Undersubscribed Offerings: Discover the Key Influences and Impacts
Undersubscribed refers to a scenario where the demand for an issue of securities, such as an initial public offering (IPO) or another form of security, is less than the number of available shares. This situation is often attributed to overpricing the securities or inadequate marketing to potential investors. Undersubscription, also known as “underbooking,” stands in contrast to oversubscription, where demand outstrips supply.
Key Takeaways
- Undersubscribed (underbooked) signifies an issue of securities where demand does not meet the available supply.
- An undersubscribed IPO usually signals a lack of sufficient investor interest, which can be due to poor marketing or overpriced issue.
- High offering prices may lead to underbooking if investors consider the investment not worth the cost.
- Institutional or accredited investors are typically the audience eligible for subscribing to a new issue.
Gaining Insight into Undersubscribed Offerings
An offering becomes undersubscribed when the underwriter fails to generate sufficient interest in the shares up for sale. During the initial phase, purchasers often subscribe to a certain number of shares without a definitively set offering price. This subscription process allows the underwriter to gauge market demand, referred to as “indications of interest,” and decide on a fair price.
The goal of a public offering is typically to sell all issued shares to investors at a precise price, with neither a surplus nor shortage of securities. However, if demand is low, the underwriter and issuer might reduce the price to attract more investors. Conversely, a high demand that exceeds the supply (a shortage) indicates that a higher price could have been charged, thereby enabling the issuer to raise more capital. If set too high, a lack of investor subscriptions will occur, leaving the underwriting company with unsellable shares or forcing them to sell at a reduced price, potentially generating a loss.
Factors Leading to Undersubscription
Once the underwriter ensures all shares in the offering will sell, the offering is closed, and the underwriter purchases all shares from the company in a guaranteed offering scenario. The issuer then receives the funds minus underwriting fees, and the underwriters sell the shares to subscribers at the offering price. If underwriters can’t find enough investors for the IPO shares, they are compelled to purchase the remaining shares—a situation often referred to as “eating stock.”
Even though underwriters can set the initial price of securities, they lack full control over all trading activity on the IPO’s first day. Once shares start trading on the secondary market, free-market supply and demand forces dictate prices, which can impact the initial selling price. Underwriters typically maintain a secondary market for the securities they issue to stabilize the securities’ price and safeguard against extreme volatility by agreeing to purchase or sell securities from their own inventories.
