3 Ways to Juice Returns with IPOs
Last month Model N (NYSE:MODN), a hot enterprise software company, pulled off a successful IPO. The shares spiked nearly 29%.
It may not have been on par with the giddy 1990s — when it was routine for IPOs to double or triple — but the Model N offering was still impressive.
Hey, who wouldn’t want to book such a return?
Of course, just about any investor would. The problem: most investors are shut out of IPO allocations. They are mostly for favored clients of the investment banks. It’s been this way for decades.
But do not despair. There are still ways to make a buck off of IPOs.
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Keep in mind that the IPO process is highly regulated and structured. Because of this, there is often an interesting playbook for timing certain events, which can have a big impact on the stock price. Often, they lead to some nice signals to short companies!
OK, so let’s take a look at three:
Broken Deal: The first day of an IPO is usually a media-filled event. Hype is normal.
But in some cases, a deal will have trouble. If it falls below the offering price, it is known as a “broken deal.”
Now, the underwriters actually have the ability to make stabilizing bids to prop up the shares (this is allowed under federal regulations). In this case, the IPO may remain near the offering price. Although, this is still a negative sign. All in all, investors are just not thrilled with the prospects of the company and there will likely be ongoing weakness in the stock. For investors, it often means there is a nice opportunity to go short.
This happened with the Facebook IPO, which was unchanged on its first day of trading. Despite the efforts of the underwriters, there was not enough firepower to stabilize the stock. Over a four month period, the shares plunged from $38 to below $20.
Ahead of the IPO, few would have thought that the mighty Facebook would have been a good short. But when the when it turned out to be a “broken deal,” it certainly got the attention of the shorts.
Quiet Period: This means that the underwriters of a company cannot issue research reports — that is, until 40 days after the deal hits the market. As should be no surprise, the analysts are often bullish, even with the various IPO reforms. Thus, when the IPO period expires, there are usually plenty of “buy” recommendations. The result is usually a pop in the stock, say 5% or so. The reason there is usually such a big move is that there is generally a limited supply of shares on the market and it does not take much to move the stock.
But another way to play the “quiet period” is to note any “neutral” or even “sell” recommendations. It certainly takes a lot of guts for an analysts to do this. So when you see this, be wary. There’s a good chance that the company could face serious problems.
This was actually the case with Groupon (NASDAQ:GRPN), which garnered weak coverage from its underwriters. Within six months, the shares would lose about 60% of their value.
Yes, it turned out to be another short opportunity for alert IPO investors.
Lockup Period: This is a contract between the underwriters and the insiders that prevent the sale of shares. In most cases, it lasts for six months after an IPO. The rationale for the lockup is to hold back massive selling during the early stages of a deal.
However, it usually does not help to soften the blow. When a lockup period expires, it’s often the case that the shares will drop. Interestingly enough, the selling generally takes place a week or so before the expiration.
But if the company is solid — and still has strong growth prospects — this could be a great entry point to buy shares. An example is LinkedIn (NYSE:LNKD). About a week ahead of its lockup period expiration, the shares fell 10% to $70.
For those who wanted to get a great social networking company, this certainly turned out to be a good entry point. Within four months, the stock price was over $100.
As with any trading strategies, nothing is full-proof. This is especially the case with the IPO market, which can be extremely volatile.
Yet over time, you’ll begin to see some general themes and trends with the timing of key events. And these can definitely help you get better prices on shares — or to find some lucrative short-sale opportunities.