Was LinkedIn Scammed?
nytimes.com
nytimes.com
There was an editorial in the WSJ on friday that strongly suggested the price action in LNKD has to do with the current easy credit environment driving money into riskier assets. I agree this seems likely. Certainly it seems difficult to justify the valuation on any traditional metric. If when pricing the ipo Morgan also felt that any frothy demand was based more on the easing environment than real interest in LNKD as a company, perhaps they were right to hold the pricing a bit more conservative than the market was suggesting.
After all, they already had increased it by almost 33%, and the current QE program is scheduled to shut down in June. Many smart people appear to be betting on interest rates climbing after the program ends, that may take enough money out of the market to cause someone like LNKD to correct.
Another thing to keep in mind is that LNKD offered a relatively small amount of stock as compared to many offerings. This kept supply low and could have contributed to the large pop, but also means that they probably have plenty available for a potential secondary offering, which could allow them to profit from these very price moves down the line,
Besides, who can say that they actually could have floated the stock at $80? Just because some retail investors or momentum traders bought at $80-$100 on the first day doesn't mean they could have moved the whole volume of stock at that level, especially to some of their institutional clients. Just because you could potentially find one guy out there to buy one share of LNKD at $1000 doesn't mean it's a reasonable price for it or that you could find anyone to buy 100,000 shares at $1000 - but you could still get a print off of that one share transaction.
None of this is meant to say that I trust investment banking firms a lick, or I'm sure Morgan did the right thing here. I'm just trying to suggest that it's a much more complicated situation than the NYT and the Zynga sound bite might suggest.
Wrong. Underpriced IPOs (almost all of them) have been welfare for well-connected friends-of-investment-wankers for quite some time. The idea that banks would have trouble allocating public offerings is laughable.
The claim that banks need to underprice IPOs for some systemic reason is laughable. It's a back-filling rationalization for spinning, which would otherwise rightly have bankers in federal PMITA prison.
I believe the market price today is overvalued, and it will come down in the future.
I think it's a bit absurd that these prices aren't somehow determined by...say... a market rather than what a few guys at a bank "believe". Isn't that sort of the whole point?
All a market is is what the participants believe. LinkedIn was not forced to do this through Morgan Stanley. I am sure they shopped offers at all the big investment banks. There is a market for underwriting IPOs, and there is a market for the actual public shares after the offering.
Hindsight's 20/20. We could just as easily be sitting here weighing up all the information Morgan Stanley had that should have told them not to give such a high valuation.
I understand there's a stigma, but why does the stigma exist? Let's just assume that the investment bank's only goal is to accurately predict the demand for a new IPO, and to set the offer price accordingly; why is overpredicting demand stigmatized whereas underpredicting is not?
I can't imagine the LNKD investors are too disappointed about a $300+ million payday.
I'm not a market "fundamentalist", but they're an awfully good way of pricing things in many circumstances compared to the central planning approach of having several experts decided on a price.
I'm no economist, but I'm sure a clever one could find a good way to auction off IPO shares to get the best deal possible for the company.
It's an IPO, and the first social media network to do one. New territory, doubly so. Of course they pulled a price out of their asses.
If LinkedIn didn't like that price, they'd have gone elsewhere. They didn't. They could've affected the price, too, or chosen an auction.
Typically, the biggest blocks of money for IPO investing will be institutional investors : meaning that the actual beneficiaries will be the pension funds, and investment funds of regular people.
The sources of profit to 'Wall Street' are the 7% underwriting fee (which is an enduring travesty, IMO) and performance fees on the managed money (which get a boost because the underlying fund appreciated step-wise).
Regular performance fees are mostly related just to the size of the fund (approximately 1%) - so the effect of the IPO jump on an overall fund will be negligible. However, individual managers potentially benefit indirectly because their performance relative to their peers would improve, and they may be able to get bigger portfolios to manage (which is the big win for an institutional money manager).
If the IPO buyers were hedge-funds, then they would benefit from a 20% performance kicker (which is why people at hedgefunds can be very handsomely rewarded). OTOH, the hedgefund investors would likely just be 'flipping' the shares within a couple of days - so they're less attractive/stable initial holders than the investment banks would ideally like for a 'solid' IPO.
>> I can't imagine the LNKD investors are too disappointed about a $300+ million payday. <<
That is exactly the sort of cavalier attitude folks on wall street display when these issues persist - "who cares, we made you a lot of money didn't we?". When in fact their responsibility is to try and find the most accurate price and minimize risk to the underwriters.
The thing is like others have mentioned, there is a degree of "buyer beware" going on here. Its not like LinkedIn had no clue about the market situation. They probably had a staff of ex-bankers (like most tech companies do) help them price the offering too.
It's just the nature of the beast. Taking companies public is an oligopolistic business and till we figure out alternative ways of doing this (a-la google tried) this is going to be a perennial problem.
There isn't a "market price" until it goes on the market. Nothing prevented LinkedIn from having their own experts (and I suspect they did) weigh in on the proper price.
It would be like selling 10 of the bricks from the house for $10, and then the guy you sell them to turns around and sells them for $20. Far from being upset, you now realize that the remainder of your 150 bricks just doubled in value.
To complicate the analogy further, you would need to sell 10 bricks to 10 different people and spend a month negotiating the price to a point where everybody agrees on the same price - which is the problem with an IPO.
There are even further complications with LinkedIn in particular, but needless to say the analogy falls apart very quickly.
It's not as important that my remaining 150 bricks are more valuable. I can't sell those right now. But I could have built an addition 2X the size if I had gotten 2X cash for the bricks I sold.
I'd say that their main goal is to make sure that the shares are all sold at a price that everyone is happy with - the management team of the company going public is heavily involved in all the steps on an IPO.
Like taking VC money, nobody makes you go public and both are things to do with your eyes wide open.
The problem most people refer to: if you have over 500 shareholders of record, you have to make a lengthy filing which is almost as onerous as going public. Hence, since the incremental effort isn't that much, most companies in that position go public. There's technically no compulsion to do so.
However, in this situation it is more a case of damned if they did and damned if they didn't.
Before the IPO there was a fair amount of nervousness about a big launch of yet another dot com. It is easy to look at this with the benefit of hindsight and say - they should have known the share price would more than double but I doubt they purposely got it that wrong.
In each case, you are relaxing some control of your company in exchange for something else valuable: other people's money. Whether such exchange is fair or not depends on specific circumstances; each side can always ask for more (money, control) to make the exchange fair.
I don't know of any company of any significant size (e.g. with >$100M of annual revenue) that hasn't made such an exchange at some point in its history.
The public stock market is a real-time debate about valuation in the open. The VCs do it behind closed doors. Being critical of the markets for being divorced from reality is fine, but surely having a public stock price is better than having it all hidden from view?
If you're not a fan of more openness, maybe you are hoping to 'pick off' a VC who over-values your company, away from a public analysis of its actual worth?
As for having a public listing forcing a company to do anything - it's not true at all (except for publishing audited accounts). The company is free to ignore the gyrations of the market, and keep its plans secret too.
Edit: From another story on the home page right now - Red Bull $5B in sales
I would bet that most of these companies were created decades ago and that most of the recent "success stories" took public money at some point - anybody knows any examples?
Is, was, and will be privately held for the forseeable future.
Also, eventually your employees with stock options and investers will want to see liquidity to stick with you.
Finally, you may not have a choice. A company must become public after it has 500 shareholders. This can happen if you have enough investors and enough employees exercising their options early (presumably because they have left the company).
I believe 7 million shares were floated out of ~94 million outstanding shares. If more shares are floated, the price per share should go down (not considering other factors) as there will be a larger supply of shares in the public market. The assessment that the investment banks that the IPO should be priced at $45 sounds more reasonable had all 94 million shares been floated (speaking hypothetically; this never actually happens).
For this reason, valuing LinkedIn by multiplying 94 million (total outstanding shares) by the current stock price on the NYSE (as most news articles have been doing) is probably not a very accurate measure.
Not really true. If you want to buy or sell a million shares right now, you're probably going to see that effect-- it's called "slippage" and occurs when you trade any stock in large quantity, but the market self-corrects soon after. At a few hundred or thousand shares for a decently liquid stock, slippage is not a real concern and the only cost of trading is the bid-ask spread, which is usually a penny or two.
No, this is an absurd claim. Investment bankers are not clairvoyant.
Profit? Who's askin'?
- If it's a customer, you're making a little bit of profit.
- If it's an investor, you're making a LOT of profit.
- And if it's the government, you're making no profit at all.
http://www.nytimes.com/2009/01/24/business/24nocera.html
Most important, the government has made clear it will not
allow a major bank to default, to avoid the replay of the
Lehman catastrophe.
AIG failing would have caused an investor panic across banking as a whole due to their position as the leading insurer of investment risk.
In the UK, Lloyds TSB and RBS (two of the 'big four' UK banks) both very nearly collapsed; the smaller Northern Rock bank did collapse and had to become 100% government owned. The alternative in each case was depositors having their assets frozen for a long period with only the promise of pennies on the pound a long time later, with a knock-on loss of confidence for the sector, combined with a large compensation bill for the taxpayers. Would you _really_ like to see what that happens when 20% of the banking market suddenly freezes?
...I should add that Northern Rock did not have to be nationalized, nor should taxpayers be obliged to pay any kind of compensation bill. Bankruptcies can and must happen to clean out the dead wood.
And I agree that bankrupticies must be possible and are a good thing for businesses as a whole; Too Big To Fail explicitly works against this. NR was big enough regioinally that it'd have caused major economic damage to that (already fragile) region had it been allowed to go down.
But the quote you cite is of him observing the government's behavior - accurately - not prescribing what the government should do, or evidence of the government following his suggestions.
Case in point, it turns out, is the banking crisis. It
sure looks like the government’s first impression about
how to save the banks was the right one, after all
Thanks largely to actions taken by the Federal Reserve,
the commercial paper market has thawed, and banks are
lending to each other again — if not to the rest of us.
Customers aren’t racing to pull their money out of the
banking system and stuff it under a mattress.
Most important, the government has made clear it will not
allow a major bank to default, to avoid the replay of the
Lehman catastrophe. (Though it would have been nice if Mr.
Geithner, who had been involved as head of the New York
Fed, had acknowledged that the Lehman default was a
terrible mistake. Instead, he fell back on the old “there
was nothing we could do” dodge. Not exactly confidence-
inspiring.) The government showed its determination to
stick by this thinking when it rushed in to shore up the
faltering Bank of America.
edit: presuming your client understood you were guessing. If you pretended to KNOW and were guessing, you could be prosecuted then.
Let's not forget that the point of an IPO is to (a) provide an exit for the startup investors. (b) raise funds for the company's future operations (c) make the company's financial executives and founders rich.
Who loses when the offering price is lowballed? Everybody who sold shares into the offering. That's the first two of my list. Usually the insiders have a six-month lockup; usually they can't sell their own shares until six months after the IPO. So, if the shares hold their price the execs will do well.
There's a big PR penalty if the stock drops below the opening price. That will turn into a money penalty on the execs in six months unless the company can overcome it.
So, the smart bet for self-interested execs is to lowball the offering price. As long as the startup investors don't call foul, the only loser is the company itself.
If I were an investor, I'd insist on the execs giving me (selling me cheap) options to buy half their shares at the opening price, as an incentive for them to price the offering right.
Henry's analogy is asinine. Better is the owner of a 10 unit building renting to a tenant for $1000 who turns around and rents for $2000. The owner, without doing anything, has just increased the value of his building by 90%.
I think the reason they did not go with a Dutch auction is they lack the confidence of Larry and Sergey. What if it fails? What if the bankers get pissed off and sabotage it by not working hard enough to sell the issue.
Having the price jump by 100% may be leaving money on the table but it is not a disaster. Having the IPO fail would be a disaster, and the management of LinkedIn would be personally blamed for it.
Have things become so bad that companies must ingratiate themselves with 40-50% tributes to the banks?
I hate investment wankers with a passion and would love to see the people involved in IPO spinning get the Paris 1793 treatment. But the "40-50% tribute" claim is not correct. LinkedIn only offered about 7% of its stock, so it was only a 3-4% tribute.
Knowing how scummy banks are surrounding IPOs, this was a very intelligent strategy. Now the stock can trade to a fair level and then they can do a secondary offering at a real price.
So for example, in the case of LinkedIn, the theory is that the bankers knew that the shares could go for 100% higher price than the IPO price and sold those shares to their buddies at a much lower price with the understanding that their buddies would pay them back a percentage of the money they make flipping the shares by doing various other business with the banks.
Of course none of this is proven, but it is a theory many serious people have.
Which underwriters price IPOs most accurately and which ones leave huge amounts of their clients' money on the table?
In hindsight it's easy to say they should have known it would get to this price but in the weeks leading up to the IPO it would have been pretty difficult to justify pricing at 80. The current price is difficult to justify and may not hold beyond this initial frothy period.
Add to that the greater downside of underpricing and I just don't think the author is really making much sense.
Also, for reasons that seem irrational to me, I'm told institutional investors consider it a strong indicator things are going downhill if a stock ever trades below it's offering price.
Like others pointed out, the price slowly grew from $25, $35 and finally $45. I had placed a limit buy order for $47, and it opened at $85.
If there are any finance folks here, I have a question - who set the $85 price? Was it the underwriters? It could not have been the market because the stock started trading at $85. Also, I could not get any stock data from any of the sites (NYSE, yahoo, google, ameritrade etc) untill past 10:15am EST or so. Is this delay normal for IPOs?
So if it opened at $85, that means there were limit orders placed at that level and higher.
I don't know why there was a delay in the price reporting.
"People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public"
Then you'd get a feel for an appropriate price on the first few trading days, so you can't get scammed except for a few percent of the stock.
I'm not sure if LinkedIn will do that, but it's common among small companies that are capital intensive.
Usually the goal is not to capture the fluctuation in short-term price, but rather the long-term appreciation from demonstration of potential. For example, if Tesla sold everything when it IPOed, it would be unlikely to get a good price for it, not to mention it doesn't need all that cash now so it's somewhat wasteful. But if it sold half then and sold half in early 2012 or so, it will be able to (hopefully) get a better deal in the second chunk.
Back to the issue of short term mispricing, companies like Google hold open Dutch auctions so the actual price is very close to the fair market value. I don't know why LinkedIn didn't do that but I suspect it's because it wants to keep good relations with bankers.
I hope that answered your question.
It did, thank you.
Anyone know why this isn't done more often?
Instead of selling a bunch of shares at the "fair price" up front, LinkedIn created the perception that LinkedIn is undervalued, desired, and worth more than it really is worth. All it had to do was sacrifice a tiny portion of the shares in the IPO and it's the new hot money maker.
Now the company and its investors have created an environment where they can unwind more of its shares at a hefty premium, more than making up for the IPO "loss."
Maybe LinkedIn didn't plan this out so perfectly. But it probably saw this as one possible result of the IPO strategy it chose.
Which is it, did LinkedIn scam investors or have investors scammed LinkedIn?
http://features.blogs.fortune.cnn.com/2011/03/13/inside-the-...
There are many ways to IPO (auction, etc) and you have to keep in mind that a big IPO pop makes everyone feel good about the stock. Yes, perhaps LinkedIn possibly could have made an extra $352 million, but if that strategy resulted a $70 IPO with no pop then they would have lost $1 billion in market cap. Pricing and seeing an upward trend have a big impact on the perception of value. Stocks are not priced according to some logical rational algorithm, it's about perception of value and big returns and amazing articles about how it doubled in value on it's first day help fuel those perceptions.
Pricing for a listing is a very complicated process. The underwriters, along with the company executives, go out on a very long roadshow and book orders well before the listing date. It is through these orders, not some magic made up numbers, that the final price is determined from.
In the case of LinkedIn, they changed their list price no less than 4 times between the time they filed their S1 with the SEC and the time they finally listed. Initially it was $31, and the last hike to $45 only happen the night before the listing.
LinkedIn management are professionals who understand their business and understand the process, they have a choice of underwriters to work with and a choice of investors to take orders from. This isn't a single bank taking them for a ride - to suggest that is offensive to those who run LinkedIn
Where the real problem lies, and a problem that was not raised in this criticism, is in how orders are taken. This is what Google attempted to solve with their Dutch Auction system. The claim is that the banking community is so tight-knit that they collude with each other to keep the book price down. So what Google did was to hold a silent auction on bids and allotments, only to find when the process was over that most banks essentially bid around the same mark anyway.
Paying out 6.5% of your company to go public does suck - but it is the cost of creating a viable and flowing public market for your stock. You can't just sell that part of the company to 4 or 5 banks and then ask them politely to pass it on - you may as well just raise another private round in that case. The point of the IPO is to diversity ownership as broadly as possibly and to engage firms that would be willing to take on and trade the stock so that a market is created.
None of the alternate mechanisms work, and you need to be a very large and hot company to even challenge the status quo in the way Google did (and in a way LinkedIn did as well - with their two classes of stock). Note that the underwriters are taking a risk since they end up holding a lot of stock, and in the event of the list price dropping there would be a lot of questions asked about the prospectus and roadshow and potential lawsuits. Also on the other hand, there are not a lot of IPO's that take place, so the underwriters need to make the most of the business they do get - they are the ones with the connections to the large funds that purchase stock, so acting as a risk-bearing agent in that capacity does deserve compensation.
LinkedIn didn't help their cause by listing so few shares. When there is scarcity in the market and so much demand, then there is only one way that the list price would go - and that is up. If they listed twice the number of shares to meet demand then there definitely would not have been so much volatility on the opening day (a lot of which was caused by 'market' orders - which means 'buy at any price').
tl;dr: creating a free flowing and liquid public market for your stock is a very complicated, highly regulated and risky process and nobody has figured out a better way to do it
Your tone seems dismissive of the claim, but finding out that a bunch of people all bid about the same amount when they only way they could find out what each other were bidding is collusion doesn't exactly count as evidence against collusion, does it? It's not great evidence for, but at least if bids were all over the place it would be evidence that many banks don't have an informal cartel or whatever.
I didn't mean it to come across that way, because I totally believe that they do collude. If they didn't then that entire part of the industry would become hyper competitive, unstable and probably a zero-margin (or even loss-leading) business.
These conglomerates in investment banking could handle the business and not make anything on it, they just don't like that. There also is a lot of work involved, so the fees are somewhat justified (see the Microsoft IPO article for an idea of how much work goes into it) - this wasn't helped by Sarbanes Oxley which added a whole new layer of pain-in-the-ass to the process, that only a select few hold the cure for.
There is also an element of this only being a problem when there is a significant first-day rise. You don't hear anybody complaining about it when stocks tank or run level on the first day (if you look at all the tech IPO's from past few years - opentable, rackspace, netflix, renren, etc. most have not done too well in short term).
What would improve the situation would be the companies being able to raise more of the money overseas and thus introducing more competition into the process. Atm overseas funds can buy in after a listing, but for some reason a lot of the pre-listing sales tend to take place in the USA and amongst the usual suspects.
Well, that's what all colluders and monopolists say. I don't see any problem with this outcome. The inefficient get out of the business, and margins settle back to what the market demands.
Debt auctions, in which governments sell debt instruments, such as bonds, to investors. The auction is usually sealed and the uniform price paid by the investors is typically the best non-winning bid.
The underwriting bank would just take bids for a set period of time, and then the winning bidders would pay the highest losing bid. This would help ensure no first-day price spike since any buyer who wanted shares could have bid his top price for them in the auction.
It surprises me, though, considering that Google has blazed the trail, that others wouldn't be eager to follow, if only to encourage people to think of them as "the next Google".
Obviously you would need regulations around this but why is there a middle man at all?
While the idea of doing a 'soft launch' IPO by building up from a toe-in-the-water market makes some sense, the reason that Second Market is being looked at hard by the SEC is because it's doing something that should be regulated far more than it is (because they're using accredited investor exemptions to get around the various disclosure/oversight rules).
This will attract all sorts of scammy pump-and-dump schemes that will convince the public that FOR LIMITED TIME ONLY they have an UNBELIEVABLE OPPORTUNITY to invest at LOW-LOW PRICES.
Like it or not, but investment banks have access to a cadre of accredited retail and institutional investors, so they serve as a filter between legitimate opportunities and outright scams.
Same filter could be achieved, if you got a bunch of emails from accredited investors and just set up a Google group for them.