Warning signals generally ring out for professional investors when a huge private business decides to opt for an initial public offering (IPO) on the markets.
Three questions should spring to mind for investors –
- Who is selling?
- Why are they selling?
- Can anyone massage the IPO share price by inflating earnings and expectations for the company?
In many IPOs, the answers to the questions are straightforward – the seller is someone who has been with the business from day one and owns a majority of the shares for sale and they have the ability to influence the share price.
This seller can influence the share price by cutting costs or putting off capital investment before the IPO to highlight profits.
Putting a gloss on the offering
Putting a gloss on the figures can make the IPO more attractive and encourages investors – and as demand rises and supply of shares diminishes, the price is pushed up.
Often for these reasons, institutional investors steer clear of IPOs, but the recent Alibaba offering on Wall Street is different.
Banks and institutional investors have jostled with each other to buy millions of shares, pushing the opening price more than a third above the expected $64 – $68.
So what’s different about Alibaba?
The firm is the largest ecommerce platform in China with unique access to a huge marketplace.
Besides offering a shoe-in into China, the platform works in reverse and allows Chinese businesses to show their wares to the rest of the world through the portal.
However, the big pull for professional investors was the founder, Jack Ma, was selling few shares. The market driver was internet firm Yahoo! profit-taking by divesting much of their minor shareholding.
Low expectations
This was important because Yahoo! had no executive influence over the running of the company and could not put a spin on the financials.
One investment house looking seriously at Alibaba was Invesco.
Their opinion was this was not a typical IPO and that the company was looking more at protecting and promoting their brand rather than marching off with big profits.
“We had several meetings with Alibaba executives and the management clearly was not encouraging investors to seek excessively high expectations for future growth. They told us margins could well fall in the future,” said fund manager William Lam.
These favourable indications led Invesco to join the queue of suitors that led to a vastly oversubscribed IPO.
