Initial public offerings
Initial public offerings, commonly referred to as IPOs or share floats provide an opportunity to invest in a company prior to the initial listing and trading on a stock exchange.
Examples of past opportunities include AMP, Commonwealth Bank, Telstra, and Medibank Private.
If you are considering taking part in an upcoming IPO, you may be able to use your Margin Loan to subscribe for shares.
The attraction of an IPO is the potential under-pricing of the issue price relative to the first few days of trading. It is not unusual to see an issue price 25 per cent below the market price during the first week after an initial offer. Of course, for every successful IPO there are others that incur a loss over the initial listing period.
Margin lending is not available for all IPOs although if there is sufficient demand from investors most margin lenders will consider applying an LVR. In any event, it may not be practical to invest in all IPOs. When used appropriately, borrowing against an IPO can add good returns, complementing a well constructed medium-term investment strategy.
Get to know IPOs
Upcoming IPOs
| Code | Security name | LVR | Concentration limit | Activate a new margin loan facility by | Closing date for broker firm offers | Trading on ASX begins |
|---|---|---|---|---|---|---|
| WBCPI | Westpac Capital Notes 6 | 70% Standard, 75% Diversified | 50% | 10 December 2018 | 11 December 2018 | 19 December 2018 |
Using your margin loan in an IPO
Typically an IPO will comprise numerous offers to participate, as outlined below:
| Offer type | How do I apply? | How do I pay for the shares using my Margin Loan? (Subject to available funds) | When will a Lending Ratio apply? (If applicable) |
|---|---|---|---|
| Broker firm | Contact your broker about a firm allocation | If successful, instruct your broker to settle to your Margin Loan in the same manner as you do for your day to day trading | At the time of settlement |
| General | Complete the application form attached to the prospectus | Contact your Leveraged Relationship Manager to organise a cheque or a funds transfer to your nominated bank account | Once shares are allocated to your Margin Loan |
| Shareholder | You will receive a personalised application form | Contact your Leveraged Relationship Manager to organise a cheque or a funds transfer to your nominated bank account | Once shares are allocated to your Margin Loan |
Let's look at an example
Under-pricing is the attraction
The attraction of an IPO is the potential under-pricing of the issue price relative to the first few days of trading. It is not unusual to see an issue price 25 per cent below the market price during the first week after an initial offer. Of course, for every successful IPO there are others that incur a loss over the initial listing period.
A real world example
An example of IPO under-pricing is Regis Healthcare Limited (ASX Code REG). REG was offered on 6 October 2014 at a price of $3.65. A week later, the average traded price for REG was $3.99. That was 10% growth over one week, when the overall market fell by around 3%.
Mix in some sensible borrowing and you have a potentially profitable short term strategy. Assume you have $10,000 to invest. Interest on a margin loan is currently 6%p.a. and you are in the second highest marginal income tax bracket (39% including Medicare Levy).
You buy REG through the initial offering and sell a week later at the prices shown above. This means the 50% discount on capital gains tax will not be available. During that time no dividends are paid.
If you borrow $10,000 for the week, investing a total of $20,000 your return over the week would have been 12.20% after tax. Compare this to an after-tax return of 6.10% over the week if you had not borrowed to increase your stake. Obviously, the outcomes would be reverse if the price had fallen.
Something else to keep in mind
The other point to keep in mind is that IPO securities tend to have lower loan-to-value (LVR) ratio. Leveraged Equities for example has an LVR of 55% for REG compared to a more typical 75%. In the example above, your gearing ratio (loan divided by portfolio value) starts at 50%. This means the portfolio would have to fall by 23% from its initial price before triggering a margin call (assuming a 10% buffer).
Risk management
Even if you are comfortable with borrowing close to the LVR, prudent investors implement a variety of risk management tools. A short term geared investment should be part of a diversified portfolio which includes some liquid investments to cover unexpected outcomes. Higher risk strategies such as borrowing close to an LVR, ought to be monitored more frequently. Finally, set target returns, both profit and loss, and sell the investment when it achieves the target, both good and bad. And of course, never borrow beyond your capacity to meet repayments.
IPOs can be a longer term strategy too
While we have focused on a very short time frame this does not suggest that an IPO can not be held as part of a longer term strategy. For example, Aurizon Holdings Limited (previous QR National Limited) was offered at $2.84 on 26 November 2010 and is currently around $4.25. This is an annual growth around 13% excluding dividends.