Ben's IPO Syndicate Primer, Part 2

On Monday I started this series with a very basic overview of the IPO syndicate market. The reason, as I wrote earlier, was to bring those readers who are new to the equity syndicate process up to speed. Judging from the amount of email I received on that first column, I'd have to say that it was well-timed.

Today we're going to cover the basics of the secondary and follow-on markets and how they tie into the overall picture of equity syndicate. First, here's a little lingo that you'll need to know.

Remember that a company issuing stock for the first time to the public markets is doing an initial public offering (IPO). But a company that is already public and whose stock is already traded on an exchange can issue stock as well. These deals are commonly referred to as secondaries. The term secondary is only correct about half of the time, though, because there are actually two types of deals that occur when a public company increases its float via an underwritten offering -- the secondary offering and the follow-on.

A secondary offering occurs when previously issued stock is offered by one or more selling shareholders. This is done for a number of reasons, most often in the case of a large seller that wishes to liquidate a position without putting heavy downward pressure on the stock. An underwritten offering like this is a much more orderly method of selling a lot of stock, without the unwanted effect of trashing the share price.

A follow-on offering differs from a secondary in that the shares are all primary. By primary, I mean the shares have not been previously issued. These, of course, come from the company itself. Follow-ons are done to raise cash for the company's till for any number of reasons. The money may be earmarked for an acquisition or may be used to buy back and retire some of the company's outstanding debt. If you're curious, the intended use of the proceeds is almost always stated in the filing.

Buying a secondary or follow-on deal is not unlike buying shares in an IPO. The same system of indications of interest (IOIs) is used to organize the marketing and allocation of these deals. The same brokers you would go to for IPO shares are likely to be aware of any secondaries that are being offered as well. And just as with IPOs, the seller pays the commission, which means you pay nothing over and above the offering price. What is different, however, is the way the deals are priced.

When an IPO is marketed, there is a stated price range that is expressed long before the deal is completed. This range is simply the best guess of the investment banking team as to where they think they can sell the shares.

A typical price range may be something like $10 to $12 or $18 to $20. While not a rule, a $2 spread between the upper and lower values is fairly common. By stating a range, the bankers are giving themselves a bit of discretion in the final price of the IPO. Think of it as wiggle room used to match demand with price.

Secondary and follow-on offerings, on the other hand, are priced somewhere in relation to the stock's previous day's closing price. Let's say that a stock closes at $24.50 on the eve of a follow-on offering. Depending on the demand for the deal, the underwriters may price the offering right at the closing price.

Or, as a form of enticement, they may discount the offering to the previous day's close. A heavily discounted deal often offers an instant profit, or "pop," to the investor. Typically, secondaries have nowhere near the potential upside of an IPO, but by carefully selecting which deals to get into, investors can make consistent, if modest, gains.

That about covers the mechanics of secondaries and follow-ons. In my next installment, I'll cover some of what you'll need to know when evaluating an IPO or secondary deal for investment. I'm truly enjoying your email, so keep it coming to me at [e-mail]. And if you have a specific question or need more on the topics I've covered so far, let me know.

Trade safe.

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