Dictionary Stock Market

8/6/2019 Dictionary Stock Market

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American Depositary Receipts (ADRs) — These are offered by non-US companieswishing to list on a US exchange. They are called "receipts" because they represent acertain number of a company's regular shares.

Aftermarket performance — Used to describe how the stock of a newly public

company has performed with the offering price as the typical benchmark.

All or none — An offering which can be canceled by the lead underwriter if it is notcompletely subscribed. Most best-effort deals are all or none.

Best effort — A deal in which underwriters only agree to do their best to sell shares tothe public, as opposed to much more common bought, or firm commitment, deals.

Book — A list of all buy and sell orders put together by the lead underwriter.

Bought deal — An offering in which the lead underwriter buys all the shares from a

company and becomes financially responsible for selling them. Also called firmcommitment .

Break issue — Term used to describe a newly issued stock that falls below its offering price.

Completion — An IPO is not a done deal until it has been completed and all trades have been declared official. Usually happens about five days after a stock starts trading. Untilcompletion, an IPO can be canceled with all money returned to investors.

Direct Public Offering (DPO) — An offering in which a company sells its shares

directly to the public without the help of underwriters. Can be done over the Internet.Liquidity, or the ability to sell shares, in a DPO is usually extremely limited.

Flipping — Buying an IPO at the offering price and then selling the stock soon after itstarts trading on the open market. Greatly discouraged by underwriters, especially if done by individual investors.

Greenshoe — Part of the underwriting agreement which allows the underwriters to buymore shares — typically 15% — of an IPO. Usually done if a deal is extremely popular or was overbooked by the underwriters. Also called the overallotment option.

Gross spread — The difference between an IPO's offering price and the price themembers of the syndicate pay for the shares. Usually represents a discount of 7% to 8%,about half of which goes to the broker who sells the shares. Also called the underwriting

discount .

Indications of interest — Gathered by a lead underwriter from its investor clients beforean IPO is priced to gauge demand for the deal. Used to determine offering price.



Initial public offering (IPO) — The first time a company sells stock to the public. AnIPO is a type of a primary offering, which occurs whenever a company sells new stock,and differs from a secondary offering, which is the public sale of previously issuedsecurities, usually held by insiders. Some people say IPO stands for "Immediate ProfitOpportunities." More cynicIt's Probably Overpriced."

Lead underwriter — The investment bank in charge of setting the offering price of anIPO and allocating shares to other members of the syndicate. Also called lead manager .

Lock-up period — The time period after an IPO when insiders at the newly publiccompany are restricted by the lead underwriter from selling their shares. Usually lasts 180days.

New issue — Same as an IPO.

Offering price — The price that investors must pay for allocated shares in an IPO. Not

the same as the opening price, which is the first trade price of a new stock.

Opening price — The price at which a new stock starts trading. Also called the firsttrade price. Underwriters hope that the opening price is above the offering price, givinginvestors in the IPO a premium.

Oversubscribed — Defines a deal in which investors apply for more shares than areavailable. Usually a sign that an IPO is a hot deal and will open at a substantial premium.

Penalty bid — A fee charged to brokers by the lead underwriter for having to take back shares already sold. Meant to discourage flipping.

Pipeline — A term used to describe the stage in the IPO process at which companieshave registered with the SEC and are waiting to go public.

Premium — The difference between the offering price and opening price. Also called anIPO's pop.

Prospectus — The document, included in a company's S-1 registration statement, whichexplains all aspects of a company's business, including financial results, growth strategy,and risk factors. The preliminary prospectus is also called a red herring because of thered ink used on the front page, which indicates that some information � such as the price

and share amounts�

is subject to change.

Proxy — An authorization, in writing, by a shareholder for another person to representhim/her at a shareholders' meeting and exercise voting rights.

Quiet period — The time period in which companies in registration are forbidden by theSecurities and Exchange Commission to say anything not included in their prospectus,which could be interpreted as hyping an offering. Starts the day a company files an S-1



registration statement and lasts until 25 days after a stock starts trading. The intent andeffect of a quiet period have been hotly debated.

Road show — A tour taken by a company preparing for an IPO in order to attract interestin the deal. Attended by institutional investors, analysts, and money managers by

invitation only. Members of the media are forbidden.

Selling stockholders — Investors in a company who sell part or all of their stake as partof that company's IPO. Usually considered a bad sign if a large portion of shares offeredin an IPO comes from selling stockholders.

S-1 — Document filed with the Securities and Exchange Commission announcing acompany's intent to go public. Includes the prospectus; also called the registration statement .

Spinning — The practice by investment banks of distributing shares to certain clients,

such as venture capitalists and executives, in hopes of getting their business in the future.Outlawed at many banks.

Syndicate — A group of investment banks that buy shares in an IPO to sell to the public.Headed by the lead manager and disbanded as soon as the IPO is completed.

Venture capital — Funding acquired during the pre-IPO process of raising money for companies. Done only by accredited investors.

All-hands

A company that is thinking about going public should start acting like a public company

as much as two years in advance of the desired IPO. Several steps experts recommendinclude preparing detailed financial results on a regular basis and developing a business plan.

Once a company decides to go public, it needs to pick its IPO team, consisting of the leadinvestment bank, an accountant, and a law firm.

The IPO process officially begins with what is typically called an "all-hands" meeting. Atthis meeting, which usually takes place six to eight weeks before a company officiallyregisters with the Securities and Exchange Commission, all the members of the IPO team plan a timetable for going public and assign certain duties to each member.

Selling the deal

The most important and time-consuming task facing the IPO team is the development of the prospectus, a business document that basically serves as a brochure for the company.Since the SEC imposes a "quiet period" on companies once they file for an IPO -- whichgenerally lasts until 25 days after a stock starts trading -- the prospectus will have to domost of the talking and selling for the management team.



The prospectus includes all financial data for a company for the past five years,information on the management team, and a description of a company's target market,competitors, and growth strategy. There is a lot of other important information in the prospectus, and the underwriting team goes to great lengths to make sure it's all accurate.We take a closer look at the prospectus in part three of this series.

Once the preliminary prospectus is printed and filed with the SEC, the company has towait as the SEC, the National Association of Securities Dealers (NASD), and other relevant state securities organizations review the document for any omissions or problems. If the agencies find any problems with the prospectus, the company and theunderwriting team will have to make fixes with amended filings.

In the meantime, the lead underwriter must assemble a syndicate of other investment banks that will help sell the deal. Each bank in the syndicate will get a certain number of shares in the IPO to sell to clients. The syndicate then gathers indications of interest fromclients to see what kind of initial demand there is for the deal. Syndicates usually include

investment banks that have complementary client bases, such as those based in certainregions of the country.

On the road

The next step in the IPO process is the grueling whirlwind multicity world tour, alsoknown as the road show. The road show usually lasts a week or two, with companymanagement going to a new city every day to meet with prospective investors and showoff their business plan.

The typical US stops on the road show include New York, San Francisco, Boston,Chicago, and Los Angeles. If appropriate, international destinations like London or Hong

Kong may also be included.

How a company's management team performs on the road show is perhaps the mostcrucial factor determining the success of the IPO. Companies need to impressinstitutional investors so that at least a few of them are willing to purchase a significantstake.

The road show is also the most blatant example of how unfair the IPO market can be for the average investor. Only institutional and big-money investors are invited to attend theroad show meetings, where statements regarding a company's business prospects --discussed only minimally in a prospectus -- are talked about quite openly. According to

the SEC, such disclosures are legal, as long as done orally.

The SEC hasd new rules that, ifapproved, will make it easier for companies to broadcasttheir road showsover the Internet.

Once the road show ends and the final prospectus is printed and distributed to investors,company management meets with their investment bank to choose the final offering priceand size.

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Investment banks try to suggest an appropriate price based on expected demand for thedeal and other market conditions. The pricing of an IPO is a delicate balancing act.Investment firms have to worry about two different sets of clients -- the company going public, which wants to raise as much money as possible, and the investors buying theshares, who expect to see some immediate appreciation in their investment.

Investment banks usually try to price a deal so that the opening premium is about 15%.Of course, many hot Internet IPOs have risen much more than that on their first day.

If interest in an IPO appears to be flagging, it's common for the number of shares in theoffering or their price to be cut from the expected ranges included in a company's earlier registration statements. If a deal is especially hot, the offering price or size can also beraised from initial expectations. Although it is rare, a company can postpone an offering because of insufficient demand.

Let the games begin

Once the offering price has been agreed on -- and at least two days after potentialinvestors receive the final prospectus -- an IPO is declared effective. This is usually doneafter a market closes, with trading in the new stock starting the next day as the leadunderwriter works to firm up its book of buy orders.

The lead underwriter is primarily responsible for ensuring smooth trading in a company'sstock during those first few crucial days. The underwriter is legally allowed to supportthe price of a newly issued stock by buying shares in the market or selling them short(which means selling shares it doesn't have in its account). It can also impose penalty bids on brokers to discourage flipping, which is selling shares in an IPO soon after thestock starts trading. This ability to control the price of an IPO somewhat is one reason

investors feel it's such a negative when a stock quickly falls below its offering price.

An IPO is not declared final until about seven days after the company's market debut. Onrare occasions, an IPO can be canceled even after a stock starts trading. In such cases, alltrading is negated and any money collected from investors is returned.

All-hands

Adequate research is, without a doubt, the most effective way to identify and stay awayfrom the IPO disasters waiting to happen. The prospectus, which contains nearly allaspects of a company's business and game plan, is the first place any investor interestedin purchasing a new issue should look.

Finding an online prospectus is a snap

Getting a prospectus is easy. If you're reading this online, you should be able toelectronically download a prospectus without any problem. Prospectuses for all UScompanies are available for free from the Securities and Exchange Commission's Website, FreeEDGAR.com, or on a delayed basis from EDGAR Online.



If you don't have access to a computer -- or your access is too slow for downloading a prospectus (which is an extremely long document) -- you can also obtain a prospectus bycalling the investment banks that are involved in selling the shares of an IPO. Calling thecompany will also work.

The fine print: A confusing readWarning: A prospectus is not an easy read. Written mostly by lawyers, they are ladenwith confusing jargon.

In addition, the tone of these documents is decidedly negative. Companies have to becompletely honest about all of their warts in order to avoid future lawsuits. Thus, bullishstatements are often followed by cautionary disclaimers, and there's an entire sectiontitled "Risk Factors" dedicated to what may go wrong at the company.

Before you get scared off from investing in an IPO, however, you should realize thatmany of these risk factors and disclaimers are included in every prospectus. Then again,

just because they're boilerplate doesn't mean you shouldn't pay attention.

Following is a list of some warning signs that prospective IPO investors should pay closeattention to. In general, they're listed in order of where one would find them in the prospectus, from the front of the document to the end.

Again, this is only a partial list, and in the final analysis, what's most important is that aninvestor feels comfortable with a company, its business, its market position, its growthstrategy, and its management.

Second-tier investment banks -- Investment banks hired by a company to handle an IPO

must do a fair amount of due diligence, so it's always comforting when the names on thefront of a prospectus are well-known and well-regarded. Of course, even the best bankstake out some turkeys. Plus, a number of small regional banks have solid reputations. Just be a little more careful if the name of the investment bank doesn't ring a bell. Found on bottom of front page.

Recent developments -- This section, usually added to amended filings, updates anyrecent notable events, often how a company performed in its most recent quarter. Makesure this section is mainly good news. Usually found in "Recent Developments" (notalways there).

Selling stockholders -- It's usually a bad sign when a large number of shares in an IPOcome from selling stockholders, meaning pre-offering investors who are cashing out. Notonly does it mean that the company won't receive the money from the sale of thoseshares, but it also should make one wonder why investors would want to sell their sharesso quickly if a company's prospects are strong. In fact, investors usually prefer thatmanagement retain a sizable stake in the firm after the offering is completed. The number of selling stockholders is found in a section called "The Offering," while management'stotal stake can be found in "Principal and Selling Stockholders."



Use of proceeds -- If a company is st majority of the money to pay off debt or dole out ahuge dividend to pre-IPO investors, watch out. That means people buying shares in theIPO are in essence paying for the company's past, not its future. Also be careful when acompany says it's allocating most of the money for general corporate purposes. It'scomforting if a company has more specific ideas about where your money will be

invested -- acquisitions, advertising, capital formation, research and development, etc.Found in "Use of Proceeds."

Declining revenue -- If revenue for a company's most recent fiscal year is down from theyear-ago period, it may be time to run as far away as possible. Revenue for companieslooking to go public should be growing rather significantly. Even slowing revenuegrowth is a warning sign. At the very least, read a company's explanation for the revenueslowdown, found later in the prospectus. Revenue totals can be found in "SummaryConsolidated Financial Data" or "Selected Consolidated Financial Data." The explanation behind the results is found in "Management's Discussion and Analysis of FinancialCondition and Results of Operations."

Declining margins -- Along the same lines as declining revenue, declining operatingmargins are not a good sign. It means the company is becoming less and less profitable.However, if a company is in a fast-changing, highly competitive industry, it may need tosacrifice profitability for market share and brand equity. Again, read the explanation behind the shrinking margins. Margin totals found in "Summary Consolidated FinancialData" or "Selected Consolidated Financial Data." Explanation behind results can befound in "Management's Discussion and Analysis of Financial Condition and Results of Operations."

Working capital deficit -- This is when a company's liabilities, or debts, are greater than

its assets. This is not uncommon for a new issue, but it should be explained and shoulddisappear on an "as adjusted" basis after the completion of the offering. Details can befound in "Summary Consolidated Financial Data" and an explanation is in "Liquidity andCapital Resources."

Other financial red flags -- A number of other problems can be found on a company's balance sheet or income statement. Things such as inventories or accounts receivablerising more rapidly than revenue, high interest expenses, or extraordinary charges should be explained. Found in "Selected Consolidated Financial Data" with more detail in the"Index to Consolidated Financial Statements."

Over-reliance on one customer-- A clear danger sign. Several IPOs have imploded

after the companies announced they were losing one of their major customers. Of course,like all of these warning signs, there are exceptions. Found in "Risk Factors."

Supplier reliance -- A company can be too reliant on its suppliers as well as itscustomers. Make sure a firm can switch from one supplier to another rather easily.Suppliers that double as competitors are another danger. Found in "Risk Factors."



Competition -- Given that monopolies are illegal, competition will always be there, butyou better watch out if some well-run, well-capitalized firms are on the list. One namethat jumps quickly to mind: Microsoft. Found in "Risk Factors" and "Business."

Other risk factors -- Patent disputes, heavy indebtedness, and litigation are just some of

the other more dangerous risks. Read the entire "Risk Factor" section carefully, but don'tget overly discouraged.

Too-small pie -- No matter how effective a company is at selling widgets, there needs to be enough people willing to buy those widgets at high-enough prices. A company's targetmarket should be large and rapidly growing. This information can be found in the"Business" section.

Decliningvaluation -- Pre-offerint an IPO be priced so they get a huge return on their initial investment, often as much as 10 times. You can find out what those originalinvestors paid on average for their shares in the section entitled "Dilution." Compare that

to the offering price. If the two prices are close, then you can bet pre-IPO investors at one point were too optimistic about the valuation for the company. While it may seem like agood deal to buy a company for about the same price as earlier investors, there's a reasonfor the lower valuation. On very rare occasions, IPO investors can actually pay less onaverage than the company's pre-offering backers.

Overvaluation -- A lot of factors go into determining an IPO's offering price and not allof them have to do with the price-to-sales or price-to-cash flow multiples that determinethe value of most other stocks. Unfortunately, professional investors are at an advantagesince they can often find out a company's sales and earnings projections. As a regular retail investor, you won't get any future estimates until analysts start covering the new

issue about 25 days after the stock starts trading. Still, you can compare how companiesare valued to past results. Just take the number of shares outstanding after the offering,multiply it by the expected offering price (take the midpoint of the listed pricing range),and find out what the market value of the company will be. Then, divide that figure bythe firm's revenue and profit for the past four quarters. Hopefully, these multiples,although rough calculations, will be comparable to similar publicly traded companies. Number of shares outstanding is found in "The Offering," expected offering price rangeis usually found on the front page (but it is not always there), and quarterly sales resultsare usually found in "Selected Consolidated Financial Data" (if quarterly results are notavailable, use results from the most recent fiscal year).

Overcompensated or overmatched management-- You usually don't want members of

the management team in a newly public firm to be making hundreds of thousands of dollars in base salary. Rewards are fine, but make sure most of them are in the form of stock options. That way, management will only be rewarded if the shareholders are. Also,look for a management team that has extensive experience in the industry and/or withother public companies. A chief financial officer with little experience running a publiccompany could be overwhelmed by the duties. In addition, watch out for an executive





getting (the lead underwriter will have the largest allotment), how large your account is,how much trading you do, how close your relationship is with your broker, how wellyour broker knows the business, how successful your broker is, etc.

Many brokers, especially the greener ones, don't even realize they could get IPO

allocations for clients. Brokers get fat commissions for selling shares in new issues, sothey're usually reserved for the best, most industrious salespeople.

If you want to invest in an IPO but don't have a relationship with one of the managing banks, you can also try to start an account, making it a condition that you receive someshares in the new issue you're interested in, but you may not have much luck with thistactic. IPO shares are saved to reward a firm's biggest, most active, and longest-standingcustomers.

With an electronic brokerage that's participating in an IPO, the allocation process is moreobjective, although no less difficult. Some firms, such as DLJDirect, only give shares to

customers with a certain account size; others allocate shares based on statistics such astrading frequency to reward their best and most profitable customers.

Wit Capital uses a quasi first-come, first-served system, allocating shares via a randomlottery to all investors who respond to their solicitation e-mails within a certain timeframe.

Of course, even investors able to get shares in an IPO willnot be able to sell those sharesright after the stock starts trading, a process called flipping that is often employed byinstitutional investors to boost returns. Try to flip, and you'll probably never get anallocation in an IPO again, at least not from the same broker.

Electronic brokers are particularly harsh against quick sellers. Wit Capital, for instance,says it puts those who sell their IPO shares in the first 60 days at the bottom of the priority list in upcoming deals, while E-Trade also punishes flippers by restrictingallocations in the future.

Patience is a virtue

If you can't get in on an IPO at the offering price, what's the next best time to invest?Analysts have differing opinions on this, but most agree on one point: You must be patient.

It may be incredibly exciting to watch a stock like Netscape or theglobe.com soar on thefirst day of trading, but it's a potentially dangerous way to invest, especially if you're planning to be in for the long term.

When a stock first starts trading, its price will nearly always rise to an artificially highlevel. First of all, investor demand is often unusually heavy because of the hypesurrounding an IPO and the strong selling effort employed by the syndicate





its own research and only sells to individual investors. "Institutions may be deal hogs, butthey demand research and provide credibility," she says.

A small deal is an IPO which places a company's market value (shares outstanding timesoffering price) at less than $50 million, Smith adds.

Funds and (gasp!) shorting

If you don't have the time to do adequate research for your own stock picking, you maywant to consider putting money in a growth-oriented mutual fund that invests heavily innew issues. Renaissance Capital has started such a fund, and you can contact Morningstar for others out there that fit the bill.

Finally, an investor may want to consider shorting a new issue, which is when an investor sells borrowed stock in hopes of buying it back at a lower price and pocketing thedifference.

Shorting a hot IPO is a dangerous strategy that Smith says requires a "stomach of steel," but if timed right (wait until all the initial momentum has faded), the opportunities arelarge. In order to short a stock, you'll have to find shares to borrow, which isn't easy in anew issue, and you'll need a margin account with your broker.

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