Thursday, June 9, 2016

Reg A+ Portal Opportunity for Short Sellers?

As a former IPO market maker for a Wall Street investment bank and as one who found short sales for short sellers, I would like to comment on Reg A+ IPO portals. 

As I understand the model, the portal gets companies to list on the portal. The portal then helps the company beat the drum to attract investors. So far so good.

Presumably, the Reg A+ offerings will be smaller and more speculative. Institutional investor interest may be limited and the deal will be placed in some part with small, speculative individual investors. 

Next, when the deal is ready, the investors buy the stock. 

The issues raised are (1) when all the demand is filled, who buys the stock in the aftermarket, and (2) small holders are not necessarily the most stable. 

Historically , there are two IPOs that show the result of these factors.

First, Facebook filled all the demand for stock that it saw. Normally, for a hot issue, you make an indication of interest beyond what you actually want so you can wind up getting what you want. So if you want 100,000 shares, you may request 200,000. Now Facebook was a hot issue so people were making indications for many times what they actually wanted, believing that they would be greatly cut back.

Facebook increased the offering at the last minute to fill all this demand, with the result that not only was there no buying power left, people had more than they actually wanted. The stock price dropped like a stone to nearly half price in a few months. There was no one left to buy in the aftermarket. No demand = price drop. 

Second, Vonage sold to many customers who were small, perhaps even new, investors. The shorts, who love to look for vulnerable IPOs anyway, loved this and drove the price down in the aftermarket to panic these small investors into selling. 

Thus, a process that fills all the demand by selling to small investors, is likely to be bait for short sellers.

By the way, both these deals attracted plaintiffs' attorneys when the price fell. This is automatic. If the stock goes way down, the attorneys show up. Fortunately, they were both successful companies and went on to do well. 

IPO underwriters generally have something called a Green Shoe – https://en.wikipedia.org/wiki/Greenshoe -- which allows the underwriter to buy more stock in a deal. They can go short as much stock is covered by the Green Shoe with no risk because they can always cover the short with the Green Shoe. Thus, the underwriters can afford to support the stock in the immediate aftermarket.

I do not believe any portals will have Green Shoes. 

Time will tell if Reg A+ deals attract short sellers. The offerings may not be large enough. 

The smart company will pay attention to its aftermarket.  

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