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Imagine this scenario:
You hire an investment banker to represent you in the sale of your company.
She finds a group of angels and negotiates a deal for a tidy $50 million – a bit higher than the upper end of her expectations.
The next day, hungover from a night celebrating with cheap champagne left over from your brother-in-law’s bachelor party, you turn on CNBC and bolt upright when you read the news crawl and learn that those very same angels just sold your company for $72 million. In a mere 24 hours, your buyers flipped your company for a 44% gain – $22M that could’ve, should’ve, would’ve been yours.
Worse yet, after biting down on your remote in anger, the channel switches to TMZ and video of your angels quaffing Cristal – at a thousand dollars a bottle – with your investment banker under the story line, Charlize’s Angels Take Manhattan (yup, her name was Charlize). It seems that Charlize and the Angels go way back to their sorority days as Tri-Delts.
Dastardly, you say, but pretty far-fetched (if you consider a week ago the distant past).
Take the Snapchat Initial Public Offering:
Shares were priced at $17.00 – higher than the bankers’ initial price range.
With a limited number of shares available for sale, the offering was more than ten times oversubscribed. Naturally, the bankers followed long established norms by allocating shares to their most loyal clients (cue the theme song to Charlie’s Angels).
By the time the market closed the very next day, the shares rose to $24.48, a first day “pop” of 44%. Commenting on the event, the New York Times’ Deal Professor positively gushed that “Snap’s bankers deserve more than the commissions they will receive for a successful, perhaps flawless, initial public offering.”
You know, the offering that vastly underpriced the shares and cost the company $1.5 billion, much of which was funneled to the bankers’ favored clients.
So how is it that under comparable circumstances and calculations, Charlize is the spawn of Snooki and Bernie Madoff, but Snap’s bankers are wizards of Wall Street?
Well, you see, in Wall Street World (Wally World, for short), successful IPOs are measured by the size of their first day “pop.”
But if the pop essentially represents the degree to which the company was undervalued, why is it so acceptable in Wally World?
Well, first, it helps to get all the shares get sold – to suffer a KO in an IPO is a NO NO.
The company generates a lot of excitement and publicity, which theoretically sets up the firm for strong, go-forward momentum.
And why would the company and management go along?
Well, the theory is that they can still get their arbitrage on in secondary offerings and when lockup periods expire (if, of course, the pop hasn’t gone poof by then).
But if you believe in Occam’s Razor (the theory that when faced with multiple explanations for something, the simplest is often the best), you might conclude that the real reason Wall Street celebrates the Big Papi is that it provides long-term institutional investors and other favored clients (including management from the issuing company who are often let in on subsequent IPOs) with instant gains as a quid pro quo for their continued business and loyalty.
But at the very least, the practice of undervaluing IPOs deserves a good, long, hmmmmmmm.