A tale of two IPOs
Often cited as one of the worst IPO processes ever, Facebook shares went public in May 2012. The most anticipated IPO in years, the big question was whether Facebook would surpass the $100 billion valuation barrier with its IPO. After initially being priced at $28 to $35 for a maximum valuation of $96 billion prior to the IPO, demand led to shares eventually being priced at $38 for a $104 billion valuation.
As traders and investors around the world waited for the official opening that Friday morning of May 18th 2012, everyone wanted to know what the shares would do and how high they would jump after opening? (As a side note, one of the comical aspects of the IPO was that many of these people, myself included, were following real time coverage on Twitter. Making Facebook the first company to go public on Twitter.) However, glitches at the NASDAQ delayed the process, with the eventual opening happening well after the planned time period.
The glitches were ultimately an omen for the rest of the day as after shares hit a high of $45 they sank back towards the IPO price of $38 and closed at $38.23. Shares continued to dive the next week, and by the end of May had closed below $30.
In a different story, shares of payment provider Square went public this past November. Unlike Facebook, Square faced lackluster demand as they priced their shares at $9 after initially targeting an $11 to $13 range.
Upon opening, the $9 price was revealed to be a bargain, with shares closing their first day of trading at $13.07. They have since gyrated between $12 and $13 in the month following their IPO, thus revealing that the $11 to $13 range was in fact the proper pricing for their shares.
So who had the better IPO?
Taking a look at the headlines, it is easy to argue that Square had the more successful IPO. Following the rise of shares, investment outlets focused on the price increase of Square shares. On the other hand, Facebook was seen as a flop as the investors that bought shares immediately were underwater with their holdings.
Despite the decline in Facebook shares, their IPO can be considered to have been the better one, and arguably one of the best of all time.
If the point of an IPO is for a company to sell its shares and return maximum value to the company and its shareholders, Square was a flop. Shares sold at $9 were offered at a discount to what was found to be at least a $12 value. In contrast, Facebook returned near full value when they sold their shares at $38.
First day IPO jump
The example of Square is one of a long list of IPOs where the stock price opened higher and rallied well above its pricing. In these situations, investors that are able to purchase shares at the IPO price can quickly lock in strong gains as the IPO opens higher. However, this pricing process reveals that proper demand isn’t being reflected in the new shares.
For companies going public, the difference between the pricing of their shares and the actual opening price is money left on the table. In Square’s case, with 27 million shares being sold, the firm could have raised $100 million more if their shares priced at $12.70, or just about where the stock is trading today.
Interestingly, despite the goal of so many technology firms to go public, the ‘leaving money on the table’ problem that has existed for years has failed to gain much of a movement for change. One of the few vocal critics of the IPO process problem has been Howard Lindzon, Founder of StockTwits and an investor in many fintech related startups.
Among his creative tweets about Square’s IPO:
Jack like giving his Square and Twitter stock to charity and employees….and bankers and their buddies $sq
— howardlindzon (@howardlindzon) November 19, 2015
The problem though begs the question of whether there can be a solution?
On paper, the most conducive answer would be the opening of the auction process of pricing shares to a wider audience. In fact, this was done by Google, who handled the pricing side of their IPO and opened indications of interest to both institutional and retail investors alike. However, Google’s IPO is the rare exception.
The lack of an ongoing solution to such a glaring problem, and one that affects many of the world’s most notable tech founders and investors appears to be an opportunity to be tackled by fintech startups or innovative investment banks.
Among the examples being discussed, but yet to be widely implemented, is blockchain technology. With it, a startup could issue shares, with any investor able to enter a bid to buy shares. Demand is then aggregated and shares are issued at the same price to those investors bidding at or above the official price. Investors with failed bids would see their deposits for shares returned, while winning bidders would have their funds converted to shares.
The drawback of such a solution is that price discovery would reside solely on bid demand. For well-known companies this may not be a problem, but lessor known names may struggle to drive interest for their shares. In the current process, this problem is solved by the investment banks leading the IPO that market the sale to their customers to create demand for the sale.
As an alternative, what could potentially work is a hybrid solution where blockchain or another open framework is used by investment banks. In such a scenario, the open platform would allow the bidding process to be more easily accessible to a wider range of investors. For their part, the investment bank though would be in charge of marketing the IPO to deliver institutional investor demand.
Although different to the current IPO process, these new solutions follow what is arguably the biggest trend in capital markets finance: the electrification of trading. Nearly every major exchange is now dominated by computerized trading, with pits of traders relegated to the history books. Beyond just the most liquid assets, even ‘off the run’ derivatives which are customized for the buyer have electronic platforms that can be used to receive offers from multiple bank dealers at once. As such, for pricing new shares, a technology solution would be a natural extension for the existing exchange driven supply and demand model.
Fintech Spotlight is a new column on Finance Magnates devoted to reviewing innovative financial technology companies and sector trends.