The stock of social-network LinkedIn has had a heck of an IPO debut this morning, popping 90%+ above the IPO price.That means folks like us get to write breathless stories about how much money investors are making and how everyone’s partying like it’s 1999.
It also means LinkedIn’s underwriters, Morgan Stanley, Bank of America, et al, just screwed the company and its shareholders to the tune of an astounding $175 million. (Just the way the underwriters of another recent hot IPO, Zipcar, screwed that company).
By wildly underpricing the deal and selling LinkedIn’s stock to institutional clients way too cheaply.
LinkedIn’s stock is trading above $80 a share this morning. Bank of America and Morgan Stanley sold the same stock to their best institutional clients at $45 a share last night. The value of LinkedIn-the-company, it seems safe to say, has not appreciated by 90%+ in the past 12 hours. And that means that, on its underwriters’ advice, LinkedIn sold its stock too cheap. It also means that the institutional investors who bought LinkedIn’s stock last night are high-fiving each other this morning, celebrating their instantaneous 90% gain. (Lots of them are probably also dumping some stock).
By underpricing the stock, Morgan and BOFA gave their best institutional clients a gift of at least $175 million. And that money came out of LinkedIn’s pockets and the pockets of the LinkedIn shareholders who sold on the deal.(Specifically, assuming a fairer price for the stock would have been about $60, LinkedIn probably left about $130 million on the table. LinkedIn’s selling shareholders, meanwhile, left about $50 million.)
And the best part of this screwing is the fact that LinkedIn probably has no idea it got screwed. In fact, the company is probably thrilled with the IPO result. Why? Because they’ve been told for so long, by so many people, that having a big “first day pop” is what every company should pray for in their IPO.
But it isn’t.
Here’s a simple analogy:
Imagine if the trusted real-estate agent you hired to sell your house persuaded you to sell it to her best client for $1,000,000 by telling you this was the best price she could get. And then, the next morning, the person who bought your house immediately turned around and sold it for $2,000,000 (using the agent to sell it, naturally).
How would you feel if your agent did that?
And that’s EXACTLY what BOFA and Morgan Stanley just did to LinkedIn and LinkedIn’s shareholders.
Now, it’s true that BOFA and Morgan, et al, did a great job of marketing the company: LinkedIn’s $80+ share price is a testament to that. The underwriters deserve a lot of credit and a big reward for this. (And don’t worry–they’re getting one. They’ll be splitting up a ~$30 million IPO fee, for starters.)
And it’s also true that underwriters should always try to modestly underprice deals, to the tune of a 10%-15% “IPO discount.” They do this to reward institutions for taking the risk of analysing and buying the stock of an unproven company. If there were no discount on IPOs, there would be little incentive for big investors to play ball before the offering: They’d just wait until the stock started trading and buy it then. This, in turn, would make it harder for companies to raise capital. So the modest discount, in which companies and underwriters reward investors with a good deal, makes sense.
(It’s also the reason that, in hot IPO markets, individual investors get furious about not being able to “play IPOs” the way institutions do. They see all the free money institutional investors are making, and they want some of it.)
It’s also true that pricing IPOs is a craft, not a science: The underwriters pick the price based on the level of interest (and the prices) they get from their institutional clients. And they can get played like anyone else.
But there’s a huge difference between at 10%-15% IPO discount and a ~50% discount, which is what LinkedIn’s IPO just sold for. The institutions that bought the LinkedIn stock last night are now 100% richer, just by virtue of being good clients of BOFA and Morgan. And that money came right out of the pockets of LinkedIn and the LinkedIn investors who sold on the deal.
Yes, LinkedIn will get a lot of breathless headlines this morning. And, yes, most folks will think that LinkedIn’s IPO was a roaring success. And the positive halo this “amazing IPO” will cast on the company will be worth something. It will also make it easier for LinkedIn to raise more money in the future–because the investors in the last round did so well.
But having watched this game for two decades now (and played it for one of them), I don’t think there’s any way that this positive halo is worth a 50% IPO discount. And I think that companies have been told for so long, and so persuasively, that a “huge pop” is a sign of success that they never even give it a second thought.They should.
If LinkedIn can sustain a price above, say, $75 a share, BOFA and Morgan should have sold it to institutions at $60. Because the stock was instead sold at $45, LinkedIn and its existing investors just got screwed to the tune of $175 million.
In other words, an IPO that LinkedIn thinks cost a “7% IPO fee” on the $400 million the company raised (~$28 million) in fact cost the company about $200 million.
That is an outrageous price. And the windfall accrued to the huge institutional clients of Morgan and BOFA. And don’t think that Morgan and BOFA are going to let those clients forget it.
(And, by the way, those clients won’t forget it. Which is why they’ll never stop doing business with Morgan and BOFA, no matter how many examples of Morgan and BOFA “putting themselves ahead of their clients” the press and regulators dredge up. As this morning’s $175 million gift illustrated, it’s GREAT to be a big client of Morgan and BOFA, and the clients will always keep coming back for more.)