The ABC’s of Internet IPO ETNs
by Paul Springer
In the year preceding the dotcom bust in 2000, craven greed for hot IPO shares elevated begging to an art. News of oversubscribed offerings got around fast, and it wasn’t just the individual investor who was out there paying relationship baksheesh to get on a friends & family list or cozen ten shares out of a broker.
For some hedge funds and people with serious wealth, getting in on hot internet IPOs was a mark of status. It signaled a connection to the amazing free money machine created by Wall Street, Silicon Valley, and a lot of people who should have known better.
For those waxing nostalgic about those days, UBS is offering a pair of IPO-based exchange traded notes (ETNs).
The vehicles track UBS’s proprietary Internet IPO Index. “The Index provides exposure specifically to those Internet companies that have been publicly traded for less than three years,” UBS says. The IPO notes come in regular (EIPO) and double-leveraged (EIPL) flavors.
The index rebalances once a month to maintain 15 constituents. Additions to the index normally need to meet five basic eligibility criteria: Listing on the NYSE or NASDAQ; Appropriate industry designation; IPO date within the previous three years; Capitalization ranging from $200 million (U.S.) to $1 billion (foreign); and Trading volume of at least 100,000 per day.
Investors would do well to take note of prospectus provisions for what happens if there are not 15 such eligible companies in existence at rebalancing time. In that event, criteria for IPO date, capitalization and volume are all relaxed.
These are clearly dangerous investments, and the scenario for eligibility relaxation suggests that in the event that the hot IPO market chokes, the index will start opening its doors to companies that might not be so hot.
Another reality of these vehicles is timing of index inclusion. The five-day volume requirement means stocks will not go into the index for at least five days after an IPO, and possibly a good deal longer depending on the jump between an IPO date and the monthly rebalancing.
That means investors in these ETNs will not get a bite of the insane first-day gains of pre-bust IPOs. At the same time, the index is spared the indignity of high watermarks from first day trading that are likely to be followed by lower prices that drag the index down.
Because the early days of trading won’t go into the internet index, the index will likely correlate with NASDAQ or existing tech indexes, which will probably offer better liquidity and less likelihood of becoming “ghost town” ETFs like some of those put together around early internet offerings back in the day.
And this is a complicated product, whose structural and credit risks take up many pages of the prospectus. Even good news can be bad news:
Even if the index valuation level . . . has increased relative to the index closing level at the time your purchased the securities, or the applicable index valuation level is greater than the index closing level on the initial trade date, you may receive less than your initial investment in the securities.
As of the prospectus date, the four biggest index constituents, representing 10% each, are LinkedIn, HomeAway, Yandex, and Rackspace Hosting. Don’t look for Facebook – it has not set an IPO date.
The UBS IPO notes are not for everyone, and in fact they might be a sign that the end is near. The Motley Fool opines:
There are only so many times in your life that you literally fall out of your chair in reaction to the sheer lunacy of what you’re reading. You’re left to wonder if the words in front of you are some kind of elaborate prank from the folks at The Onion, or if the world has just gone crazy.
In all likelihood, many investors in these units will be naïve retail players arriving very late at the ball. They will be crushed.
However, these notes could serve a good purpose as short-term tactical investments that are a small part of a much broader portfolio. They will provide early entry into new web-based businesses, some of which may go on to become the next Amazon.com, and could return profits far in excess of the broader market. Yet as with any instrument offering high potential, the risks are equally large: any number of changes in the IPO market and the broader economy could argue for dumping these funds almost immediately.
For those who buy these things as a concentrated long-term “don’t think about it approach,” the screenplay may end up being called “Dot.com Bust II: Deja Vu.”
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