December 6, 2012 9:13 pm

IPOs: Outlook brightens for grey market

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The market for initial public offerings remains sluggish, enlivened only by a few recent high-profile deals, such as the flotation of Direct Line, the insurance company. This inactivity has been accompanied by a corresponding decline in opportunities in the so-called grey market, in which investors can make spread bets ahead of a float.

But the €1.5bn offering in October – the biggest IPO in Europe this year – from Telefónica Deutschland, the telecoms company, has given commentators hope that the IPO market is becoming more robust and this in turn could spur more interest in the grey market.

“This is an opportunity only spread betting and contracts for difference providers can offer over traditional stockbrokers, allowing clients to get ahead of the game,” says Andrew Edwards, chief executive of ETX Capital, which has offered clients the chance to make early trades on previous share offerings, including social media company Facebook, Manchester United, the football club, and Direct Line.

The trades are made in the same way as all other spread bets: investors can benefit from price movements in advance of a deal and use their experience to make an informed decision about investing when the stock trades. Clients can also opt to convert pre-listing spreads into a physical holding when the stock is officially listed.

“An early indication of pricing ahead of the IPO debut provides a greater sense of certainty over the levels at which the stock will potentially trade at once officially listed,” says Mr Edwards.

“This augurs well for retail investors, who tend to be more prudent with their investment approach and would rather have a heads-up before taking positions.” It also helps them to decide whether they believe in the hype that can accompany a new listing, he adds.

However, he warns that, despite hype and expectations, IPOs do not necessarily trade at a discount to their price/earnings ratio.

The lack of IPOs in recent years, however, has made it more difficult for investors and analysts to draw conclusions about trends. This means that instead of comparing like with like, and judging how a company may perform by looking at how its rivals have fared, investors must make their decisions based on other factors.

This matters, as although investors who choose the right direction can profit from a rise in a company’s share price following an IPO, traders who move in too late can suffer losses if the price falls – unless they go short.

Betfair, the online sports betting company, is an example often cited to warn traders of the potential difficulties in making bets on IPOs. The company, which listed in London in October 2010, saw its shares lose nearly a third of their value within a few months.

In the case of Direct Line, an impending review of the motor insurance industry by UK regulators placed pressure on insurers, the effects of which were felt on the grey market before the company had started to trade.

Pricing an IPO on the grey market can be tricky, says David Jones, chief market strategist at IG. “[At] the beginning [of the Facebook IPO] nobody knew how many shares were going to be issued, so there was no indication for the share price,” he says.

“We quoted it as its market cap at the end of the first day’s trading – we started at $80bn, but pretty quickly buying by clients pushed this up and just ahead of the flotation it was trading around $120bn.”

In spite of the problems, there remains a significant level of interest in high-profile floats, he adds, and that can make a difference to prices. “It really is a market affected by the activity of clients. Large buyers and sellers will push the price around and can offer plenty of opportunity if someone thinks the grey market is out of line with reality.”

Marko Jagustin, chief dealer at GFT Global Markets, says investors should remember trading grey markets can be a high-risk proposition. “Liquidity is invariably low, which can present some execution difficulties, and this is something we never want to compromise our clients with,” he says.

Although the company provides access to IPO stocks as soon as the underlying listing has gone live, it prefers not to get involved in the grey market.

“The choppy nature of pricing these markets also means clients will struggle to put a sensible risk management strategy in place. Again, the low liquidity is going to result in prices gapping quite significantly from day to day,” Mr Jagustin says.

There are other ways, however, to gain a degree of exposure to an asset just before it is issued, he explains. Investors who do not want to go into the grey market could instead look to buy or sell a competitor to the company due to float, depending on their opinion of the early performance of the newly listed equity.

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