What is it? A stabilization fund (“stab fund”) is a pool of money that the owners/sponsors of an IPO can choose to give to a stabilization agent (“stab agent”) can use to help push up the price of an IPO for a month, or until the pool of money is exhausted, whichever comes first. The stab agent can only use the stab fund to buy shares below the IPO offer price, so it should be seen as a defensive (loss lessening) measure as opposed to an offensive (gain maximizing) feature. The amount of a stab fund is usually about 10% of the base/firm offer.
Where does the money come from? The over-allotment shares are sold at the IPO offer price to institutional investors, and the proceeds from this sale are considered the stab fund, which is then transferred to the stab agent before the IPO. Over-allotment options are almost always secondary shares that are being sold by one or more of the owners of the company that is going public.
How does a stab fund work? The stab agent uses the stab fund money to purchase shares of the IPO on the open market that are being offered for less than the IPO asking price. By purchasing these shares, the stab agent fills the role of “willing buyer” for IPO stock sellers that are looking to get rid of their shares.
Does a stab fund push the price above the IPO offer price? No. The stab fund only buys shares when the asking price is below the IPO offer price. The stab agent cannot use stab fund money to buy shares above the IPO offer price. The purpose of the fund is to increase the stability of the IPO’s price through purchasing stock from sellers that are willing to sell below the IPO offer price.
Does a stab fund protect against loss? No, not completely. It’s possible for the price of an IPO stock to fall well below the IPO offer price on the first day of trading, and to remain at a negative price for the duration of the stabilization period. It is up to the stab agent to deploy the limited stab fund money that it has to support the price, but the stab agent isn’t required to act. The stab agent isn’t required to spend stab funds like a robot and buy every single block of shares being sold below the IPO offer price. The stab agent has wide discretion in its use of the funds, and has to use its judgment as to best deploy the very limited amount of money at its disposal.
Is it bad if the company doesn’t have a stab fund? Not necessarily. I think of a stab fund like a little insurance policy. It doesn’t protect against the full loss that I might incur as an IPO investor, but it (in theory) temporarily helps to reduce the downward pressure of a post-IPO sell-off. There have been many IPOs that have performed very well without having a stab fund, like Solar Philippines NEC [SPNEC 1.56 0.64%], and several IPOs that have performed terribly that went public without a stab fund, like Medilines Distributors [MEDIC 0.58 13.43%]. Would a stab fund have prevented MEDIC from falling 75% over the last six months? Probably not, but it might have made the first few weeks temporarily less painful.
What is a stab fund good for? Liquidity. A stab fund can provide the demand needed for an investor to sell a large number of IPO shares at a better price. But that support/demand isn’t certain. There’s a chance, as with Raslag [ASLAG 1.62 6.36%], that the stab agent will choose to sit on the sidelines and watch as the sellers dominate and the price of the IPO tumbles in the first few days of trading. There’s a chance that the stab agent will aggressively deploy the stab fund in the early days of the offering to keep the stock price very tight to the IPO offer price, as with AllHome [HOME 4.47 3.25%], only to run out of money before the end of the month and expose the stock price fully to the natural push and pull of the market.
What happens to the stab fund at the end of the period? The stab agent returns any leftover money (the proceeds of the original sale of the over-allotment shares) to the owners that wrote the over-allotment option, and returns any of the shares that it purchased during the stab fund period to the owners. The stab agent collects a fee (a percentage of the original stab fund amount) for conducting the stab fund activities.
Is this selfless on the part of the owners? Not really, they get something out of this, too. Remember the original over-allotment option? That’s really just a nicer-sounding way of selling secondary shares. If the IPO is successful and the stab fund is not utilized, the owners just get all the proceeds from the sale of over-allotment option in cash. If the price tanked and the stab agent needed to use some of that money to buy shares, then the owners just get to pocket the difference from the IPO price (that they sold the shares for) and the stab fund purchase price.
MB BOTTOM-LINE
This is another one of those finance things that is very simple when zoomed out, but that gets more complicated and nuanced the closer you look and the more you zoom in.
The big picture is that a stability fund helps to temporarily protect IPO investors from the full downside risk of their investment. But zooming in, that’s when things get interesting.
This protection isn’t forever. It isn’t complete.
It isn’t even predictable in terms of how it will be used. It’s a nice-to-have, but definitely not something that I would count on as a potential IPO investor.
At best, the presence of a stab fund increases my ability to quickly exit a bad IPO in the first few days, at a better price than I might normally get without the stab agent prowling the market.
It doesn’t guarantee that I won’t lose money, and it doesn’t guarantee that I’ll be able to exit quickly or at a better price.
It just potentially softens the losses, and potentially increases the chances that I can exit at a price that is maybe better than what I would have received unassisted by the fund’s artificial demand.
A stab fund is good to give IPO investors some options if it becomes important to sell, but if the market thinks that a stock is not worth its IPO price, the market is eventually going to win that battle regardless.
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