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Alibaba’s Massive IPO

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Thursday marked the record $21.8 billion IPO on the NYSE of Chinese e-commerce titan Alibaba Group Holding, commonly known as Alibaba. This pegs Alibaba’s market value at $168 billion, or $18 billion more than’s. Shares opened at $68 apiece and climbed 138% before closing at $93.89 after the first day of trading. Undoubtedly, major players wound up with major money. So who are these players and how are the shares allocated to them? The multiple teams of bankers hired by Alibaba to oversee a successful offering held a mediated auction, one where potential investors submit bids and the overseers dictate which investors get how many shares and at what price. These potential investors plus Alibaba’s combined IPO team formed the “players” in this massively complex game.

The investors come in different flavors, each with their own strategy. Some fast money funds, mostly hedge funds, ride the first day pop in share price and flip for a tidy profit. Others, like pension funds, are in it for the longer term. The latter, more patient bunch by nature is risk averse in their investments, as they need to take into account future liabilities. Both types of investors are judged by performance over their peers. Therefore, every fund operating in the tech market will need to decide whether they want in, and if so, how much. If everyone gets in and Alibaba is a flop, then no one firm is worse off because the whole lot did relatively poorly. However, if a fund decides not to opt in and the IPO is a whopping success, it will fall behind and its clients will be asking tough questions. Therefore, if the price is right and risk is reasonable, fund managers will feel obligated to participate with a meaningful chunk of shares.

In fact, this market-wide feeling of obligation is what drives prices up pre-IPO. The bidding process for a promising IPO is often so oversubscribed that if you, a fund manager, want any meaningful amount of shares, you will have to relinquish your control over share price and order much more shares in hopes of getting a small fraction of that bid. Sometimes, this artificially inflated demand will cause the IPO team to expand the offering, and some funds may end up with much more shares than they anticipated at too high a price. This is the risk of making large bids.

At the other end of the court, Alibaba’s IPO team has its own set of problems and strategies. It must allocate the pool of shares to the funds it thinks will be solid investors, and peg the offering at a price fair enough to attract them. It is a tightrope effort to balance raised capital and investor happiness. Achieving this balance means the difference between winning or losing future IPO deals to competing firms. They would also like the right mix of investors to keep the stock price afloat. Alibaba’s team opted for a strategy where prices started low to attract the “biggest institutional investment firms” that will provide solid foundational backing to the raised capital.

The entire IPO process is a massive game of anticipation and reaction from multiple players operating on multiple sides of the field. It is this complexity that requires herculean efforts from everyone involved right up to the ringing of the bell, and makes game theory a major part in the finance industry.


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