Don’t Be Upset About Missing Out on Alibaba

Posted in: Economics, General, Stock Market, Thought of the Week

Alibaba (ticker: BABA) is a Chinese ecommerce company that recently completed their Initial Public Offering (IPO) on the New York Stock Exchange and the deal size ended up being one of the largest in history. The media and investment community had eagerly anticipated this IPO given the growth potential for the company over the coming years. In fact, demand was so high that for every share available for sale, there were more than 10 willing buyers. Many investors were frustrated and confused as to why they were not able to participate in such a “hot” IPO. Before we explain why individual investors were left out of this deal while so many others made a quick buck, let’s first explain how the IPO process works.

When a company chooses to go public, the first step is to hire an investment bank to facilitate the sale of their stock, which is typically targeted towards big-time money managers. These banks have deep relationships with the largest money managers across the globe, and companies would much rather pay a bank to make these introductions than to try to sell the stock on their own. The process is similar to using a real estate agent to sell a house. These bankers initially target investors with billions under management because they can buy large amounts of stock and are generally considered long-term holders. Management teams strongly prefer to sell their stock to investors who will hold the stock for many years because they believe in the strategic direction of the company.

A few days before the IPO, investment banks will begin the process of soliciting orders from these investors. If a money manager is interested, they will tell the bank exactly how much stock they want. The bank then compiles all of the orders to see how the overall demand compares to the amount of stock being sold. The main purpose for all of the work from the bankers is to determine where to price the stock for the first time. Bankers are often in a tough spot on hot IPOs because on one hand, they were hired by the company to get the best price for their stock, while on the other hand, they cannot price too high and potentially damage their relationships with big investors who may feel that they got a bad deal.

Simply put, retail investors and even most medium-sized institutional investors rarely get an opportunity to get an allocation of a hot IPO because the bankers would much rather put this stock in the hands of those with the most money to spend. Smaller investors will typically only receive allocations in IPOs when the bigger money managers have little interest in participating.

Alibaba made a lot of money for those investors who received an allocation by the bankers. The stock was priced in the mid $60s but opened in the low $90s. Now the shares are available for purchase in the same manner as any other stock on the New York Stock Exchange. However, it is important to remember that newly traded stocks carry a tremendous amount of risk during the first year because it takes a while for a stock to trade on fundamentals. The bottom line is that our Investment Committee urges investors who missed out on BABA to sleep well knowing that getting such an allocation is nearly impossible. Furthermore, if you are ever offered to participate in an IPO in the future, keep in mind that you are only getting the change because the larger, more sophisticated investors did not like the deal and chose to pass.

Read this week’s Thought of the Week to learn more about the Alibaba IPO.

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As an Investment Advisory Representative working in conjunction with Global Financial Private Capital (GFPC) we are provided weekly thoughts on what is happening in the economy and the market. Written by our investment committee at GFPC we find these thoughts to be informative and interesting.