Funny what you don’t know about investing until you try to do it yourself.
As a journalist, I’m not an especially active investor for conflict-of-interest reasons. My portfolio, as I laughingly call it, is handled by my brilliant PSG financial adviser who makes all the substantive investment decisions. But occasionally I do invest directly through EasyEquities to get a bit of a hands-on feel, though I never invest in local stocks that I might have to write about at some point.
It’s been fun investing for my own account. I’ve bought some bitcoin, some $melania (not a great idea) and some big US funds to try and get a feel for fees, for example. My portfolio as a whole is 13% up year to date. I wrote recently about buying into SpaceX, which was fun if not entirely rewarding. But I did learn one practical thing from the experience: bookbuilds are mad.
The bookbuild is where the glamour of an IPO meets the plumbing. Typically what happens is that a company preparing to list appoints investment banks as bookrunners. They help shape the equity story, test investor appetite, prepare the documentation and assemble a “book” of demand.
During the roadshow, institutional investors say how many shares they would buy, and at what price. One fund may say it wants R500m worth at the bottom of the range, R300m in the middle and nothing at the top. Another may say it will take whatever it can get. A third may praise the management team, admire the sector, ask clever questions, and then quietly decline to place an order.
Science, meet theatre
At the end of this process, the issuer and its banks set the final offer price and decide allocations. That final step is where science gives way to theatre. A book can be “covered” but weak; “multiple-times covered” but flaky; or genuinely strong. Demand from long-only institutions is treated differently to demand from hedge funds that may flip the stock in five minutes.
Price-insensitive orders are better than heroic bids that vanish at the first sign of trouble. A respected anchor investor can steady the whole transaction; a book filled with hot money can make the IPO look like a success until the opening bell.
There are two things that bookrunners don’t want, and the first to is to set the price too high. That means a share may fall on hitting the market, which tends to make investors very grumpy. You don’t want that in your life. So IPOs tend to pop on listing, which makes everybody happy, and because they do, they are very popular investments.
The second thing you don’t want is to set the price too low. This is almost worse. For a company raising money, it means cash left on the table. In the short term, the upside then flows to investors and not to the listing entity, which is after all the client in this instance, and which is paying investment banks truck-loads of cash to conduct the listing. But this is mitigated by the fact that the share price has increased, so for cash-hungry businesses, there is always the prospect of further capital calls at a better price in the future.
Too successful?
What happened in the SpaceX case was not a failed bookbuild in the conventional sense. It was worse, in a way: a successful bookbuild that immediately advertised how much value had been handed to the people lucky enough to get stock.
The shares priced at $135, opened at $150, and were soon trading well above that. If $160 was the market’s early clearing price, the bookrunners had missed the mark by about 18.5%. On the actual opening trade, the gap was a less dramatic but still chunky 11%. Either way, the lesson was painfully clear: the best time to buy SpaceX was not when the stock hit the screen, but before the screen was allowed to light up.
Personally, I only managed to get an allocation at $165, and the share is currently trading at $148 so I’m currently about 10% down on the trade, which is frankly a better outcome than I thought would transpire.
But when it comes to SpaceX, you have to have some sympathy for investment banks. The company is technically losing money, so valuation metrics are fabulously difficult.
At $130 a share, SpaceX was being valued at roughly $1.7-trillion. At $160, it was a $2.1-trillion company. That is more than $300bn of market value materialising almost instantly, which is less price discovery than price discovery arriving late, wearing a party hat.
The language of valuation
Bookbuilds also become fragile when the issuer and the market are using different valuation language. Private shareholders remember the last funding round. Public investors look at listed peers. Founders sell the dream. Fund managers ask about margins, cash conversion, churn, debt, governance, dilution and what happens if the miracle takes 18 months longer than expected.
With valuation metrics becoming more volatile, the role of the banks in the bookbuild process is, well, uncomfortable. In public, they are the issuer’s champions. In private, they are the messengers carrying bad news from investors. They must tell the company whether the range is realistic, whether the cornerstone investors are real, whether the book is deep enough, and whether the deal should be cut, postponed or abandoned. The temptation is always to keep the transaction alive. But a bad IPO is not merely a failed financing act; it can permanently damage the company’s reputation.
The allocation process is another reason regulators pay close attention. Bookrunners have enormous discretion over who receives shares. In hot IPOs, that discretion has value. It can reward loyal institutional clients, encourage aftermarket support and create a stable register. But it can also create conflicts. International regulators have long worried about IPO allocations being used to curry favour, reward executives or compensate clients indirectly.
The US rules are explicit on some of these dangers. Finra rule 5131 prohibits something called “spinning” – the allocation of hot IPO shares to executives or directors of companies from which the bank has received, or expects to receive, investment-banking business. The same rule requires book-running managers to report indications of interest and final allocations to the issuer’s pricing committee or board.
South Africa has its own version of this architecture. A company seeking a main board listing on the JSE must prepare a pre-listing statement. If the listing also involves an offer of securities to the public under the Companies Act, the pre-listing statement must include a prospectus filed with the Companies and Intellectual Property Commission. The document must give investors full information to make an informed decision, must not omit material information, and must not contain false or misleading statements.
The JSE’s main board requirements also impose basic eligibility hurdles: audited historical financial information, profit or asset thresholds, at least 25-million equity shares in issue, and a free float of at least 10% held by public shareholders, representing at least 100 shareholders.
The JSE also retains discretion to decide whether securities are appropriate for listing even where formal requirements are met. Once listed, the market-abuse framework under the Financial Markets Act covers insider trading, market manipulation and false, misleading or deceptive statements, with the JSE monitoring trading and referring possible abuse to the Financial Sector Conduct Authority.
Hot to trot
In a hot IPO, the best trade is often not buying the stock when it hits the screen, but getting an allocation before it gets there. And this is significant because there are a whole bunch of hot IPOs that might be happening in the near future, including Anthropic and OpenAI.
How do you get in on that? The short answer is: with difficulty. The bookbuild advantage is real, but it is rationed by the banks, skewed towards favoured institutions, and most valuable precisely when it is hardest to get meaningful stock. There are also laws restricting investors outside the country in which the IPO is taking place from participating. It is possible to get around these problems, but it’s tricky.
What SpaceX demonstrated is the core unfairness at the heart of hyped-up IPOs. The public market discovered a $160 price almost immediately, but the privileged bookbuild investors were allowed in at $135. That $25 gap was not just a first-day pop; it was the price of access.
For everyone else, price discovery arrived on time – but the party had already started.
ALSO READ:
- SpaceX IPO: were the best seats already taken?
- This is not an offer to the public. Except, it is
- How Pick n Pay shortchanged retail investors with Boxer’s IPO
Top image collage: Rawpixel; Currency.
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