There’s a strange new animal among the spirits of Wall Street: the cautious investment banker. Born of the disastrous Facebook (FB) IPO, he is well-groomed, sober (thanks to 2008), and terrified of another flop. How do we know? Investment bankers have dramatically underpriced IPOs this year, leaving scads of money on the table.
Six U.S. companies that hit the market this year doubled in their first day of trading, a feat that, prior to this year, happened just eight times since 2000, according to the Wall Street Journal. In somewhat simplified terms, investors were willing to pay twice as much for those companies as the bankers handling the offerings thought they would.
For Container Store (TCS)—which closed its IPO Thursday night and saw its share price double in trading Friday—that would have meant an extra $225 million. That’s roughly four months of sales for the Texas-based retailer.
Another good example is Rocket Fuel (FUEL), an online advertising company. Shares of the California outfit doubled overnight in late September, between the time the IPO closed and the time markets opened.
The trend to underestimate isn’t confined to a few hot offerings. Of the 190 companies that had IPOs in the U.S. this year, the average one-day return was 17 percent, a level not seen since the tech boom of the late-1990s, according to data from market research firm Dealogic.
No one is saying pricing an IPO is easy. Generally, it takes equal parts math, storytelling and salesmanship—particularly with some of the young, fast-growing companies hitting the market recently. With a promising outfit still poking around for profit, say, a budding biotech or an ad-shy social network, value is based on long-term potential more than any recent business activity. Consider this tidbit from the WSJ: 61 percent of U.S. listed IPOs this year lost money in the 12 months before they hit the market. That doesn’t give bankers a lot to go on in setting an initial share price.
There is also good reason to fear a flop. Gains in the early days of a stock trading, the IPO “pop,” build confidence, what some investors call “momentum.” Whereas a stock that falls, even after months of PR buildup, has a much more difficult time convincing investors to bet on it over the long haul. See, for example, Facebook, which took 14 months to claw back to its IPO price, despite a string of healthy earnings updates.
All of these dynamics come to a head this week, as bankers at Goldman Sachs, Morgan Stanley and others try to put a price on Twitter. Can they strike the balance between the froth of the current market and the fear of a Facebook-like flop? It appears that the balance is tipping toward the froth. Today, Twitter’s banking team raised its expected IPO price range to between $23 and $25, from $17 to $20. At the low end of the range, that’s a 35 percent hike.
There are plenty of valid arguments as to why many of the newly public companies are overvalued, chief among them a gracious Federal Reserve. But at any given moment, something is worth what someone is willing to pay for it, and no one should know that better than the investment bankers pricing a company’s stock market debut.
