Some IPO Basics, and a Take on Amerigroup

It seems that every new IPO market brings with it an army of inexperienced investors trying to find their way through what many believe is a closed door. Having been there myself at one point, I know how frustrating it can be to get a handle on how the IPO market works.

Last week I received a number of emails from readers who are just starting out buying IPOs. The questions they ask are very basic. This tells me that it's time again to write a primer on how the game works. Not a problem -- that's what I'm here for. Let's go over what I think are the need-to-know fundamentals. If I miss anything, you can write me with more questions and I'll handle them in my next column.

A good place to start is with some common language. Some of the terms that I frequently use in my dispatches spawn little email floods asking what the heck I mean, so here are a few you should know.

IPO, of course, stands for initial public offering. This is the first round of stock offered by a private company to the public markets. It is for this reason that companies doing an IPO are often said to be "going public."

Syndicate, or equity syndicate, refers to the community of underwriters and their personnel who put together and coordinate the marketing of the stock offerings that are IPOs and secondaries. For now, we'll limit our discussion to IPOs (if you're interested in knowing the basics on secondaries, email me and we'll cover them in another column).

IPOs are of two types, underwritten and best efforts. An underwritten deal is one in which a syndication of brokerage firms buys a specified number of shares from the company going public, marks them up and then sells those shares to buyers at a fixed price. These buyers are the customers of the brokerage firms. A best efforts deal, on the other hand, occurs when one or more brokerages use their "best efforts" to try to sell as many shares as they can at a specified price. There is usually a minimum number of shares required to be sold in order for the deal to be done. Because of the iffy nature of best efforts deals, I don't cover them and I recommend that you don't buy them. Stick to underwritten IPOs and you'll avoid some very serious risk issues.

OK, so how do you buy an IPO? I'll answer this one on a purely mechanical basis and leave the question of which ones you should buy for my future columns.

To purchase shares in an IPO you need to enter a type of order known as an indication of interest or IOI. This IOI is transmitted by your broker to his syndicate department and tells them that you are interested in buying a specified number of shares of that deal. Your IOI is pooled with the others entered at that firm, which are then communicated to the managing underwriter of the deal.

The managing underwriter, often referred to as the lead underwriter, decides which accounts get stock and how much. Once enough IOIs are collected to distribute the entire deal, and the IPO has clearance from the Securities and Exchange Commission to be sold, the deal is priced, shares are allocated and the stock opens for trading. That's the basic framework. Chew on this for a while, then send me any questions you have.

Now, on Friday, I promised you my opinion on the IPO of managed-care company Amerigroup (proposed symbol AMGP:Nasdaq), out of Banc of America Securities. This deal is scheduled to price tonight for tomorrow's trading. As I mentioned last week, this deal was originally filed in May of 2000. After 535 days, this one is a bit "long in the tooth" as far as registrations go. For comparison, the deals that priced in October of 2001 averaged 165 days in registration before they went to market. Normally, a fact like this would just kill my enthusiasm for a deal. Not so on Amerigroup.

The company has managed to improve its balance sheet and some key operating ratios in what has been a very tough economic period. The string of pricing postponements has amounted to what must be a very frustrating time for the company, but it's hung in there. My feeling is that the market is right for Amerigroup. I'm calling it up anywhere from 5% to 15% in the first session.