What are the differences in listing gains between stocks that go through initial public offerings (IPO) and those that do not?

 

Differences in Listing Gains Between IPO and Non-IPO Stocks

 

Introduction

 

     Listing gains refer to the profits that investors make from the difference between the price at which they acquire a stock during the offering period and the price at which it begins trading once listed on an exchange. Typically, listing gains are associated with Initial Public Offerings (IPOs), but not all stocks go through IPOs. There are other ways companies get listed, such as direct listings or reverse mergers, which have their own dynamics in terms of listing performance.

 

    The differences in listing gains between IPO and non-IPO stocks are shaped by several factors, including investor sentiment, pricing methods, market conditions, and regulatory frameworks. This article explores these differences in depth, focusing on how IPOs and alternative listing methods affect the stock price upon listing and what that means for investors.

 

IPO: the traditional route to listing gains

 

What is an IPO?

 

     An Initial Public Offering (IPO) is the process by which a private company offers shares to the public for the first time, becoming a publicly traded entity. During an IPO, companies typically sell new shares to raise capital, although existing shareholders may also sell their holdings. The process of an IPO involves underwriting, pricing, regulatory compliance, and roadshows to market the company to institutional investors.

 

Factors driving IPO listing gains

 

Underpricing strategy

 

      One of the major drivers of listing gains in IPOs is the strategy of underpricing. This occurs when the offer price is deliberately set below the stock’s estimated fair value. Underpricing ensures that the IPO is fully subscribed and even oversubscribed, creating demand for the stock. When the stock starts trading, this pent-up demand can cause the price to rise significantly, resulting in substantial listing gains. This "IPO pop" is common in companies with high visibility, strong growth potential, or those operating in booming sectors.

 

Investor sentiment

 

     Investor sentiment plays a pivotal role in determining the listing gains of an IPO stock. If investors are excited about the company’s future prospects—driven by factors like a well-known brand, a disruptive business model, or strong market conditions—the stock may see high demand on its debut. This demand can push the stock’s opening price significantly higher than its offer price, translating into listing gains.

 

Scarcity effect

 

    In cases where there is a limited number of shares available to the public during the IPO, scarcity can drive up demand. The oversubscription rate—how many times the offering is oversubscribed—can be an indicator of future listing gains. Scarcity, combined with investor enthusiasm, often leads to greater volatility and higher listing gains.

 

Market conditions

 

    Favorable market conditions at the time of the IPO are another critical factor in determining listing gains. During bull markets, when investor confidence is high, IPOs tend to perform better, and companies often see higher listing gains. On the contrary, in bearish or uncertain markets, the same stock might struggle to achieve significant gains.

 

Volatility and risks in IPO listing gains

 

     Despite the allure of listing gains, IPO stocks can be volatile. Many IPOs experience price swings in the initial trading period. While the price may jump on the first day due to high demand, it can later correct as the market evaluates the company’s actual worth. Some IPOs experience a "post-pop drop," where the stock price declines after the initial surge. This makes it important for investors to balance the potential for gains with the risk of loss.

 

Non-IPO Listings: direct listings and reverse mergers

 

     While IPOs are the most common method for companies to go public, alternative listing methods have gained popularity in recent years. These include direct listings and reverse mergers. These approaches differ in how they are structured and what they mean for listing gains.

 

Direct listings

 

What is a Direct Listing?

 

     In a direct listing, a company goes public without raising new capital or involving underwriters. Instead, existing shares held by employees, insiders, and early investors are made available for trading. Unlike an IPO, where new shares are issued, a direct listing doesn’t dilute the company’s stock. There is also no price setting by underwriters; the stock begins trading based on market supply and demand.

 

Listing gains in direct listings

 

Market-driven pricing

 

     One of the most significant differences between direct listings and IPOs is the absence of an underwriter-set offer price. In a direct listing, the opening price is determined entirely by market forces. As a result, there is no deliberate underpricing to create an IPO pop, and the listing gains depend on how the market values the stock on the first day of trading.

 

Stability over volatility

 

     Direct listings generally see less volatility compared to IPOs. Since no new shares are issued, and the available shares are from early investors or insiders, there is often less speculative trading in the early days. Without the underpricing strategy and the scarcity effect that drives IPO volatility, direct listings may not offer the same explosive listing gains but are typically more stable.

 

Transparency and price discovery

 

    Direct listings are often seen as a more transparent process, as the stock’s price is based purely on market demand rather than being influenced by underwriters or roadshows. This transparency can result in fairer price discovery and potentially lower risk for retail investors, though it may also mean smaller listing gains.

 

Reverse mergers

 

What is a reverse merger?

 

     A reverse merger, also known as a reverse takeover (RTO), allows a private company to go public by merging with an already publicly listed company, typically a shell company. The private company effectively "takes over" the public company’s listing, bypassing the traditional IPO process.

 

Listing gains in reverse mergers

 

Pricing and market sentiment

 

      Since reverse mergers do not involve issuing new shares to the public or underwriters setting an offer price, the stock price at the time of listing is determined by market demand. However, reverse mergers often do not generate the same level of investor excitement as IPOs. This is partly because reverse mergers are typically associated with smaller or less-established companies, which may not attract the same level of attention as high-profile IPOs.

 

Regulatory concerns and stigma

 

     Reverse mergers have, at times, been associated with companies looking to avoid the scrutiny that comes with the IPO process. As a result, they may carry a certain stigma, which can affect investor sentiment and listing gains. Regulatory concerns, especially regarding transparency and due diligence, can also dampen enthusiasm for reverse mergers, resulting in lower listing gains.

 

Long-term gains vs. short-term listing gains

 

      While reverse mergers may not offer significant short-term listing gains, they can sometimes deliver long-term value if the underlying business performs well. However, because reverse mergers often lack the fanfare of IPOs, investors might not experience the same early price surges.

 

Key differences in listing gains: IPO vs. Non-IPO

 

Underpricing vs. market-driven pricing

 

     In IPOs, underpricing by underwriters often creates immediate listing gains, whereas in non-IPO listings like direct listings and reverse mergers, market forces drive the opening price, which may result in more moderate or stable listing gains.

 

Volatility and speculation

 

    IPOs tend to be more volatile in the early days of trading, with speculative interest driving price fluctuations. Non-IPO listings generally experience less volatility, as they often attract more cautious or long-term investors.

 

Investor sentiment and visibility

 

     IPOs usually generate more investor interest due to the involvement of underwriters, roadshows, and media coverage. Non-IPO listings might not receive the same level of attention, which can affect the stock’s initial performance and listing gains.

 

Transparency and risk

 

    Direct listings are seen as more transparent, with pricing determined entirely by market supply and demand. This can result in less speculative trading but also fewer opportunities for significant listing gains compared to the often-opaque pricing mechanisms in IPOs.

 

Conclusion

 

      Listing gains in IPOs tend to be more pronounced due to the underpricing strategy, scarcity, and investor enthusiasm. However, they also come with higher volatility and risk. On the other hand, non-IPO listings like direct listings and reverse mergers often result in smaller but more stable listing gains. These methods provide greater transparency and are less susceptible to speculative trading. Understanding these differences is crucial for investors looking to capitalize on newly listed stocks, as the path a company takes to go public can significantly impact its initial trading performance.