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Ben's IPO Syndicate Primer, Part 3

Ben Holmes

You're beginning to get it, aren't you? You're starting to notice the signs everywhere that this IPO market is for real. Jim Cramer was absolutely right yesterday when he wrote that the underwriters are giving away free money again. The game is on, people.

So what are you going to do? If you've been involved with IPOs in past cycles, especially the last one, you've no doubt learned a few lessons that will help you this time around. If you're new to the game, believe me, you're in the right place. I'm going to do what I can to bring you up to speed and help you separate the myth from the reality. That's why they keep me around here.

The biggest hurdle you face in buying IPOs is getting your hands on the shares. IPO shares, unlike most stocks already trading in the open market, are usually in an extremely limited supply. This is a function of the number of shares being offered in a particular deal. A typical IPO goes, say, 5 million shares. That's not a lot of stock, and that is what makes it hard to get. Some deals are smaller, some larger.

I've seen dozens of IPOs of the 100 million-or-more share variety, but these are more the exception than the rule. So how do you get your slice of what tends to be a very small pie? Simple. You just have to ask the right people.

To play the IPO game you need to persuade a broker who has access to IPO shares to let you participate. You'll need an account with at least one of the firms that either underwrites deals or acts as a selling group member. Who are they? The easiest thing to do is make up a hit list of those firms that are doing successful IPOs. Merrill Lynch, Morgan Stanley, Goldman Sachs and Credit Suisse First Boston are among the top underwriters. They are the obvious places to go for IPO shares.

Less obvious, but every bit as viable, are firms such as UBS Warburg, Deutsche Bank Alex. Brown, Thomas Weisel and Banc of America Securities. There are literally hundreds of underwriting firms out there. Don't be afraid to stray from the well-worn paths when looking for IPO shares, but don't stray too far. There are plenty of crooked little firms out there looking to get a piece of the action. The best advice on this I can give you is to stick to the big-name houses or the smaller regionals that have lengthy track records.

OK, so you've identified a nice young man in a suit who says he can get you shares in the IPOs his firm underwrites. You've filled out the myriad forms and dropped some dough in your account. Now what? Most brokers will indulge a new account with a small allocation of shares in an IPO, but after that initial kiss, they are going to want something in return if they are to keep taking care of you. This is where it gets complicated.

The brokers know full well that in a hot market, those IPO shares are worth their weight in gold. Remember that in most cases, those shares are in limited supply. Now consider that there are many, many brokers involved in the game, and each of them has a client book full of mouths to feed. In order to stand out in a broker's client book and therefore garner significant allocations of stock, you've got to bring something to the party. This can be assets -- stocks, bonds or cash -- or even more enticing, commission dollars.

Remember that brokers get paid by dropping buy and sell tickets to execute their clients' orders. If you help your broker out by giving him business, he's more likely to look favorably on your requests for IPO shares. The common saying in the business is "IPOs go to the biggest clients." In a way this is true, but "biggest" doesn't always equal "most profitable" for a broker. A small to medium-sized trading account that is active and ongoing is money to a broker. Compare this with a big portfolio of muni bonds and utility stocks that hasn't moved a nickel in years, and the choice for allocating is obvious. Pay your brokers and they should pay you.

As you've probably figured out by now, there is a lot to this IPO thing. My advice is to read everything you can get your hands on and ask lots of questions. Most important, however, is to use your head and be persistent. I know hundreds of RealMoney readers who have been successful at breaking into the IPO market. Stick around -- your turn is coming.

On Friday, I'll look at how this week's IPOs performed and highlight some upcoming deals. Stay tuned.