interest. This balance will optimize earnings for the corporation and its underwriting banks if done correctly.
The underwriters must balance the size of the IPO and the excellent price for the degree of interest.
When shares of such IPO go public, and the market corrects for the high demand for the stock, the price of the underpriced issuing often rises quickly.
While the higher price favors the underwriting bank issuing the shares as it only earns money on the initial issue, overpricing the IPO might cause a sharp decline in prices. There are alternatives for businesses to go public, such as a direct listing or a direct public offering.
Example
The initial public offering of the social media behemoth Facebook is frequently referred to as a hot IPO.
Analysts predicted that the long-awaited IPO, which aimed to raise $10.6 billion by offering more than 337 million shares at $28 to $35 per share, would attract a sizable amount of investor interest in early 2012.
They projected that the IPO would be oversubscribed. However, when the market opened on May 18, 2012, the investor demand for the business's shares was higher than what the company could supply.
Facebook upped the number of shares to 421 million to take advantage of the IPO's oversubscribed status and satisfy investor demand. However, the price range was also increased from $34 to $38 per share.
To fulfill demand, Facebook and its underwriters successfully increased both the share supply and price, which reduced their oversubscription.
Facebook's stock, which had been oversubscribed at its IPO price, swiftly lost value in the first four months of trade, proving that it had been overhyped. Until July 31, 2013, the stock didn't rise over its IPO price.
Reasons for Launching Hot IPOs
Companies use IPOs to obtain equity financing while enabling early investors to profit quickly. In addition, most funds from selling such stock allow businesses to finance their expansion and pay their debts.
There is a lot of regulatory compliance involved in conducting an IPO. A prospectus is used to provide all information to potential investors.
Some IPO-issuing firms are at an early stage, tiny, and presumably hazardous, but attract significant interest because of their competitive positioning in the market.
Companies may also receive a ton of attention by going public through an IPO. Consequently, companies get the prestige and stature of being publicly traded, possibly enabling them to negotiate better loan conditions.
When internal resources are judged insufficient to support expansion, obtaining a financial infusion from an outside source becomes the only practical choice.
The Underwriting Process
The IPO process consists of five major phases. First, a firm that wants to issue its shares often has to work with one or more underwriters. The steps that make up the procedure are as follows:
- A deal is negotiated when the issuer chooses an underwriter or group.
- To create a prospectus and register the offering with the U.S. Securities and Exchange Commission (SEC), the issuer collaborates with the underwriter.
- The underwriter organizes roadshows to promote the offering and its management to potential investors.
- After the SEC approves the offering, the underwriter decides on the issuing price.
The lock-up period occurs after the start of trading. It prevents institutional investors from selling their shares on the open market to avoid a possible stock run and price volatility.
Planning is essential while getting ready to issue stock through an IPO. Company planning, CEO remuneration, the corporate charter and bylaws, and corporate structure are a few of the fundamental problems that need to be solved.
Most of the time, famous investment banks with a network of institutional investors are chosen by issuers.
As a result, the issuing firm may retain market interest due to the institutions' familiarity with the underwriter's operations and ongoing market monitoring.
Oversubscribed and Hot IPOs
Investors who are drawn to hot IPOs typically anticipate that there will be a shortage of publicly-listed shares. This is because oversubscribed shares have more demand than the number of available shares.
Investors who hold equities to trade them quickly are attracted to these kinds of IPOs. Due to the enormous demand for shares on the first day of trade, trading prices also rise. Businesses attempt to control this occurrence to guarantee that their IPO is successful.
The size of the IPO, the stock price, and the level of interest in the shares are the three factors that determine whether underwriting is successful. When done appropriately, the alignment optimizes profit for both the issuer and the investment bankers.
After the shares are listed on the market, the price of an underpriced IPO will rise, and eventually, the market will respond to the extreme demand.
However, because the registration statement specifies a certain number of shares, the underwriter cannot simply balance supply and demand by issuing and distributing more shares.
Instead, an underpriced IPO compared to market demand will experience a significant price increase shortly after the stock starts trading. An IPO is "hot" because of the rapid increase in trading prices.
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