November 8, 2013

"Did Twitter Leave Money on the Table?"

Back in March 1983, the marketing research company I worked for went public at $23 per share, while this week Twitter went public for $26 per share. Both stocks immediately shot into the 40s.

The way an initial public offering works is that a firm, whose stock has previously been owned by its founders, favored employees, and private investors (such as venture capitalists), creates new share and offers them to the public through a 2 stage process. A price per share is picked and the new shares are offered just before the opening day of trading to selected allies, such as the Wall Street firm taking the company public, the investment bank's financial friends, and to more employees.

Initially, the IPO price before trading was going to be $16 a share, but at the last second the buzz was so intense that the shares went for $23 each. For example, as brand new employee, I was given the privilege of buying some shares at the IPO price. I bought $2,000 worth at $23 per share.

But the stock instantly shot upwards as soon as trading began and quickly stabilized around $43 per share, and finished the day at $43. So, I made $1739 on my $2000 investment in one day. Woo-hoo!

Of course, all that raised questions about who, beside junior employees like me, benefits when the IPO is severely underpriced.

The numbers for Twitter's first day of trading were almost identical (instead of $23 to $43, Twitter was offered to the privileged at $26 and instantly shot up to $45 in public trading, although the total number of shares Twitter offered was vastly greater.
Did Twitter Leave Money on the Table? 
BY DAVID GELLES AND PETER EAVIS 
The first day of trading in Twitter stock added more than $10 billion to the company’s market value.

Twitter’s stock jumped 73 percent in its first day of trading, adding more than $10 billion to the company’s market capitalization. 
If the company had sold its 70 million shares at $45.10, the price of the first trade, instead of at $26, the price of the initial public offering, it would have raised $3.16 billion instead of its more modest $1.82 billion. 
That math suggests that, as Dan Primack of Fortune wrote, “Twitter left more than $1.3 billion on the table.” 

In case you are wondering about the arithmetic ($10 billion v. $1.3 billion), note that Twitter, like all IPOs, only offered a fraction of its shares to the public.
This is a common assertion when new stocks soar in their first days of trading. It suggests that the bankers managing the offering miscalculated investor demand for shares and that the company somehow lost out. Twitter shares closed down 7.24 percent, to $41.65, on Friday. 
But unpacking this claim raises thorny questions about who, exactly, is supposed to benefit from an I.P.O. and what exactly is motivating investors when they seek shares in a new company. 
Should a stock offering maximize value for the companies selling shares, for the investors looking to gobble those shares up, or for early employees and funders? And why are investors buying the shares – because they love the company’s fundamentals, or because they sense a good deal? 
One school of thought says companies should use I.P.O.’s to raise the maximum amount of cash, regardless of what that does to its short-term share price.
“It’s not in Twitter’s interest to really care about the price they close at today,” David Stewart, co-founder of a start-up called JumpCam, said in an email on Thursday. “What should matter to them is one, how much money they raise via the I.P.O., and two, their long-term valuation.” 
Mr. Stewart argues that Twitter and its banker, Goldman Sachs, widely miscalculated demand for the stock, depriving the company of cash in the bank and long-term market value. 
There may be some truth to that, but Twitter is clearly satisfied with the amount of cash it raised and now has access to the capital markets should it need to raise more money soon.

You know, in the opening day jubilation, the founders of my company laughed off the money their investment bankers had left on the table by underpricing the stock. But, a half decade later, they desperately needed that money and, indeed, just barely avoided bankruptcy.
As for the investors who bought the stock as part of the offering, they did indeed make out well. Those who were able to secure an allocation of shares recognized an instant 73 percent gain on their investment. Mr. Stewart and those who share his view argue that that’s an irresponsible move, “transferring some value” from Twitter “to pre-I.P.O. speculators.”

Here's an anecdote I've told before:
When I was getting an MBA many years ago, I was the favorite of an acerbic old Corporate Finance professor because I could be counted on to blurt out in class all the stupid misconceptions to which students are prone. 
One day he asked: "If you were running a publicly traded company, would it be acceptable for you to create new stock and sell it for less than it was worth?" 
"Sure," I confidently announced. "Our duty is to maximize our stockholders' wealth, and while selling the stock for less than it's worth would harm our current shareholders, it would benefit our new shareholders who buy the underpriced stock, so it all comes out in the wash. Right?" 
"Wrong," he thundered. "Your obligation is to your current stockholders, not to somebody who might buy the stock in the future." 

That's not the easiest moral point to understand. And you see almost everybody who is anybody mess it up when it comes to the value of citizenship and immigration.

In the case of an IPO, the small number of executives signing off on the price picked by the investment bank generally own a large fraction of pre-IPO existing shares, so if they want to feel cool for having their stock shoot upward on the first day, well, that's their loss. (Of course, they aren't all the pre-IPO shareholders, so my old prof's moral point still applies.)
But it is also in Twitter’s long-term interest to remain in the good graces of institutional investors that believe in the company and will continue to invest. 
After all, based on fundamentals alone, it was hard enough to justify valuing Twitter at $13 billion, let alone $30 billion. 

In other words, the IPO industry exists in sizable part to give Wall Street insiders a discounted price on shares that they can, if they want, sell to the public. In return, the Wall Street insiders whoop up the stock to get the rubes in Shaker Heights and Scottsdale excited about it. In fact, the bigger discount the firm gives the Wall Street big boys, the harder they'll work to make the doctors and dentists out there who keep an eye on CNBC worked up over the stock.
As for the early employees, venture investors and those who managed to secure Twitter shares on the secondary market, they also made out well in the debut.
Like I made $1,700.

Of course, the founders/executives could have gotten a higher valuation and paid bonuses to employees, so shortchanging yourself seems like an inefficient way to pay for Steve Sailer's big night on the town. (I don't recall the exact size of the bar tab I picked up that evening in 1983 with some friends back home at the snazziest bar in Sherman Oaks, but it must have been $40, maybe even $50.)
Sometimes insiders sell during the I.P.O. Such sellers might therefore favor pushing hard for a high offering price. Such was the case at Facebook, where internal pressure for a lofty valuation contributed to its high offering price.

Facebook was offered to insiders at $38 and closed its first day of trading at $38.23. This was widely considered shameful by all the Wall Street insiders who you usually pick up a larger profit out of being pals of the underwriter, but Mark Zuckerberg appears to have preferred getting the market price for his firm to being the toast of Wall Street.
But no Twitter insiders sold stock as part of the offering, meaning their shares, valued at as little as $17 just a week ago, are now worth more than $40 a share. With the shares still at least 60 percent above the I.P.O. price, Twitter’s insiders must feel rather pleased with how the offering was executed.

At my employer, the feeling was universal: if our stock goes up 87% in one day, then surely it will go up 8.7% tomorrow and the day after and the day after. Instead, the stock price drifted back down from $43 per share back to $23 per share over the next year. In other words, the IPO price had been quite reasonable, but there just happened to have been a mini-tech IPO bubble blowing up the week we went public. (Spring 1983 may have been the first broad tech IPO bubble in American history. It definitely hasn't been the last.)

But, the firm couldn't get its hands back on the capital it could have acquired by setting the IPO price at, say, $40 per share.
The truth is, there’s no way to know how much money Twitter left on the table.
If Twitter had priced its shares more aggressively in recent weeks, the tenor of media coverage might have been more skeptical, investors might have been scared off and demand could have lagged. 
By taking a more conservative approach to pricing, Twitter possibly deprived itself of some capital. But it won the good graces of the market, which will help determine its fate going forward. 
Without a doubt, Twitter probably could have raised more money for itself by increasing its I.P.O. price. But an I.P.O. is far more than a fund-raising exercise. 
When a company has publicly traded shares, it has taken the bracing step of putting itself at the mercy of investors. Twitter’s stock is now a public barometer of sentiment toward the company. That is something that had to be considered when pricing its I.P.O. 
If the price had been much higher than $26, the stock might have plunged below the offering price on the first day of trading, setting off a swirl of negativity. 
Facebook’s shares sagged after its I.P.O., complicating management’s efforts to convince investors that it was working on ways to increase advertising revenue. 
Twitter still has to prove it can make money. But for now, at least, it has the confidence of the public markets.

Oh, boy ... I think we need to subdivide the concept of the "public markets" a wee bit, from, at the high end, Twitter's underwriters (Goldman Sachs, JP Morgan Chase, and Morgan Stanley) to the middle range being close personal friends of the underwriters who got shares for only $26, down to the low end of daytrading dentists who paid $45.

The upper and middle ranges of the public markets love Twitter for putting hundreds of millions of dollars in their pockets. The mass end of the market, the people who pay the retail price for Twitter shares, loves Twitter because the business press, which takes their leads from the upper and middle section of Wall Street who pay the wholesale price, tells them to love Twitter.

Just because Goldman, the two Morgans, and you are all playing in the same game doesn't mean you are all playing on the same team.

32 comments:

IA said...

Steve, the insiders cannot sell their stock options for a certain time after an IPO. Apple got into trouble for back-dating options in about 2008 I think. Big scandal in which Jobs could have had to resign but he got off. Dell was trying to to entice his CFO.

Anonymous said...

Sorry, OT, but there's something of interest here: http://www.independent.co.uk/news/science/exclusive-jawdropping-breakthrough-hailed-as-landmark-in-fight-against-hereditary-diseases-as-crispr-technique-heralds-genetic-revolution-8925295.html

For 2 days, I haven't found anything about it in the U.S. media (googling Crispr), and yet it's an astonishingly groundbreaking genetic development.

Anonymous said...

I don't understand any of this, but I'm willing to push a fat tweeter tycoon before a trolley to death if it makes me rich.

Ex Submarine Officer said...

Sorry Steve, that was then, this was now. Don't become grandpa sitting on the porch. You can do better than this.

ironrailsironweights said...

Investing in Twitter is a smart idea no matter what the stock price because Twitter earns vast amounts of revenues from ... actually, just where does the company make money?

Peter

Anonymous said...

About 75% of stocks trade for less then their IPO price one year after being on the market. As an investor, you are usually better off to ignore IPO's. The hype and hysteria is rarely justified.

Auntie Analogue said...


Games of chance are always rigged in favor of the house, because the house didn't get to be the house by actually taking chances, but by rigging the games.

Anonymous said...

That's a piquant summary, Steve.

cipher

Dave Pinsen said...

Another point to consider is the potential for secondary offerings. If Twitter shares stabilize at this level, they can do a secondary offering in a month or two at a higher price than their IPO and raise another billion or more.

Also, Re insiders not selling after the IPO: that's probably due to the lockup period. There will be a bunch of insiders selling six months from now.

Dave Pinsen said...

One general observation about this Web 2.0 bubble versus the 1.0 bubble in the late '90s: the wealth seems to be getting spread more narrowly this time. In the '90s, the doctors and the dentists and the day traders made some money in the aftermarket when tech startups went public.

Of course back then companies were going public much earlier, so Main Street investors had a shot at a good part of the hockey stick growth, if there was to be one. In contrast, Twitter just went public as a $20 billion+ company - only angels, early employees and VCs got a piece of it when it was worth < $500 million.

Also, in the late '90s the tech bubble coincided with ~4% unemployment, so there was a sense the average Joe was benefiting from the boom somehow, even if there wasn't much of a direct connection.

Dave Pinsen said...

They're all skinny hipsters, so one of them might not stop the trolley.

Dave Pinsen said...

Advertising and datamining.

Anonymous said...

I'm still waiting to hear a convincing argument that "insider trading" is somehow immoral.

Hunsdon said...

If you can't tell who the rube at the table is . . . .

carol said...

where does the company make money

Funny they only recently started pushing spam "suggestions" the way Facebook did. I report every one (lol) but they're going to just turn it into a targeted ad spot generator.

It's insulting to see what they think I might be interested in.

Anonymous said...

http://www.amren.com/news/2013/11/hearing-violence-epidemic-linked-to-bad-diet/

"The latest research concludes that too many french fries and other heavily processed foods are contributing to the nation’s epidemic of violence.

“Junk foods make junkie minds,” said Capt. Joseph Hibbeln, National Institute of Health."

If junk food makes for junkie minds, researchers need to go easy on potato chips.

Anonymous said...

http://www.amren.com/news/2013/11/hearing-violence-epidemic-linked-to-bad-diet/

"The latest research concludes that too many french fries and other heavily processed foods are contributing to the nation’s epidemic of violence.

“Junk foods make junkie minds,” said Capt. Joseph Hibbeln, National Institute of Health."

If junk food makes for junkie minds, researchers need to go easy on potato chips.

Next time there is a rape, damn that Coca Cola.

(Funny. Crime in NY declined prior to the attempted banning of big gulp drinks).

Anonymous said...

The media are horrible at reporting on IPOs, thinking of it as a big win for everyone if the price shoots up, much like how they always cheer for a "strong" housing market.

There are two bad possibilities, and you covered the first. If the high price is justified by the fundamentals, then the readers should know that the underwriters pocketed high fees for badly failing at their jobs.

Alternatively, if the high price isn't justified by fundamentals then the original investors got rich not by creating any value, but by convincing suckers to throw their money in the garbage. If these suckers are CNBC watching dentists who like to gamble then we shouldn't really care. But if the suckers who got caught up in another fad are institutional investors or hedge funds getting high fees to manage public pensions or publicly guaranteed pensions, then they should also be identified so that we don't waste any more of our tax dollars on them.

Michael Ryan said...

you mean to say open markets work?

freudwasrightaboutafewthings said...

Of course they left money on the table and of course the whole thing is a scam manipulated by and for the benefit of the rich.

This is a no-brainer, Mr. Sailer.

****

OT but more important to me is the recent revelation of Ronan Farrow as gay gay gay. And don't give me this, "I don't label myself, I date men and women" stuff. He's gay gay gay.

Two observations.

One, he does look awfully like Frank Sinatra in this picture:

http://www.vice.com/read/does-it-matter-that-ronan-farrow-is-gay

Two, his loverboy is a dweeby, short, nebbishy, excessively verbal Jewish guy in show biz.

Mr. Anon said...

"Anonymous said...

About 75% of stocks trade for less then their IPO price one year after being on the market. As an investor, you are usually better off to ignore IPO's. The hype and hysteria is rarely justified."

The investing equivalent of standing in line for two days to buy the latest Ipod.

Anonymous said...

The Sailer Conundrum.

Sailer says whites should be more like Jews(esp Israelis) in regards to their own self-interest, but Jews are the ones doing most to prevent this.

Anonymous said...

When I was getting an MBA many years ago, I was the favorite of an acerbic old Corporate Finance professor because I could be counted on to blurt out in class all the stupid misconceptions to which students are prone.

One day he asked: "If you were running a publicly traded company, would it be acceptable for you to create new stock and sell it for less than it was worth?"

"Sure," I confidently announced. "Our duty is to maximize our stockholders' wealth, and while selling the stock for less than it's worth would harm our current shareholders, it would benefit our new shareholders who buy the underpriced stock, so it all comes out in the wash. Right?"

"Wrong," he thundered. "Your obligation is to your current stockholders, not to somebody who might buy the stock in the future."



AOL were appalled that Time-Warner paid real money to people as salary when it was far easier to give some payment as stock options which were not expensed thus seeing a higher reported profit leading to a higher stock price which meant AOL-Time-Warner losing out on stock that they could not sell into the market to raise capital.

Some students are ahead of their Warner er Time.

Our yachting hero at Oracle works for $1 which he pays income tax on with the rest made up of $77 million options on which he pays Capital Gains tax. Great for financing yacht races but if Oracle need $77 million to develop a successor to SunOS they cannot tap the market with those shares thus hindering all the current shareholders to the benefit of a single shareholder.

Anonymous said...

"I'm still waiting to hear a convincing argument that "insider trading" is somehow immoral."

Well, outsider traders get it in the neck.

Watch what happens in TRADING PLACES.

Anonymous said...

http://www.dailymail.co.uk/news/article-2487501/How-migrants-outside-Europe-leave-100billion-hole-public-purse-Amount-taken-benefits-services-14-higher-money-back.html

Not to worry. More immigrants will fill in the hole.

--------

Interesting:

"However, migrants from Europe – including those from Eastern Europe who came in large numbers after 2004 – have paid more in taxes than they received, researchers said."

Poles work, Africans shirk.

Billare said...

Steve, the insiders cannot sell their stock options for a certain time after an IPO. Apple got into trouble for back-dating options in about 2008 I think. Big scandal in which Jobs could have had to resign but he got off. Dell was trying to to entice his CFO.

Charmingly naive. If you weren't aware, the innovation of the Silicon Valley private market has changed all the usual rules of the corporate IPO. Probably close to a cool hundred of Twitter employees were liquid millionaires before the official float. Moreover, even if the company's lawyers managed to craft strong enough protections on premature sales -- there is tension between employee and employer in that many of former want to realize their gains and move on, while the latter would like to retain its talent and prevent further dilution of its equity base when it has to replace them -- there are all sorts of tricky ways to get around that, like repo agreements where technically no sale occurs (e.g., you give me cash now, I promise you stock later, compensating for interest). Have no doubt; the insiders have profited off the rubes, massively.

Strangely enough, though I'm a big fan of how technology has enhanced my own life, more and more the bizarre valuations of tech companies have brought me closer to Marx than I previously thought possible. Allow to me illustrate with an analogy, I think cribbed from an idea of Taleb's, with made-up numbers: Suppose the comforts of modern life afford me $1000 worth of value per year, of which Twitter creates $1 and makes 5 cents in profit. Now you could say I'm fairly indifferent to whether Twitter lives or dies (it enhances my livelihood by < 0.1%), and someone naive might want to forsake Twitter's business because of the low margins. But 5 cents leveraged across a billion people is an awful lot of money...and the nature of technology industry is to have steadily decreasing infrastructure costs, with fewer and fewer employees required to leverage that infrastructure.

In other words, should we esteem and accord a voice to these nascent rich, as we usually do because they've genuinely enhanced our lives somehow, mainly because the nature of their business allows to them address a vast number of people with very few employees? I mean, I think everyone should give Zuckerburg some grudging respect, because he seems to have forsaken alot of temptations to control his creation and maximize value for himself and his employees, but the Twitter guys haven't even proven that their service is socially useful, which one does by being profitable. I'm beginning to think that American capitalism is starting to create an awful lot of entitled people who don't deserve to be simply because they were in the right place, at the right time.

You don't have to invent conspiracies, or "bankstas", or anti-Semitic nonsense to believe that Twitter's IPO could presage a bad thing. Quite rationally, understanding the logic of network effects and the ever-diminishing costs of the tech industry, investors could jump at the chance to undeservedly enrich the founders of nine out of ten wasteful startups, so that they were in at the ground floor of the monopolizing tenth. That's all well and good until you have those nine legitimated founders thinking they're God's gift to our green Earth, talking nonsense, inserting themselves into politics, unable to be questioned because they were there at the beginning of Tumblr, man...

Dave Pinsen said...

Here's an essay from New York Mag by an author who went from a Twitter mocker to addict: "How Twitter Hijacked My Mind". Excerpt:

"But Twitter, man. The medium I mocked most. The one I joined last, and was sure I’d quit first. The hardest to initially understand, and the most seemingly inane. The one so easily vilified from afar as antithetical to nuance, substance, elegance, depth. The one most at odds with my own country-mile prose. Also: the one I adore. The one to which I am addicted. And the one that, over the course of the past three years, in tiny nibbles exactly the size of this sentence, has proceeded to eat me alive."

Anonymous said...

Pinson Said:

"Another point to consider is the potential for secondary offerings. If Twitter shares stabilize at this level, they can do a secondary offering in a month or two at a higher price than their IPO and raise another billion or more."

That ain't gonna happen. I used to day trade all the time. Now I do occasionally, and the rules favor the house big time. For example, you can't send a market order for the first day of trading on an IPO. Couple that with some amazingly wide spreads between the bid and the ask, and we have a "market" that allows the market makers to hose you good.
Limit orders mean they're not obligated (not really) to fill your order, and they can pass you by when the stock is going up, while filling orders to their cohorts. Then when when the stock is about to dive, your order will be filled first. There are ID numbers attached to each order, and MM's know what broker you're trading from, and treat you accordingly.
Also, the NYSE apparently is allowing MM's to use "emergency shares" outside of the declared float to hose down any large orders they want. I suppose that's to help suppress hedge funders flooding the stock with buy orders, but it's not clear how many extra shares are thrown into the declared float in the aftermath, but you can be sure the shares are being deluted. Again, I don't know how the math is gonna work with that, or if they will ever declare how many "emergency shares" are thrown into the float at the MM's discretion when all is said and done.
In any case, Twitter's got more down to go. I wish I could short it yesterday.
They kept it from going nuts after the market opened, but at a long term price to shareholders.
The only difference between Twitters first day and Facebooks is with Twitter, the market makers had enough class to give the buyers a reach around while defiling their collective proverbial anus.

Anonymous said...

Ex Submarine Officer:

"Sorry Steve, that was then, this was now. Don't become grandpa sitting on the porch. You can do better than this."

As opposed to you? The old guy with the broken down dog shitting on Steve's lawn?

Mellow said...

$2000 worth of $23 shares going to $46 is much better than $2000 worth of $35-40 going to $46.

Once the company got the bucks that owners and buddies thought was needed, why not get the cut they wanted?

Obviously, "investors" were happy enough to buy up to the $46. Everybody got what they wanted.

Dave Pinsen said...

Options will start trading on Twitter on Friday, so you can buy puts on it then if you want.

IA said...

@ Billare,

That's an interesting article but I hope you aren't serious about Marx. You, I would say, have a naive belief in the benign goodness of centralized power not apparent to me. The article does mention Sarbanes-Oxley and government regulation that encourages these distortions in a market. Social media should be looked at as a kind if gold rush, it seems. I know very little about it other than I made the mistake once of joining Linkedin. I cannot get out of the damned thing. I have deleted all my information but they still send me other people's contacts, so I assume they're doing the same to them. I feel far more violated by this than people cashing in on the idiocy of the mob. Fools and knaves deserve what they get. Con artists always exploit the greed of their marks. Social media exploits hubris, I suppose. Hubris and envy, and maybe greed thrown in for good measure. Government regulation won't change human nature.