How Investors Buy Hype Rather Than Reality
As each new hot stock goes to market, there is a rush of investors scrambling to buy IPO stock at the offering. The calls to brokers from their clients asking for an allotment rises and the brokers scramble to get an allotment themselves in order to fill the demand. Filling the demand fills the brokers pockets as the commission on IPO offerings is normally greater than the commissions on trading.
Investors have a mistaken belief that buying an IPO is an automatic way to make money. It is usually more like the lemmings rushing over the cliff to fall in the ocean. There was a time when Goldman Sachs and the rest of the Wall Street firms set aside blocks of stock of new offerings for their favorite clients. Then the stock would immediately jump from the IPO price and if the clients sold soon enough, it was like a free gift. It was a great way for the brokerage firms to guarantee companies going public that the stock offering would be fully subscribed, and at the same time create insatiable demand for the stock because investors couldn’t buy it until after the IPO.
Everyone was happy. Great fees were earned by the brokerages from the firms going public, while great commissions were earned from clients buying and then selling the stock. Life couldn’t have been sweeter. And best of all, the price of the stock rose because the demand was greater than the supply.
But All Good Things Come to an End
The year 2008 proved a difficult year for the brokerages as many of their shady practices were exposed, and at the same time, some investors grew a little more cautious.
In due course, the IPO market again started to gain life, and recently the hottest craze has been the IPO’s of the great social media companies. As firms such as Zynga, Groupon and others, and most recently Facebook took the IPO route, the initial offering was priced based on the most optimistic of valuations. Google was in everyone’s mind. Everyone wanted to own cheap stock in the next Google.
The value of a stock is supposed to be based on the future earnings of the company but as we all know, the future is hard to predict. Google was the first truly successful social media company that proved to have enough staying power to change the world. Google was a new model for advertisers. After its IPO Google’s revenues continued to climb above expectations, and its revenue and profits soared. It turned out that the revenues at Google far exceeded even the optimistic expectations of Wall St and the stock rose accordingly. Those that were skeptical and didn’t buy the Google IPO now realized the error of their ways and watched for their next opportunity.
Now there was a new model to follow that was foolproof, and investors need only get an allocation of stock from a new offering of a company in the social media space, in order to automatically make money. But that profit has proven illusive. With some minor exceptions, this path to riches has been strewn with obstacles and falling stock prices for the Social Media darlings.
Social Media Firms Going Public Have Been a Disaster
Zynga (ZNGA) went public in December 2011 at $10.00. Today it is trading at $3.00.
Groupon (GRPN) went public in November 2011 at $20.00. Today it is trading at $7.50.
Facebook (FB) went public in May 2012 at $38.00. Today it is trading at $23.70
Facebook was the biggest and the best since Google. The anticipation was enormous, and worldwide, investors were telephoning their brokers to buy stock. The issue was at $38, and the stock quickly rose at the start of trading, but then it paused and hesitated. Then it weakened, strengthened for a while, and then collapsed.
What seemed to be easy money, turned out to be a hard lesson for investors.
How to Value an IPO
As a reminder of the business of trying to invest in IPO’s, IPO’s are priced at the highest price that the underwriting brokerage firms believe that they will be able to sell to investors. An IPO usually means that money is raised for the company, but it is also a liquidation event for that company’s shareholders. Usually insiders, and the brokerage firms sell a significant part of their holdings to those that they are able to convince to buy the stock at IPO.
If you buy shares at or near the IPO, it is a risk that you will be able to sell those shares quickly at a profit. Don’t forget that the offering price is at the highest price that insiders and advisors believe that they can sell the stock at. Maybe the stock will jump up. Maybe not. But if you intend to hold the stock, remember that the promises of future operations, revenues and profits have to match the initial hype. If not, the IPO price may have proven to be optimistic,
The views expressed in this blog are opinions only and are not investment advice. Persons investing should seek the advice of a licensed professional to guide them and should not rely on the opinions expressed herein. This blog is not a solicitation for investment and we do not accept unsolicited investment funds. Larry Cyna and/or the CymorFund may have positions in the shares of companies mentioned.