Monday, May 23, 2011

Quotes of the day: LinkedIn Sanity installment

... here is another way to think about the LinkedIn I.P.O: the offering price was generous — and maybe even too high--Andrew Ross Sorkin

This is a really bad miss for the investment bankers. But I'm not sure if a few outliers like this means that there is systemic cheating going on. Bankers have a reputation to uphold, which includes stocks that do not crash below their IPO levels, because that would stave off future deals. The owners want to get paid, but then so does the secondary market.  Alan Greenspan missed just as badly on a couple of key things during his tenure at the Fed, and things turned out much worse for many more people. I don't think people who are wrong some of the time are necessarily guilty all of those times.--Cav

More to the point, do you really care? You got your money, you still own 95% of the equity in your house. ... They did it to go public, which means, in this case, that current shareholders will be able to sell their shares in future offerings. They are priming the pump for bigger paydays in the future. Believe you me, I can guarantee the underwriters were begging company executives and big shareholders to increase the size of the offering, especially after they began to see the strength of demand. After all, the investment banks get paid 7% of the offering proceeds; the bigger the offering, the more money they make. Viewed this way, the approximately 50% haircut the company and its current shareholders took on the offering was the price they paid to establish a public trading market for their shares. It was indeed a steep price—several hundred million dollars—but I doubt many of the newly minted billionaires and multimillionaires are too bent out of shape about it. ... Giving new investors in an IPO some value for free is the price of being able to do successful follow-on offers in the future. Now, you can see that this exercise is an art, not a science. Investment bank IPO pricing is the epitome of (very) highly educated guessing. We often get it wrong, but, on average, IPO pricing is normally pretty accurate. Let me make this perfectly clear: Investment banks do not set the ultimate price for IPOs; the market does. And sometimes, as in the case at hand, you get what we call in the trade a "hot IPO." Investors work themselves into a buying frenzy, the offering becomes massively oversubscribed (e.g., orders for 10 or more shares for every one being offered), and the valuation gets out of control. Underwriters have a limited ability to respond to these conditions, which typically emerge during the pre-IPO marketing or "bookbuilding" process, including revising estimated pricing up, like LinkedIn's banks did (+30%), and increasing the number of shares offered. But eventually you just have to release the issue into the marketplace and let the market decide what the company is really worth.--Epicurean Dealmaker

The twofold objective is to build a book of indicative orders that exceeds the anticipated size of the offering—to create conditions for a sustained level of demand support after the stock opens for trading—and to build this book with investors who do not have hard limits on the price they are willing to pay. Now, every underwriter worth its fees will do its damnedest to build what we call a high quality book of orders. In other words, we want to weight the initial buyers in the deal toward investors who intend to not only hold the stock after it frees to trade but also add to their positions in the aftermarket. These are the type of investors virtually all of our issuer clients want: investors, not traders; buy-and-hold accounts, not fast money hedge funds. Of course, the stronger the demand for the deal, the more selective underwriters can be in our allocations. The stronger the overall demand, the more likely it is that we can exclude buy side accounts who traditionally flip on the offering from the deal entirely. And believe you me, we know exactly who the fast money accounts and IPO flippers are. We track every deal, and we keep records. The other material point to relate is that virtually every investment bank makes this process as transparent as possible to its issuer clients. ... Most companies are so delighted with a strong IPO performance that they don't mind having a few more hedge funds and fast money accounts in their shareholder base for a while. After all, those guys' money is just as green as Warren Buffett's. ... investment banks by their very nature straddle both the buy- and the sell-side of markets. We have corporate clients and their inside shareholders who sell stock and institutional investor clients who buy it. Yes, we serve two client bases with potentially competing interests, but that is the very reason we are able to underwrite securities in the first place. We are middlemen, and it is the essence of what we do all day to balance the competing interests of our clients for the benefit of all. All our clients are fully aware of this. ... Of course investment banks horse trade with certain buy-side investors; of course we give certain accounts bigger than normal allocations in IPOs; of course we give a hedge fund we owe a favor to access to a hot IPO. By the same token, we earn a lot of favor ourselves for giving accounts access to such hot IPOs. The horse trading goes both ways. And because we owe an obligation to underwrite a successful offering for our issuing clients, all the competing pressures from the institutional securities side of our house are generally and pretty successfully kept in check. This—for those among you who might be unfamiliar with it—is commonly known as business.--Epicurean Dealmaker

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