What is Hot IPO and How Does it Work: Meaning and Examples
If you are a passionate investor who is eager about all the fresh upcoming IPOs, you must have heard about a term called "hot IPO".
Hot IPOs, while in high demand, can be a tricky and risky investment as there is no past performance record of the performance of the company's shares.
In this blog, you will learn:
- What is an IPO?
- What is a hot IPO?
- How does a hot IPO work?
- Reasons for issuing hot IPO stocks
- Hot IPO examples (with upcoming hot IPOs in 2023)
What is an IPO?
An Initial Public Offering is a process through which companies no longer fall into the category of "private company".
It is a way through which companies raise funds from the public by diluting their ownership, i.e. by issuing shares. Since it is done for the first time in the company's history, it is known as Initial Public Offering.
The funds raised by issuing an IPO can be utilized towards several activities, such as growth, paying off debt, etc.
One of the common terms often used while an IPO is issued is a "hot IPO".
What is a hot IPO?
A hot IPO is similar to a normal offering except that they have significant demand in the market due to the hype.
The interest among potential investors is so huge that the issue is mainly oversubscribed. Oversubscription of an issue means when the demand for a company's upcoming IPO is more than what's offered.
Since the chances of oversubscription are too high, speculators enter the game. They run after short-term gains due to oversubscription and intend to sell investments after a short term.
Usually, tech-savvy companies and popular brands experience hot IPOs.
How does a hot IPO work?
When a person or group starts building a company, it is known as a private or bootstrapped company. They bring their personal funds to sustain their company.
Once they are out of personal savings but wish to grow or pay off debt, they seek external funding. One of the popular sources is Initial Public Offering. That is by diluting their ownership.
They will hire a bank or a group of banks to act as underwriter(s). They act as a catalyst and handle all aspects of an IPO. They charge a certain fee or commission for their services.
A red herring prospectus is prepared and submitted to the SEBI. Several other formalities are also fulfilled. The underwriters and promoters go on a roadshow and promote their offering to the general public and/or potential investors. Conferences, meetings, Q&A sessions and all the possible activities are conducted to create hype about the issue.
The final price (cut-off price) is determined, and the lock-up period when investors can not liquidate their investments commences.
When brands gain great attention from the public, it is termed a "hot IPO". High demand for a company's IPO leads to increased stock prices once it is listed and trading begins.
It is time-consuming and technical because extensive planning is involved in a successful issue.
Companies issuing their offerings for the first time prefer to hire reputable investment banks. Investment banks having a strong network of institutional investors are given due importance.
Rationales behind a Hot IPO
Companies go public and create hype for their stocks due to various reasons. A few of them are:
To raise additional resources
It is one of the primary reasons behind launching a hot IPO. When a company offers shares to be subscribed by the common public, it can raise sufficient funds.
These funds can be used towards growth, expansion, research and development, reducing debt obligations, etc.
To increase its market visibility
When a company's shares get listed on the stock exchange, it automatically begins to gain attention from the public.
Listing shares on the stock exchange increases investors' awareness and builds a market reputation. It further leads to a jump in share prices due to the curiosity to invest among potential investors.
To exit the market (for existing shareholders)
When a company is held privately, promoters or private investors have the shares.
But if they likely wish to withdraw or liquidate their investments, IPO gives them a way to do so. Private investors and promoters can sell their ownership to the public.
To build and maintain trust
If a company is inclined towards issuing its initial offering, it has to comply with all the rules and regulations of laws implemented by SEBI.
Hence, the possibility of fraud and bad practices reduces because companies must disclose all the necessary information to the public.
Hot IPO example
We all know about Facebook or Meta. It is a perfect example of a hot IPO. Its IPO raised approximately ten billion dollars. Around 337 million shares were made available to the public. The approximate price of each share was $28 to $35.
The hype and popularity of the brand led to the oversubscription of its shares. The company had to increase the number of shares by around 84 million shares. The prices also experienced a hike and rose to $34 - $38 per share.
A hot IPO is no different from a normal or traditional IPO. A normal IPO is considered "hot" when the market conditions are favorable and demand for the offering is huge.
There can be many reasons for launching these IPOs, a few of which are mentioned in the blog.
If you are considering investing in such IPOs, consider it risky because not all companies with demand for their initial offerings perform well post-listing.
But if you are eager to invest and have high-risk tolerance, you can consider them next time while investing in IPOs.