The IPO Buzz: Missing in Motor City

To put it all in perspective, GM is just one of 12 companies expected to go public this week.

 

The last time an IPO calendar of this size materialized was for the week of Dec. 10, 2007. That calendar had 14 deals.

 

Besides the $10 billion GM offering, a couple of well-known companies are looking to make their public debuts. If they had been scheduled to go public at any time other than the same week as GM’s expected debut, each would have attracted media coverage:

 

Booz Allen Hamilton Holding (BAH – proposed), a provider of management and IT consulting services, and Caesars Entertainment (CZR – proposed), the world’s largest casino operator.

 

Any way you look at it, one does not smuggle a $10 billion IPO out the door without drawing attention. On Wednesday evening, Nov. 17, GM expects to price 365 million shares at $26 to $29 each to raise $10 billion. How to describe the hype surrounding the pending deal? Let’s just say the circus is in town.

 

Nevertheless, a couple of notable items have emerged from the media blitz. For starters, some securities analysts have been quoted as saying Ford Motor Company (F) is a better investment than the new General Motors Company.

 

When it comes to investing, everybody is an expert.

 

However, numbers are always an important part in making investment calls. Let’s make a quick comparison of the two giant American auto makers.

 

For the nine months ending Sept. 30, 2010, General Motors reported net income of $4.2 billion (or $2.77 per share) on total revenues of $98.7 billion. Using the mid-point of the $26-to-$29 pricing range, this would give GM a nine-month price-to-earnings ratio of 9.9 times.

 

For the nine months ending Sept. 30, Ford Motors reported net income of $6.6 billion (or $1.62 per share) on total revenues of $88.5 billion. Using the close on Friday, Nov. 12, of $16.30 per share, that would give Ford a nine-month price-to-earnings ratio of 10.1 times.

 

Now for the second theme surfacing from the media blitz: Some people have simply gone missing in Motor City. It is being reported that the small investors, also known as “the small fry,” are getting shut out of the GM offering.

 

The media have reported that the GM offering is six times oversubscribed, according to “people near the deal.” If true, then underwriters would have “indications of interest” of over 2.2 billion shares on a 365-million-share offering. It doesn’t take a rocket scientist to figure out demand of this size could result in an opening price premium for General Motors shares. And a pot of honey attracts a lot of bees.

 

There also have been numerous reports that the small investors’ brokers, such as discount brokers, have told them not to expect any GM shares. That is probably true.

 

What most don’t know or understand is how the underwriting procedure works.

 

The process of bringing a company public is a two-prong affair -– one is underwriting and the other is distribution.

 

To be a member of the underwriting group, a banker must receive an invitation from the lead manager to participate in the offering. And not every investment banking firm gets an invitation.

 

An underwriter’s responsibilities are great.  

 

The banker agrees to put its capital on the line and assume all the risks and expenses in bringing a company public. The expenses can run into millions of dollars (this is often the case) and underwriters have been known to loose money rather than to receive a check for their services.

 

The underwriters’ names are listed near the end of the final prospectus as well as the number of shares each banker underwrites.

 

Just because a banker is an underwriter doesn’t mean it will have stock to allocate to its clients. What a banker underwrites and what it gets for its clients are two different things: They’re simply not related.

 

This leads to the second function -– distribution.

 

Those participating in the distribution of an underwriting are members of what is known as the selling group. It includes underwriters and, at times, non-underwriters.

 

The lead manager will offer a non-underwriter a certain  number of shares to sell to its clients. When this happens, its name will not be listed in the final prospectus.

 

One of the biggest secrets in Wall Street’s underwriting world is the number of shares given out to each member of the selling group.

 

Other times, there will be no selling group (other than the underwriters). If your broker is not an underwriter or a member of the non-member selling group (if any), this might be the reason the general public is not getting in on the GM offering. 

 

The thinking is this: If a banker is willing to risk its capital, it should be allowed to supply the demand of its customers ahead of the non-risk-takers.