"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.