How Low Can You IPO

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What's going on?

US security company ADT Corp became a publicly traded company on Friday, but alarm bells rang as it sold its shares at a lower valuation than hoped – and then saw them decline over 10% on their first day of trading.

What does this mean?

New shareholders initially purchased ADT’s shares for $14, about 25% lower than the $17-19 range that ADT was targeting. To make matters worse, ADT’s shares then tripped to $12 on its first day of trading as investors expressed clear reservations over its valuation.

Despite the lower share price, the IPO still valued ADT at over $10 billion – meaning it will almost certainly be one of the biggest IPOs this year. (tweet this)

Why should I care?

The bigger picture: This IPO tested the waters for companies backed by private equity firms.

Private equity firms sometimes buy publicly traded companies, take them “private” (i.e. off of the stock market), try to turn them around, and then bring them “public” again via an IPO – which is exactly what the private equity firm Apollo has done with ADT. One risk for the new investors is that Apollo has already benefited from the turnaround, and there might not be many more reasons for the company’s value to increase. The poor performance of this IPO may mean that other upcoming private equity-backed IPOs will have to settle for a lower valuation.

For markets: A high level of debt makes ADT a bit less secure.

As is typical of private equity-backed companies, ADT has a lot of debt – which increases the riskiness for its new shareholders. ADT essentially has less margin for error if its profits were to decline (in other words, it has a higher risk of bankruptcy than companies with less debt). Investors will still back such a company, but often demand a lower valuation as a result of the higher risk – as appears to have been the case with ADT.

Originally posted as part of the Finimize daily email.

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