My question is about the price of certain stocks that incredibly start losing value in the first day of trading without any negative news. I have seen stocks losing 50% to 60% of their initial price in a few weeks. How can that be possible? Who is dumping something they just bought? -- Eros Grando
New Coke, the McDLT and the USFL.
All these heavily hyped products fell flat not long after their introduction.
The same thing can happen to a stock.
If no one is there to buy a new stock once it starts trading, its price will plummet.
, an online coupon distributor, went public at $7 a share a few weeks ago and fell well below $6 by the end of its first day of trading.
, an online network of sites for music fans, fell in March from an offering price of $12 to less than $10 a share on its first day.
In fact, 20 of 179 U.S. public offerings this year (through May 25) fell on their first day of trading, according to
. That works out to about 11% of the companies that have gone public in 2000.
Despite the fact that the initial public offering, or IPO, market has withered during the past few months, that percentage is in line with last year's number. In 1999, 57 of 510 companies that went public, about 11%, fell on their first day of trading.
That data tells you how often this happens. The bigger question is: Why?
When a company goes public, a group of investment banks underwrite the offering. The lead underwriter -- the investment bank in charge -- oversees how shares of the new stock are allocated and to whom.
If the investment banks sell shares to every interested buyer during the offering, no one is left to buy after the stock starts trading. The key is have heavy demand among those investors who
get shares on the offering.
In a perfect world, the underwriters are supposed to prevent this from happening. Investment banks are responsible for gauging the demand in the market, pricing the stock appropriately and making sure the offering is placed in the hands of investors that they hope won't dump the stock immediately.
Ultimately, though, the underwriters cannot ensure that everyone who bought it is a long-term investor and they cannot prevent the people who bought the stock from selling.
When a stock is hot, investors often flip, or quickly sell it, for a quick profit. If the stock starts trading down immediately due to lack of demand, investors might sell just as quickly, this time to cut their losses.
A large institution that manages billions of dollars might not hesitate to dump an IPO that starts falling, especially when it represents a tiny portion of its overall portfolio. The minute the stock breaks through its offering price, those institutions might start selling.
Some recent IPO flops can be blamed on the horrendous market conditions. The
Nasdaq Composite Index
is down 31.8% since the end of February and investors are rejecting stocks that won't have profits in the near future.
A stock like Coolsavings.com is going to be out of favor to begin with. People had already lost enthusiasm for Internet stocks," says Randall Roth, senior analyst with
, which runs the
IPO Plus Aftermarket fund. "The market conditions are tough and there's no interest because the market is bad."
The smart thing for companies to do in this situation is pull the IPO. Steve Riddick, a partner with the law firm of
Brobeck Phleger & Harrison
in Washington, D.C., says of the 10 public offerings his firm was working on in late April, seven were called off.
"A couple of them were dot-coms that weren't going to be profitable in the next few years," Riddick says. "They were seeing comparable companies getting hammered in the marketplace, which mean they would get hammered."
Among the high-profile companies that have pulled their IPOs this year, are Internet portal
and natural gas powerhouse
Duke Energy Field Services
When IPOs go out and sink like a rock on the first day, the investments banks should bear at least some of the blame. However, the issuer could be the one putting pressure on its underwriters to complete the offering. A new company's growth and expansion plans might hinge on receiving an infusion of cash from its IPO, so an overly cautious investment banker may find itself pushed aside.
, a Chicago-based business-to-business company, recently replaced its lead underwriter
Credit Suisse First Boston
because CSFB wanted to further postpone the firm's IPO, according to the
One sign that an underwriter is desperate to get a deal done is that it resorts to selling shares to just about anyone. That anyone is often the individual investor.
Retail investors are considered to be the bottom of the food chain by many investment banks, issuers and institutional investors. Small investors are seen as the people most likely to immediately dump a stock and are considered by many a last resort in selling an IPO.
"If banks start throwing shares at you for one reason or another, especially if you don't normally get them, the first thing that should cross your mind is: Why now?" says Renaissance's Roth. If your brokerage firm starts offering you IPO shares when you haven't had access to them in the past, tread carefully.
You might be a buyer of last resort in an IPO underwriting. In this market, you should use more than a little skepticism in evaluating anything that's offered to you.
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