IPOs (or why the absence of a pop is not a fizzle)

The big business story of the day is Facebook’s IPO, which is being described in the press as “modest,” a “whimper,” “fall[ing] short,” “sputter[ing],” “underwhelming,” and “a ho-hummer,” to pick a few choice terms. As even most of these articles acknowledge after their doom-and-gloom leads, these descriptions are wrong. The company (and some early shareholders) sold $16+ billion worth of shares to the public and the company is now valued at more than $100 billion. By contrast, the very-successful-in-retrospect Google IPO in 2004 sold about $1.67 billion to the public and valued the company around $27 billion.

The press finds its disappointment in the absence of a “first day pop.” A pop is the difference between the price a company is selling at and the price buyers were will to pay on that same day, so it’s often, rightly, described as “money left on the table.” A pop makes for a more exciting story, but doesn’t directly benefit the company or its shareholders.

Who does benefit? Traditionally, the good clients of the underwriters, who have just been given free money. And, indirectly, the underwriting investment banks, who have earned the goodwill of – one might argue “bribed” – those clients. The historical justification for this underpricing is that IPOs are risky and, to convince customers to invest in them, the price has to be a bit discounted. In particular, the IPOs are supposedly more volatile (riskier) because the price is a guess by the company and its bankers, who survey potential buyers, rather the result of trading in a liquid market.

But this latter condition didn’t really apply in Facebook’s case, thanks to the trading of Facebook shares in secondary markets. While those secondary markets probably overpriced the shares due to limited supply, they established a plausible range. (Late buyers in the secondary markets, who ended up paying a 10-15% premium over the first-day price, do not come off as great stock pickers.) Similarly, the Google IPO dutch auction was intended to set a fair initial price for the market.

Google’s IPO was described in similar disappointing terms to Facebook’s. One would think the press would have learned a lesson by now. (And some have.) But, instead, the absence of a pop becomes a “fizzle” in most of the press.

Is Facebook a successful business? It appears so. Did the company (and early investors and employees) successfully trade previously illiquid shares for cash at a price the market thinks is fair? I think so. Is it worth its current market cap? Time will tell. Will the stock go up or down? Yes.

Update (May 22): On the other hand, if the underwriters had inside information that revenues would be lower than estimates and shared that with some customers but not the general public, that seems wrong. Ethically wrong and legally wrong. Under those circumstances, the IPO would not reflect an honest, fair market valuation; instead, it would be little better than a pump and dump penny stock scam on a grand scale. I expect we’ll hear more in the next few days and I’m withholding judgement until more information is available.

(Disclaimer: This is my personal blog. Comments here reflect my own opinions, not those of my employer. Facebook and my employer compete in some areas; in addition, many of my friends work for Facebook. You can assume I’m very biased here, just in multiple, contradictory ways.)