Ask The Fool IPO basics Q: When a company issues shares of itself in an initial public offering (IPO), how do the original owners of the...

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Ask The Fool

IPO basics

Q: When a company issues shares of itself in an initial public offering (IPO), how do the original owners of the company retain any ownership?

A: When a company “goes public” with an IPO, it usually sells only part of itself.

Here’s a simplified example. The owner decides to sell 10 percent of the company to the public, via an IPO, to raise money for expansion.

The owner currently owns all of the 90 million shares of the company and will sell 10 million new shares, so there will be 100 million shares after the offering. Investment bankers help the owner determine the valuation of the company and decide to price the offering at $20 per share, suggesting that the whole company is worth about $2 billion (100 million times $20). This means his company will collect about $200 million when the shares are sold (less the investment bank’s fee of around 7 percent). The owner will retain ownership of 90 percent of the firm, or 90 million shares.

My dumbest investment

Bad options

Dear Fool: After reading up on options, I dove in. I got lucky with my first small investments and was soon feeling like an expert. So I took a $5,000 cash advance on my credit card to invest in options with high implied volatility. I didn’t realize high implied volatility meant very risky.

I focused on a biotech company that was supposedly on the verge of approval for a staph-infection antibiotic. It seemed to be a sure bet.

With my borrowed money, I broke even in the first month. In the second month, I made about $1,000. My plan was to double my money in four months. In the third month, I learned that the staph drug didn’t get FDA approval — the stock plunged. I owed the broker about $1,000 and Citibank credit cards $5,000.

Meanwhile, I tried riskier plays in other accounts and lost all my gains and then some.

— N.E., Seattle

The Fool responds: Options are tricky, and certain varieties can be especially risky. You can do well without ever using them.

The Motley Fool take

Alcoa trims

Alcoa (NYSE: AA) ended 2007 by trimming a host of ancillary operations. It appears to be reaching a fighting trim that could thrust it back into the merger wars — on one side or the other.

Alcoa recently sold its packaging and consumer businesses, as well as its automotive-castings business. On the acquisition front, it failed to buy its Canadian aluminum-manufacturer rival, Alcan, which took a bigger offer from London-based mining giant Rio Tinto (NYSE: RTP).

With the rapid industrialization of China, India and other developing nations, the metals and mining sector has been growing quickly in importance to those countries while becoming a hotbed of takeover activity.

In addition to the Alcan purchase, copper producers Freeport McMoRan (NYSE: FCX) and Phelps Dodge joined forces earlier this year, and Rio Tinto itself is currently the subject of a slow-moving acquisition effort by Australian mining and energy giant BHP Billiton (NYSE: BHP).

The company’s trimming of noncore assets and the application of resulting funds toward core areas could render it more attractive.

On that basis alone, to say nothing of its nearly 2 percent dividend yield and its key position in a significant metals market, consider finding a spot for it on your watch list.

In Elizabethan days, fools were the only people who could get away with telling the truth to the king or queen. Today The Motley Fool tells the truth about investing. Visit www.fool.com or write The Fool, c/o The Seattle Times, P.O. Box 70, Seattle, WA 98111.