« Kids Aren't So Dumb After All | Main | Yahoo, Google, and the Search Satisfaction Myth »
Latest Stories
- Excel Wankers and Recession Averages
- Sorry, New York is Closed. Check Back Later.
- Catching Falling 2009 Earnings Estimate Knife
- Survivorship Bias in Global Markets
- Talking Positions on a Lazy-ish Retirement Portfolio
August 14, 2007
Why First-Day IPO Pops Are Good for You
Yeesh, if I see another damn article knowingly explaining that first-day initial public offering pops are bad I'll lose it. The impetus, of course, for all these return-of-the-dot-com-daze articles was today's VMware rocket-ride, with the stock being priced last night at $29, but opening this morning at $52.The gist of the wrong-headed argument: By "mispricing" the IPO -- pricing it lower than investors were willing to pay, as evidenced by the opening price -- VMware's underwriters were being bad, bad people. More specifically, so the argument goes, they left $750-million on the table, which is the difference between VMware's value at $29 and at $52.
Wrong. Okay, naively appealing, but still wrong. Two tenets to keep in mind:
- IPOs are risky
- Investors buy IPOs to make money
You need to offer investors a pop to convince them to participate in IPOs. It's not enough to say "hang on and you'll make out okay in five years". That's what we say to idiot long-only retail investors, not to professionals who know enough to know that it's tough making money at this stuff.
There are lots of other good reasons for first-day pops, too. For instance, it signals a willingness on the part of investors to take risks, and that tells underwriters to bring more stock public, thus creating a useful virtuous cycle. Similarly, companies leaving money on the table tells investors they are confident enough about their prospects that they don't have to maximally price the new offering -- they can wait it out and get investors in and comfortable before selling more stock.
Sphere It
| 
Digg it
| 
Bookmark it
| 
Stumble it
| 
Facebook it
...why would you stick your next out to buy something risky, like an IPO, if there is an inherent 50/50 chance it falls out of the gate. Where's the reward in that?
Honest question: then why would anyone be a venture capitalist if that's the way investors think?
Umm, this whole article is kind of a financial version of the joke "What you you mean "we", paleface?"
As in: Mispricing is good for *someone*, i.e. the underwriter, so it's good for America, which is YOU!
You have to look at it from the point of view of investors. What are you offering them to buy the company? Just saying "You get the shares" isn't much of an answer for a newly-public company with no record as quarterly-earning entity.
You need to put more something on the table, and that generally includes some "underpricing" -- which then brings many more people into the game, generates lots more wealth and IPOs, and is generally almost as good for you, me, and everyone else as ... maybe tooth flossing.
The answer is *supposed* to be "superior growth prospects", not "an immediate 100% flip!"
You're arguing the "broken window" fallacy. Every misallocation has a loser and winner. Saying the winner makes out like a bandit, which creates an incentive to make more winners, etc. etc., is ignoring the other half of the equation, that the loser gets burned. By definition, mispricing means some optimal balance was not achieved.
After all, what are investors at $52 getting? (besides likely a rip-off)
Even if some 'pop' is required to attract the initial buyers, I think the issue is whether the magnitude of the pop fits the need.
Was VMW so risky only a 70+% 1-day pop could have unloaded the 33 million initially offered shares? Or would a 35% pop have been plenty?
You put the term "misprice" in scare quotes as if it is impossible to misprice an IPO. But I do not understand one thing: is an IPO like VMWare so very risky that it requires much more than the average IPO "pop"? If the underpricing is compensation for risk taken then there should be a correlation between the pop and the risk. Have you observed such a correlation?
You say that the pop signals to the underwriters to bring more stock public: but the reason to get more stock public is to get more cash, right? The same cash that was left on the table the first time. So I don't understand that explanation.
Similarly there are some dynamics I must not understand that you allude to in your last explanation as well. After all, the company is "signaling" confidence to the investors so as to build confidence so that they will buy stock later. "We're going to prove to you that we don't need your money so that later you'll give us your money." What about a bird in the hand and all of that?
What better way is there to build confidence than to take the money and do something productive with it?
I'm just an idiot retail investor, but a first day pop signals something quite different to me than it does to you: these guys don't know what their company is worth and they aren't smart enough to make sure the money ends up in the company's coffers rather than their underwriter's.