Select Comfort Corporation
a case study of an Initial Public Offering
by Ian H. Giddy
(For Giddy's Foundations of Finance course)
Are you interested in IPOs? The Select Comfort offering,
summarized below, was completed in 1998. Can you find out what has happened
to the company since its IPO? To its value? One place to look is morningstar.com
-- use SCSS as the stock symbol.
Additional Sources of Information
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Questions and Answers about Initial Public Offerings (IPOss)
- What is a Public Offering?
- How are Public Offering Shares Sold?
- How are the shares allocated?
- Will the issue definitely be priced within the estimated offering range?
What is a Public Offering?
Companies often find the need to raise new capital to support current operations, expansion or new business opportunities. An initial public offering (IPO) of stock is often chosen as the vehicle to raise a substantial amount of cash to implement a company's growth plans. After an IPO, a company may still find the need to raise additional cash and may choose to have a secondary (also known as a follow-on) public offering. A follow-on offering is simply a public offering of new issue equity securities by a publicly traded company.
Underwriters, usually investment banks, are hired by companies to help them issue new stock to the public. Underwriters play a critical role in this process. First, they provide the company with procedural and financial advice, then they buy the issue, and finally resell it to the public. An underwriter's "value-added" is its ability to gauge the public's receptivity to the new issue and properly price and place those shares.
How are Public Offering Shares Sold?
To protect investors, the Securities and Exchange Commission (the SEC) requires that companies file a registration statement with them before they issue public offering shares. This registration statement contains detailed information about the issuing company and it’s business. The SEC will review the registration statement and an accompanying prospectus to ensure that they conform to certain legal requirements. Once the SEC has reviewed these documents the issue can be cleared for sale (The SEC will neither approve nor disapprove an issue, nor will it guarantee the accuracy of disclosures, it will only clear it for sale). Only when the issue has been cleared for sale (when registration has become "effective") can the shares be priced and firm orders for them be accepted.
During the pre-effective period, when the registration has been filed with the SEC but the issue has not yet been cleared for sale, interested parties can be provided with the preliminary prospectus. The preliminary prospectus contains detailed information about the offering company, the estimated date of issue and the estimated price range of the issue. During this time interested parties can place indications of interest for the offering. An indication of interest isn’t a firm commitment to buy at this stage. Only when registration becomes effective and the issue is priced can firm orders be accepted.
The time between when the issue is cleared for sale, priced and when it begins trading in the secondary market is typically quite short. To ensure that all customers who wish to participate are able to enter orders, the investment bank will gather all current indications on our records at the time of pricing and convert them into firm orders for participation on a "when and if" basis; when the issue is cleared for sale and if the offering’s price is at or less than the limit price indicated.
Accepting indications on a when and if basis is to accommodate customers that cannot be reached during the brief window between pricing and secondary trading.
How are the shares allocated?
The investment bank’s goal is to allocate shares evenly amongst all interested participants. For this reason the process often takes place in rounds; for example, in the first round, the broker may allocate 100 shares to each order submitted in the sequence indications of interest were entered. In the second round, they allocate another 100 shares to each order greater than 100 shares. This process is repeated until all orders are filled or until they run out of shares to allocate, whichever occurs first.
Will the issue definitely be priced within the estimated offering range?
The estimated pricing range posted is based on the information provided in the preliminary prospectus. This is subject to change and the issue may be offered above or below this range.
For this reason, interested customers often place their indications subject to price limitations. At the offer indicates that you would like to participate at whatever the offering price is. Limit or better indications will only be converted to firm orders if the public offering price is at or below the limit indicated.
Please look up a pending corporate IPO at redherring.com, and try to answer the following key questions:
Investment banker:
- What steps are involved in taking this company to the market?
- How would you determine the final offering price?
- How do you make money in the underwriting?
- How would you trade this stock in the secondary market?
Investor:
- Would you buy this IPO? Why or why not?
- How would it fit into a diversified portfolio of stocks?
- What price would you be willing to pay?
- How would you expect it to trade in the secondary market?
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Go to Giddy's Web Portal • Contact Ian Giddy at ian.giddy@nyu.edu
Copyright ©2001 Ian Giddy. All rights reserved.