Break Issue

A break issue is an initial public offering (IPO) of shares that trades below its original offering price to the market soon after trading begins. Break issues can be the result of poor market conditions as a whole, industry concerns or lack of demand in the new issue itself.

Break issues sometimes occur when a new issue is priced above the company’s intrinsic value, and the stock price falls as investors reassess its fundamentals and valuation. Or they can be the result of bad news about the company just after the issue was made, or simply the result of bad market timing.

IPOs are notoriously volatile, as IPO flippers may just want to make a quick profit, and because companies have every incentive to go public at the top of the market when there is lots of demand for new issues, especially if they think their stock is overvalued. This is when they can raise capital most cheaply, or exit the firm most profitably. Private equity companies sometimes use these opportunities as a “quick exit” — although the process can be long and unpredictable, the costs are high and they often have to enter into lock-up agreements.

But eventually, investors and underwriters become wary. This is why investors should always consider the economic cycle, and at what point the company is in its market cycle, when looking at IPOs.

When several IPOs drop below their original offering price within the first few months after going public, it can be a sign of irrational exuberance at the peak of the market. This can make it difficult for companies to raise money, and the number of listings then often falls as investor demand cools. But some speculators buy broken issues in the expectation the correction has brought the price back in line with fundamentals, and that the stock now offers decent returns.