Wednesday, May 23, 2012

Private Market Bubble

Every time a company goes public and the price pops, you get a long line of economists talking about how this is inefficient and that the company has left money on the table.

Well, Facebook just IPO'd and there was no "pop". This is not being trumpeted as a triumph of efficiency.
It may be part of an underwriter’s responsibility to support an IPO at the offering price, but the fact that Morgan Stanley and its partners were forced to wage such an epic battle to do so in the final hour of trading on Friday indicates a pricing failure. Simply put, the artificial demand distorted the market — until Monday, when the shares tumbled 11%. With Morgan’s Stanley backstop gone, the market priced Facebook at a more authentic level, $34, or about $10 billion less by market capitalization than the offering price. “The underwriters completely screwed this up,” Wedbush analyst Michael Pachter told the Wall Street Journal. The offering “should have been half as big as it was, and it would have closed at $45.”
Looks like if shares go up you lose, and if shares go down you lose as well. I think this reveals something quite different.

1. Facebook has been actively traded on private markets for quite some time now, so this wasn't an IPO in the traditional sense as there had been extensive price discovery long before the company officially went public. I don't know how options were prices for recent pre-IPO hires, but the usual stuff that gets done prior to an IPO (valuation, price discovery, finding buyers) had all been taken care of.

2. There is a pre-IPO internet bubble on, with angels, VCs, and companies paying too much for private concerns.
This group needs a robust post-IPO bubble so they can make money on top of the inflated prices they are already paying. That may not happen. If so, the pricking of this bubble will be very interesting, and very different, from the late 90s asset bubble.But the truth is that Facebook’s valuation had grown so large — thanks to several huge venture-capital rounds totaling a record-breaking $2.2 billion — that by the time the offering reached the public, it was already overpriced. In other words, insiders (and others, like Goldman Sachs, which invested $500 million last year at a $50 billion valuation) bid up the company’s stock price, leaving little upside for public investors. “The I.P.O. system only works if it preserves a balance between public and private investors,” writes the New Yorker‘s John Cassidy. “If this balance is upended, and virtually all of the rewards are reserved for insiders, ordinary investors will refuse to play the game. A dearth of I.P.O.s would hurt insiders along with everybody else."
Why? Why should a corporation give unearned upside to any entity, whether it's Goldman Sachs or Joe Sixpack? The article seems to contradict itself in the next paragraph:
But the various problems with Facebook’s IPO reinforce some of the worst stereotypes about Wall Street: That it’s skewed toward insiders and top banks to the detriment of average Americans.
 I'm not sure how average Americans, staying away from an expensive valuation, did anything to their detriment while helping out insides and top banks who over payed and were looking for a greater fool but didn't find one.

2 Comments:

Blogger Greg said...

"I'm not sure how average Americans, staying away from an expensive valuation, did anything to their detriment while helping out insides and top banks who over payed and were looking for a greater fool but didn't find one."

This is the end point of our current Wall St model unfortunately. When 90+% of the people cant or dont want to play in the casino then the 5-10% only have themselves as marks. It had to get to this point with the current institutional arrangements. I only hope this happens a lot more so maybe we can get some substantive change in how our financial system is structured.

6:55 AM  
Blogger Ohm (Ώ) said...

To add mine to Greg's point - the financial system has to move from the center to the periphery.

At present, if you want to do something positive for business, you have to do it via Wall Street. You want to reduce taxes or add availability of capital for business - then Reduce taxes for Wall Street games, for that's how money is available to the businessman or consumer or home buyer. To create wealth, Wall Street needs to be appeased - by incenting them further to play their casino games even more intensely! After that, everybody needs to voluntarily submit to their hynotica that Home valuations are exactly right and will go up, FBook is worth $60/share, and what have you. Else, thee perish :-(

9:08 AM  

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