May 04, 2012
The Eternal IPO Question
Posted by Usha Rodrigues

Yesterday private equity giant Carlyle priced its IPO at $22, below its initial range of $23-25, looking for a first day pop (according to the WSJ).  It couldn't find it, and closed yesterday up just $0.2%.  Also in the IPO news, Facebook set a range of $28-35, valuing the company at $96 billion, lower than some valuations had suggested--and,notably, lower than the most recent price on SharePost, $44. It looks like Facebook is looking for the first-day pop, as well.

Why?  There are 2 dominant stories for IPO underpricing, one sinister and one innocent.  Both hinge on the fact that in an IPO investment banks act as intermediaries, buying the company's shares at a discount and then turning around and selling them to the public.  The sinister story blames greedy investment bankers that strong-arm companies into asking too little for their shares so that the bankers can curry favor with their clients.  The innocent one chalks underpricing up to information asymmetry: it's hard to gauge the true price of a stock that hasn't been traded, and uninformed investors will shy away from the market entirely unless they can be enticed in with the prospect of a sure thing.  (Steven Davidoff has a characteristically incisive review of all the underpricing theories here).

Here's what I think is weird about the recent IPO news.  First, Carlyle is a sophisticated player, not your average Groupon or LinkedIn to be victimized by investment banks.  I could see Carlyle's management saying: "You know, we want to raise as much money as possible, first day pop be damned."  No first day pop means you didn't leave any money on the table. And that's a good thing, right?  But that's not how it's playing in the press.  Carlyle's IPO is "unimpressive," "lackluster."  Uh, how about "shrewd" or "accurately priced"? 

Facebook's IPO is interesting because it lacks the information asymmetries that plague the typical IPO.  We know Facebook's market valuation as measured by sophisticated, er, accredited, investors.  As Davidoff writes, "Underpricing has also been found to be lower when information about the issuer is more freely available so that uninformed investors are at less of a disadvantage." Yet Facebook is pricing quite a bit lower than the last SharesPost sale of shares.  Which suggests either 1) that the information asymmetry story is wrong, and that management and/or the banks purposefully leave money on the table for their own sinister purposes.  Or 2) that the secondary market isn't particularly good at valuation. 

Last month I predicted that SharesPost would be in trouble if there's no first day pop.  Today's WSJ quoted an investor that was pretty sanguine about it: John Landis bought at $31-32/share, and he's still hopeful that he'll make money, speculating that the low end of the range might be a "tactic to build excitement for the IPO."  The WSJ didn't quote any investors who bought Facebook at $44/share.  I know what they're hoping now.  We'll have to wait until May 18th to find out.

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