Update: After some feedback on my original post on May 21, 2012, I've amended it to add a separate section for pre-IPO investors and to update it for recent events.
Facebook's IPO has been branded a failure by virtually everyone. However, there have been a few articles declaring the IPO a success. All of this begs a larger question: What is a Successful IPO?
My answer to this question is that it depends on perspective: that of the company; pre-IPO investors; the underwriting syndicate; the institutional IPO buyer; and retail investors buying the stock on its first day of trading. Let's look at these perspectives and use Facebook's IPO as an example.
The Company's Perspective. In my experience as a former investment banker working on IPOs, a company wants a few things in an IPO: (1) to raise the capital that it needs (and/or to facilitate existing shareholders selling in the IPO); (2) a favorable valuation; (3) to minimize IPO fees and expenses if it can; (4) seeing the stock perform well in the aftermarket; and (5) the media reporting favorably on the IPO. Let's look at #4. Why does a company want its stock to perform well in the aftermarket? The primary reason is that the wealth of existing shareholders (including founders) and employees who hold stock options depends on the stock price. Once an IPO prices, the stock price becomes a benchmark for founders and employees (and pre-IPO investors and the investing public at large). If the stock price goes up post-IPO, shareholder and option-holder value increases, which is the goal. If the stock price dips below the IPO price, there will be disappointment, especially among employees who hold stock options. Another reason is that a strong stock is helpful as an acquisition currency. A rising stock price is an attractive currency to targets.
In my view, how the company's stock price performs over the next 180+ days also matters. At 180 days after the IPO, selling restrictions for most pre-IPO shareholders will expire (this 180 day period is known as the "IPO lock-up period"). Markets take note of lock-up expirations. Also, at 180 days after the IPO, a company will have reported its first quarterly results as a public company. It's after this lock-up period that all IPO restrictions expire and shareholders can begin to sell their shares to the public (via Rule 144 sales).
So from Facebook's perspective, is the IPO a success? In three of the above five metrics, yes, but in two important metrics, a resounding no. Facebook raised significant capital (nearly $6.8 billion for the company and over $9 billion for selling shareholders). Favorable valuation? At an IPO market cap of over $81 billion, I'd say so (even though the market cap has dropped post-IPO, it's still impressive). The company paid 1.1% in underwriting fees, which is well below the 7% customary for most technology IPOs, and also lower than many of the larger IPOs (by comparison, Visa's underwriters earned commissions of 2.8% in a $17 billion IPO; Groupon's underwriters earned commissions of 6%). Based on the fourth metric, post-IPO performance, Facebook's IPO has been a failure in my view. In addition to the drop in the stock price, Facebook has granted certain shareholders a very short 90 day lock-up period, so the market may be flooded with additional stock 90 days after the IPO date, which could drive the stock price down even further. Finally, for media coverage, the pre-IPO the media coverage was generally favorable, but coverage post-IPO has been overwhelmingly negative - overall I'd say this was a failure as well. So from Facebook's perspective, the IPO was mixed - partly successful and partly unsuccessful.
Pre-IPO Investor Perspective. Investors in a private, pre-IPO company are typically friends and family, angel investors and venture capital fund investors. From their perspective, a successful IPO is typically is one where they are able to obtain a significant return on their investment either as a selling shareholder in the IPO, or a selling shareholder after the IPO (typically in a subsequent public offering or through Rule 144 sales when all lock-up restrictions expire).
From the pre-IPO investor perspective, was the IPO a success? For the investors that were selling shareholders at the IPO, the IPO was a stunning success. This includes venture capital firms Accel Partners, Greylock Partners, Meritech Capital Partners, among others, and angel investor Peter Thiel. These pre-IPO investors invested in Facebook's early stage financings and sold their shares in the IPO for significant returns. For the pre-IPO investors that will be selling shareholders at some point in the future, the answer is it depends on the price at which they ultimately sell their shares (and, of course the price at which they acquired their shares from Facebook).
The Underwriting Syndicate's Perspective. It's not just about fees - it's also about reputation: reputation with future IPO clients, with institutional IPO investors; and with the investment community in general. Attracting IPO clients is largely about league tables (e.g., which bank has the most "left lead" underwriter roles for that sector and in general), IPO performance (how the bank managed the IPO and how the stock performed post-IPO), and equity research (analyst reputation and coverage). Importantly, banks will work hard to ensure that the stock price stays above the IPO price. If the stock price falls below the IPO price, the IPO is considered "broken" and it is a black eye for the bank. Banks engage in post-IPO market price stabilization to keep the stock price at or above the IPO price. Reputation with institutional IPO investors is also important to future IPO performance - if institutional investors won't buy IPOs from a bank over valuation and aftermarket performance concerns, the bank's reputation will ultimately take a hit. It is for this reason that banks build in an IPO discount when selling to institutional investors. Partly as a result of this discount, there is usually an IPO "pop" of about 10-15% from the IPO price to the first trade. If this pop doesn't occur, then the bank may have a harder time selling the next deal to institutional investors.
So from the underwriters' perspective, was the Facebook IPO a success? I'd have to say a resounding No. Note that the syndicate did earn $176 million from the deal in fees and commissions. The stock even had an 11% pop at first trade. But the stock price dropped and "broke" the IPO price. This is a huge black eye for Morgan Stanley, the "left lead" bank on the IPO. In addition, as the stock price broke the IPO price the over-allotment option will not be exercised, so the banks will miss out on the additional fees the sale of these shares would have generated. The media has been highly negative on the IPO. Overall, my perception is that the IPO was a big failure for the underwriting syndicate.
Institutional IPO Buyer's Perspective. Institutional buyers are typically long-term investors and so the stock price one day or one month after the IPO may ultimately not be that important. But as discussed above, many have an expectation that they are buying the IPO shares at a discount to what the true valuation is, and given that they do expect the stock to trade up after the IPO.
From the Institutional IPO buyer's perspective, the Facebook IPO is currently looking like a big failure. However, as institutional buyers are typically long-term investors, how the stock trades over the long term is what is key. So the ultimate result will depend on where Facebook's stock trades in the long term.
Retail IPO Buyer's Perspective. Retail investors buying IPOs in the after-market are taking big risks, and it looks like most were burned in the Facebook IPO. In the first day of trading, Facebook opened at $42.05 (an IPO pop of almost 11%) and closed at $38.23. If a retail buyer purchased at $42.05 and sold at $38.23, that's a 9% loss. The stock price has dropped steadily since then, and so those retail investors who purchased at the IPO opening price are feeling lots of pain.
A Note on the Media. The media helps shape public opinion and so is an important part of the IPO process. From the media's perspective, a juicy headline sells papers (well today it sells online advertising...). So if the IPO is a big winner or big loser, the media wins. With Facebook, the pre-IPO reporting was generally favorable, but the media had a field day with the IPO under-performing in its first day of trading and the fall afterwards. From the media's perspective, the Facebook IPO was a huge success.
Additional Notes. The above thoughts represent my developing thesis on the topic. Any constructive feedback would be welcomed to help me further develop my views. I don't own any Facebook stock.
Facebook's IPO has been branded a failure by virtually everyone. However, there have been a few articles declaring the IPO a success. All of this begs a larger question: What is a Successful IPO?
My answer to this question is that it depends on perspective: that of the company; pre-IPO investors; the underwriting syndicate; the institutional IPO buyer; and retail investors buying the stock on its first day of trading. Let's look at these perspectives and use Facebook's IPO as an example.
The Company's Perspective. In my experience as a former investment banker working on IPOs, a company wants a few things in an IPO: (1) to raise the capital that it needs (and/or to facilitate existing shareholders selling in the IPO); (2) a favorable valuation; (3) to minimize IPO fees and expenses if it can; (4) seeing the stock perform well in the aftermarket; and (5) the media reporting favorably on the IPO. Let's look at #4. Why does a company want its stock to perform well in the aftermarket? The primary reason is that the wealth of existing shareholders (including founders) and employees who hold stock options depends on the stock price. Once an IPO prices, the stock price becomes a benchmark for founders and employees (and pre-IPO investors and the investing public at large). If the stock price goes up post-IPO, shareholder and option-holder value increases, which is the goal. If the stock price dips below the IPO price, there will be disappointment, especially among employees who hold stock options. Another reason is that a strong stock is helpful as an acquisition currency. A rising stock price is an attractive currency to targets.
In my view, how the company's stock price performs over the next 180+ days also matters. At 180 days after the IPO, selling restrictions for most pre-IPO shareholders will expire (this 180 day period is known as the "IPO lock-up period"). Markets take note of lock-up expirations. Also, at 180 days after the IPO, a company will have reported its first quarterly results as a public company. It's after this lock-up period that all IPO restrictions expire and shareholders can begin to sell their shares to the public (via Rule 144 sales).
So from Facebook's perspective, is the IPO a success? In three of the above five metrics, yes, but in two important metrics, a resounding no. Facebook raised significant capital (nearly $6.8 billion for the company and over $9 billion for selling shareholders). Favorable valuation? At an IPO market cap of over $81 billion, I'd say so (even though the market cap has dropped post-IPO, it's still impressive). The company paid 1.1% in underwriting fees, which is well below the 7% customary for most technology IPOs, and also lower than many of the larger IPOs (by comparison, Visa's underwriters earned commissions of 2.8% in a $17 billion IPO; Groupon's underwriters earned commissions of 6%). Based on the fourth metric, post-IPO performance, Facebook's IPO has been a failure in my view. In addition to the drop in the stock price, Facebook has granted certain shareholders a very short 90 day lock-up period, so the market may be flooded with additional stock 90 days after the IPO date, which could drive the stock price down even further. Finally, for media coverage, the pre-IPO the media coverage was generally favorable, but coverage post-IPO has been overwhelmingly negative - overall I'd say this was a failure as well. So from Facebook's perspective, the IPO was mixed - partly successful and partly unsuccessful.
Pre-IPO Investor Perspective. Investors in a private, pre-IPO company are typically friends and family, angel investors and venture capital fund investors. From their perspective, a successful IPO is typically is one where they are able to obtain a significant return on their investment either as a selling shareholder in the IPO, or a selling shareholder after the IPO (typically in a subsequent public offering or through Rule 144 sales when all lock-up restrictions expire).
From the pre-IPO investor perspective, was the IPO a success? For the investors that were selling shareholders at the IPO, the IPO was a stunning success. This includes venture capital firms Accel Partners, Greylock Partners, Meritech Capital Partners, among others, and angel investor Peter Thiel. These pre-IPO investors invested in Facebook's early stage financings and sold their shares in the IPO for significant returns. For the pre-IPO investors that will be selling shareholders at some point in the future, the answer is it depends on the price at which they ultimately sell their shares (and, of course the price at which they acquired their shares from Facebook).
The Underwriting Syndicate's Perspective. It's not just about fees - it's also about reputation: reputation with future IPO clients, with institutional IPO investors; and with the investment community in general. Attracting IPO clients is largely about league tables (e.g., which bank has the most "left lead" underwriter roles for that sector and in general), IPO performance (how the bank managed the IPO and how the stock performed post-IPO), and equity research (analyst reputation and coverage). Importantly, banks will work hard to ensure that the stock price stays above the IPO price. If the stock price falls below the IPO price, the IPO is considered "broken" and it is a black eye for the bank. Banks engage in post-IPO market price stabilization to keep the stock price at or above the IPO price. Reputation with institutional IPO investors is also important to future IPO performance - if institutional investors won't buy IPOs from a bank over valuation and aftermarket performance concerns, the bank's reputation will ultimately take a hit. It is for this reason that banks build in an IPO discount when selling to institutional investors. Partly as a result of this discount, there is usually an IPO "pop" of about 10-15% from the IPO price to the first trade. If this pop doesn't occur, then the bank may have a harder time selling the next deal to institutional investors.
So from the underwriters' perspective, was the Facebook IPO a success? I'd have to say a resounding No. Note that the syndicate did earn $176 million from the deal in fees and commissions. The stock even had an 11% pop at first trade. But the stock price dropped and "broke" the IPO price. This is a huge black eye for Morgan Stanley, the "left lead" bank on the IPO. In addition, as the stock price broke the IPO price the over-allotment option will not be exercised, so the banks will miss out on the additional fees the sale of these shares would have generated. The media has been highly negative on the IPO. Overall, my perception is that the IPO was a big failure for the underwriting syndicate.
Institutional IPO Buyer's Perspective. Institutional buyers are typically long-term investors and so the stock price one day or one month after the IPO may ultimately not be that important. But as discussed above, many have an expectation that they are buying the IPO shares at a discount to what the true valuation is, and given that they do expect the stock to trade up after the IPO.
From the Institutional IPO buyer's perspective, the Facebook IPO is currently looking like a big failure. However, as institutional buyers are typically long-term investors, how the stock trades over the long term is what is key. So the ultimate result will depend on where Facebook's stock trades in the long term.
Retail IPO Buyer's Perspective. Retail investors buying IPOs in the after-market are taking big risks, and it looks like most were burned in the Facebook IPO. In the first day of trading, Facebook opened at $42.05 (an IPO pop of almost 11%) and closed at $38.23. If a retail buyer purchased at $42.05 and sold at $38.23, that's a 9% loss. The stock price has dropped steadily since then, and so those retail investors who purchased at the IPO opening price are feeling lots of pain.
A Note on the Media. The media helps shape public opinion and so is an important part of the IPO process. From the media's perspective, a juicy headline sells papers (well today it sells online advertising...). So if the IPO is a big winner or big loser, the media wins. With Facebook, the pre-IPO reporting was generally favorable, but the media had a field day with the IPO under-performing in its first day of trading and the fall afterwards. From the media's perspective, the Facebook IPO was a huge success.
Additional Notes. The above thoughts represent my developing thesis on the topic. Any constructive feedback would be welcomed to help me further develop my views. I don't own any Facebook stock.
