Why Big IPOs Are The Ultimate Middle Finger To Investors

23rd May '12 by Edward Croft

3 comments 18473 reads

So they let a hoodie into the stock exchange and everyone got mugged. Well there’s a surprise. Facebook (NASDAQ:FB) has not only damaged its credibility but also the net wealth of hundreds of thousands of investors. The fact that the much hyped float has collapsed by close to 20% from its offer price in just a couple of days has ensured this shambles and its repercussions will remain on the front pages for a long time to come, but what gets less press is the fact that the Facebook listing is just the latest in a long line of IPOs that have been utterly disastrous for investors. In essence the average stock market investor is treated as the fool that the smart money sells to whenever it fancies a good exit and pays the consequences. This trail of consistently dire big IPO underperformance seems more and more like a form of systemic fraud. Can it be avoided? Let’s investigate…

Big IPOs, Bigger Investor losses?

A brief look at the larger capitalisation IPOs of the last few years shows a litany of disaster for anyone caught up in them. Many of these companies are household names brought to market by the most glamorous investment banks in the City, but there’s certainly been no glamour for buyers. The latest quotes show that Betfair (LON:BET) has slumped to reside an astonishing –52% below its float price, Ocado (LON:OCDO) –36%, Glencore International (LON:GLEN) –33%, Supergroup (LON:SGP) –41% and African Barrick Gold (LON:ABG) –39%. Hmmm spot the trend anyone?

Earlier this decade Debenhams (LON:DEB) was a classic case study in the way the smart money plays the stock market. In 2003 the fiduciaries of the wealth of millions on the stock market (i.e. fund managers) sold Debenhams to a consortium consisting of company management and private equity (i.e. smart insiders) on the cheap. In 2006 only 3 years later they then bought it back again when those same insiders re-IPO’d the company and more than tripled the value of their equity stake in the process. In the next 11 months after flotation Debenhams proceeded to issue three profit warnings and the…

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Edward Croft

23rd May '12

Just a few thoughts and links on $FB .

Everyone who cares about valuation knows that Facebook was hopelessly overvalued and over-supplied at the IPO. A great valuation piece by Aswath Damadoran suggested $28 was about right, but still factored in tremendous continuing growth rates. But a brilliant piece in the Technology Review yesterday showed that from a business perspective it's essentially a next-generation Yahoo. An ad-supported site serving billions of web impressions that become less valuable every day.

One of the main competitive edges that Facebook has is that it maps each users social connections, or 'social graph' as Zuck calls it, but makes the desperate mistake of offering this free to any other website in the world. As a result Facebook keeps spawning big competitors - Instagram, Pinterest - who ride on the coat-tails of its social graph to massive scale. You can be damn sure that Zuckerberg will spend many billions acquiring companies that jump to scale from this piggyback before he gets the message - and that may lead to a lot of botched capital allocation. Many VCs think that Facebook will have to charge for access to their social graph... making the company essentially a form of web utility.

Whatever happens to the stock, the danger for investors in the short term is that the company's valuation normalises under the stress of continuing scandal from the botched IPO. It looks like a story that will run and run.

emptyend

Part of the answer is that many fund managers often don’t have any choice but to buy big IPOs in order to keep their jobs. Fund managers job security comes down to their ability to match their benchmark (FTSE 350 etc) on a quarterly basis.

I agree with the first part of this but not (well, not very strongly anyway) the second.

Fund managers don't have any choice but to buy IPOs for a different reason - which is that they want to maintain their relationships with the underwriters and to retain access to the privileges that this confers. Fund managers all want to be "the first call" of any salesman when there is something interesting available (a line of cheap stock, a hot IPO, an invitation to whatever) - and the quid pro quo of that is that, from time to time, they have to swallow the occasional deal on terms they don't much like.

Taken in the round, that isn't an unreasonable principle.......were it not for the fact that there is an asymmetry in respect of where the costs and benefits fall: the costs are always swallowed by the underlying investors whereas some of the benefits get creamed off by the fund managers (mainly the ability to keep their jobs, these days, rather than some of the more egregious cases of abuse which have been cut back by the rules on accepting fringe benefits etc)

harryr

24th May '12

You are being sold something [new shares in an IPO]

Thus, someone is on the make, not you.

If you buy shares at all buy them in the market months or years later often at 95% off.

A few dot com shares are still around, not gone bust, and have had hundreds of millions poured into them over the last 15 years.
With tiny market caps they must = value today.

Why big IPOs are the ultimate middle finger to investors

Big IPOs, Bigger Investor losses?

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Edward Croft

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