"As Eric Tilenius, the general manager of Zynga, wrote on Facebook: 'A huge opening-day pop is not a sign of a successful I.P.O., but rather a massively mispriced one. Bankers are rewarding their friends and themselves instead of doing their fiduciary duty to their clients.' "
EDIT: I just noticed that this op-ed was published four years ago to the day!
As with most things it is somewhat more nuanced. Securities need people to buy them, otherwise they are illiquid and you can't do anything but stare at them :-). So having them go 'up' on their opening day creates a two point trend line that is up and to the right.
Of course anyone who has been around for a while has seen that IPOs always come down 6 - 12 months after they go out. Generally that is because regular employees will have a lock out period (so as not to flood the market) and that lockout is between 180 and 360 days. The interesting metric is that depending on when the employee was hired, their option price might be much much lower than what the current selling price is, and they will often make trades "at the market" which is code for put them on the sell side, I really don't care how much they go for. And the market maker will fill that order from the buy side with the sales price going down each time they fill up one tranche on the buy side and move to the next lower one. That pushes the price down, and depending on how many people are selling, potentially way down. So you will see a lot of option activity for "puts" at sales at those points as traders try to capitalize on the 'employee lockout dump'.
Of course what the bankers taking the company public do not want to have happen for any reason, is to not sell all of the shares that are in the offering. Often times the bankers will be obligated to buy any unsold shares at the offering price, and if the stock is going down that means the bankers are being forced to buy shares from the client company because nobody else wants to pay that price for them. Generally if that looks likely to happen they pull the IPO like Box did rather than lose money on the transaction.
Its these other factors which favors an IPO with a 20 - 50% up tick in price. It means all of the shares will issue without any overhang for the banker, it also makes sure that people are left with a perception of "value" on the stock (just as private financing round that leaves your shares more valuable than before is more positively perceived than a 'down' round where stock price is lower)
Adding a little more detail on the mechanics of a typical capital markets raise to your answer, there's an overallotment on the "target" raise, which the bookrunner (lead underwriter) will use to stabilize the price.
For example, ABC Inc. wants to raise $100 in an IPO, and intends to sell 100 shares at $1. The underwriters will sell 115 shares at $1 (the extra 15 shares are the overallotment) and the company sells the bank 100 shares and grants the bank the option (but not the obligation) to purchase another 15 shares from the company for $1.
One bank from the underwriting syndicate will take responsibility to stabilize the price when the issue starts trading, which means that the initial sellers might be selling to "true" buyers, or if there aren't any above the IPO price, the bank.
If the price is above the IPO price once the stabilization period is over (30 days), and the bank hasn't bought back those "extra" 15 shares (in whole or part) during the period, the bank will call the extra shares from the company for $1 to close out their initial 15 share short position from the initial IPO overallocation, and instead of raising $100, the company will have raised $100+overallotment.
If the IPO priced too high, the bank will quickly run through its 15 share overallotment trying the stem the stock price fall and you'll see the price break through the IPO price. In this case, the bank naturally will have closed out the 15 share short position, and ABC Inc. will have raised the initial $100.
This is known as a "Greenshoe Option". It got the name from a company called "Green Shoe Manufacturing" which was the first company to allow this practice.
i suppose there are reasons for those complexities, yet i can't not to wonder why a company just wouldn't put into the system on the opening day one huge limit (at "IPO" price) sale order and let the party begin.
Consider the effect of this - effectively this is saying the company should put in a huge limit SELL limit order at the IPO price ("Limit SELL 100,000,000, @ $10.00") and leave it open all day. This would almost certainly bias the price movement on the stock downward because:
1) In order for the price to rise above $10.00, there would have to be enough buyers out there to fill the entire limit order. There's no guarantee of that.
2) Consequently, if the first few buyers start to trade their stock and the price falls below $10.00, the initial "IPO Limit Order" could never get filled. Essentially, the company does not know how much capital they would raise.
The standard underwriting/IPO process aims to remove this risk. It's not really removed, however, and really just transferred to the underwriters. However, the underwriters have better ability to deal with/mitigate the risk because of their abilities in this area. (Gauging investor sentiment through roadshows, use of greenshoe/reverse greenshoe options, etc.)
The idea is that the IPO price is set conservatively to ensure the underwriters don't take a loss. This "spread" between the IPO price and the "true" price is part of the fee they take. (I'm not arguing whether it's a lot of money, just providing the details) The key part of this is that it's hard to know what the "true" price will be on IPO day, and hence, what your IPO price should be. It's the underwriters' job to help determine this.
Note that in your example, you could just set the IPO/Limit price so low that you know the entire sell order will get filled. But this naturally leads to the question: What should I set the IPO price to, to ensure the most amount of capital ("don't leave any money on the table") while still ensuring the order is filled? Again, this is a service that the underwriters would provide and is something that most companies probably don't know how to do.
(Note that the situation in (1) and (2) is also why you would never want to put in a huge standing limit order; it will push the price away from you and effectively acts as an option for other traders to "lean on")
Something to consider is that these complexities are emergent, they are not architected. Years and years of experience with different banks trying to get the best return for the company going public (in order to be the bank most likely to take a company public) is a fitness function. And over the years various strategies evolve based on what has come before them. That is why when folks like Google decide to do things really really differently it causes everyone to both flee in terror and watch intently :-).
So true. It's bizarre how journalists report on IPOs. I imagine it comes from the search for an easy narrative (e.g., "Investors raced to shop for SHOP"), but these narratives always miss the point that a pop indicates underestimated demand, not high demand.
Suppose I took Facebook public and sold the company for $10 to my friends, who turned around and sold it for $10 billion. The stock would have experienced a billion-fold IPO, but Facebook would not be happy that they only got $10. The bigger the IPO pop, the more money your company left on the table.
Here's an article I wrote a year ago discussing this very issue: "IPOs: The one topic journalists always get wrong" http://www.tedsanders.com/ipos/
It seems like this is a good argument for not going public. You have to pay a 5% tax to bankers and sell shares to institutional investors at what often appears to be a 50% discount
But liquidity is valuable, and may be worth all the costs. The average P/E ratio for the stock market is ~15, while a small private business will only have a ratio of 3 or 4.
You can't compare the average nonpublic company with the average public company to come to the conclusion that companies should go public. You are including small plumbing businesses, etc. That realistically will never have a chance to go public, with large businesses that were successful enough to go public.
"Facebook would not be happy that they only got $10."
The question I would ask is: "who is it that isn't happy"? Employees? Their stock options are worth the same regardless of what the IPO price is. Investors? Same thing. New investors? They're getting an immediate return. I mean sure, the company doesn't get as much to put in the bank, but ultimately who is upset about that?
The company itself, which essentially just lost the difference in cost between the IPO shares and their actual value in cash.
Okay, if you want to be really nitpicky, they didn't lose quite that amount. But they did lose a substantial amount of cash.
Also, employees are likely hurt indirectly, as they can't sell their stock for 90 days. Underpriced IPOs flood the market with stock, potentially causing the price to collapse (as in the case of LendingClub) before they get to cash out.
I hate, hate, hate this sentiment. Pricing IPOs is not a perfect science. You want at least a 20-30% pop to generate enthusiasm. So it actually was 50%. It's not that big a deal. Plus, I can easily envision it falling back a bit in the coming days as the excitement wears off. The big money can be raised in a secondary, but ONLY if the stock isn't perceived as a dud.
In this case they sold a good chunk of the company, and left nearly $70 million on the table. For a relatively small company, it would be hard to justify that as an investor marketing expense.
10% is not a big chunk. To leave $70m ($65, actually) on the table they would have needed to price it "perfectly" and it would have been considered a dud. With a strong opening day and a solid few quarters they should be able to float another 10% and pick up $200-300m. And you're worried about $20m or $30m.
Some amount of pop increases investor's appetite for participating in IPOs, I think. Hurts the specific company but might be good for the ecosystem. But 51% feels like a mispricing.
In this environment, it's very difficult to price IPOs "correctly". I'm no longer involved in that aspect of the business, but I was in the late 90s, and the same thing happened back then.
Basically, in a "normal" market, you'd have your company A, and comparables B, C, and D. B, C and D trade for an average of 20x earnings. So you'd price A at the traditional 15% discount for general IPO risk (unknown issuer, etc.) and it would go to the initial investors at a 17x earnings multiple (let's say it had earnings per share of $1), or $17. The initial investor would have the expectation that it would trade up to $20 in the near term.
In the late 90s though, when nearly all tech-related IPO'ing companies didn't make any money, most everything traded on revenue multiples. So when your comps B, C, and D were burning cash and were expected to continue to lose money for the next few years, and traded for 8x revenues, 12x revenues and 10x revenues, well the best the traditional theory had was to say you would take the discount off the mean.
The problem was that traditional valuation metrics (earnings, cash flow) had no bearing on the price of the stock, so if 12x revenue for a cash-burning business was valid, why not 14x or 16x or more? Your 10x average revenue with a 15% discount could take your IPO multiple of 8.5x to more than double that. It was impossible to accurately predict the first-day pop, and I imagine the same is true today.
No one wants a "failed" IPO though, so everyone tends to err on the side of caution and will generally be willing to give a greater discount to ensure that the stock doesn't break IPO price in the first month. Especially if there's not a traditional valuation that makes sense on the business (trailing/current profits or cash flow).
As hard as it is to believe, things are better these days.
the quants who study this stuff find that first-day performance is not always predictive of future success/failure. For every Zynga burnout, you have stocks like Zen Desk, Linkedin or Google that keep going up after their IPO pop.
I remember when Workday (WDAY) had its expiration coming up and there was a lot of speculation the stock would tank that day. The float was pretty small before the lockup and the thought was because of this the price was very inflated. It went down the first 10 minutes of trading but shot right back up as large buyers were waiting to see the price action that day and bought it up. The stock is up 75% or so since the lockup 2 years later.
If it were as easy as shorting IPO's (or going long PUTS) near lockup, I'd be a billionaire. As you've pointed out - it's impossible to know what will happen, if anything (making a spread unplayable too) when the lockup expires.
Others have mentioned that a soaring price after IPO means that the company was undervalued. What I don't understand is why the mechanism for IPOs hasn't changed to better capture the correct value. Why couldn't a company auction blocks of shares instead of having to set a specific price? My understanding is that companies have a guaranteed floor on valuation by the bank helping them go public, but this could certainly co-exist with some sort of auction format.
Dutch auctions have been tried before, with mixed results, most notably by Google.
The article below reviews the GOOG IPO. It's not entirely accurate in all the details (e.g., that GOOG would have paid a 7% fee (pg 429) - in reality, it would have been much lower - GOOG was a large and hot IPO). Nevertheless, it's a good summary of the process.
There's no longer a bank valuation "guarantee" for IPOs though, and hasn't been for many years. If an equity raise (IPO or otherwise) isn't going well, the offering price will be reduced until there's sufficient demand, or the issuer will pull the deal.
Google's auction was not actually a Dutch auction, but a second price auction. And despite the thought that it's the "perfect" way to do an IPO, the auction setup actually cost Google millions of dollars.
My suspicion is that this is currently more art than science; the banks/IPO underwriters want the stock to pop, aside from even the guaranteed floor you mentioned. They want the psychological effect that comes with that "pop", that shows up on potential investors' radar.
On top of that, I imagine it's a little tricky because an IPO is when the early investors cash out, so they're the largest stake-holders in the company, and creating that "pop" in the hope that people buy-buy-buy to drive up the price creates a good return for those investors/stakeholders. I don't like it, since it can essentially screw the company out of cash, but that's my guess as to why such a thing exists.
On the other hand, a decent number of companies going public these days are going to screw over the investors anyhow (cough Zynga, GoDaddy, King), so if that means they get slightly less cash in the bank, I guess I don't really care.
> I don't like it, since it can essentially screw the company out of cash,
I'm not saying you're one of these people, but there's a general meme of non-financial people who don't understand that justifications for raising capital can indeed be to liquidate investors (or founders) positions in companies. This is very normal. Investors should know (I believe they're legally obligated) what their capital is being used for. If they don't believe their capital will increase the value of the business, then they simply wouldn't invest.
The market should correct itself in this case (if not leaving enough cash in the company is a problem).
Yes, it's very uncommon (but not unheard of) to have large blocks of stock that aren't locked up in an IPO.
For SHOP specifically, 99.9% of the Class B stock (i.e., stock outstanding pre-IPO) is locked up for 180 days. (See underwriting section of the prospectus)
Google did auction blocks of shares. They ended up getting less for the shares than they were expecting to sell them for, and the price still rose by 18% later in the day.
On paper the Vickrey auction method still makes far more sense, but bankers don't like it because they can't give preferential treatment to their favoured clients.
The modest 18% increase is likely due to the fact that demand for Google's shares increased since they held the dutch auction. Compare this to Netscape which jumped well over 200% on its first day.
The 18% increase was a result of the auction designs's flaws. Buyers of course have a demand curve but for this auction they were required to pick a single demand point. So, googles IPO price was $85. If I was a big buyer who actually bid 100,000 shares at $120 for the auction, I would have received my 100,000 shares at $85. But my demand is a curve - I would probably be willing to buy 125,000 shares at $100 or 175,000 shares at $85.
So, the price increase on the first day was more due to bidders filling their demand at the IPO price.
Investment banks have a cozy relationship with VC, often as the source of significant portions of their funds. VCs have relationships with the startups that are most likely to go public, often with controlling stakes by the time they actually go public. It's a standard case of reciprocal back patting. It takes a well bootstrapped and successful company to buck the trend, and those are rare.
Because institutional buyers want to get something in exchange for agreeing not to sell for a long time and buying a risky issue that hasn't traded before.
Congratulations to Tobi and the team, wishing them many more successes. Although I have not used Shopify extensively, but have benefited from the opensource work done by the team.
It'll be interesting to see if Shopify can gain market share against WooCommerce, which was acquired by Automattic this week: http://ma.tt/2015/05/woomattic/
Of course the US stock went up and the Canadian stock went down - you could buy the shares in US dollars for $17 a pop, sell them in Canadian dollars for over $30 and then convert back to US dollars at a rate of about $1.20 per Canadian dollar and wind up with a tidy profit of $8+ a pop or 50%+.
They should have set the IPO price in one currency and the price on the other exchange as a function of the noon rate the previous day. Any deviation from a price in one currency that is the exchange rate * the price in the other currency plus or minus transaction costs will be exploited by arbitrageurs.
I'd love to get Paul Graham's opinion on Shopify. I ran a small business shopping cart software business for a decade and it's really tough market. Small businesses don't want to spend much and are just as demanding as Fortune 500 customers in terms of the features they want. Operating in the red could be fine for a SaaS model if you're growing but the valuation of 1.9B seems high.
I wonder how many years Viaweb operated in the red? I wonder if they were profitable when Yahoo! acquired them?
Can anyone explain why IPOs are performed as a block of shares instead of trickling shares out into the market over time?
Presuming that the aim is to sell shares of the company at market-price, it seems like a good idea to slowly establish what that price is rather than be subject to the variance of first-day hoopla.
Because, by definition, a series of offerings isn't a single offering, initial or otherwise.
Beyond that, I suspect the expectation of further releases would depress prices early in the series of releases, making that approach unattractive compared to the initial approach.
I also suspect that, while pips get media attention, IPOs are usually fairly well-proceed these days, but if it's not giant and/or wildly mispriced, you don't see much about it in mainstream news sources.
I'd guess that a series of releases (10% of shares each day for two weeks), each at the previous day's average price, as traded among members of the market, would do an okay job of discovering market price.
Alternatively, the entire block of shares offered at a slowly-lowering asking price might do it, too.
I don't doubt that these things have been thought about a lot...
That graphic at the end of the article, can I see that for other IPOs of the past? That was a very interesting way to visualize not only how much a gain the founders and VCs saw, but how much they would have been valued at initially.
I would be cool to pull the SEC filings at the time of IPO, then grab the Open/Close data and build a tool to generate those automatically, but i'm not sure if the ownership section of the filing is well structured enough.
"As Eric Tilenius, the general manager of Zynga, wrote on Facebook: 'A huge opening-day pop is not a sign of a successful I.P.O., but rather a massively mispriced one. Bankers are rewarding their friends and themselves instead of doing their fiduciary duty to their clients.' "
EDIT: I just noticed that this op-ed was published four years ago to the day!