Even The "Smart" Arguments Justifying LinkedIn's IPO Pop Are Bogus

Henry Blodget | May 22, 2011, 1:00 PM

Read more: http://www.businessinsider.com/linkedins-ipo-pop-2011-5#ixzz1N8NiVD4G


Last week, LinkedIn's IPO was dramatically underpriced by the Wall Street banks that underwrote it, costing the company and its selling shareholders about $200 million in lost proceeds.

This $200 million went into the pockets of big investor clients of the underwriters--rich mutual fund firms like Fidelity and hedge funds like SAC Capital.

In the wake of this mispricing, commentators like Joe Nocera and I observed that IPO "pops" like LinkedIn's--which are generally celebrated as a sign of success--are actually bad: They rob the company and its existing shareholders of cash that is rightfully theirs and they steer it into the pockets of favored money management clients who don't need or deserve it.

This revelation spawned outrage among folks who are sick of getting screwed by Wall Street. And in the wake of this criticism, not surprisingly, Wall Street began to defend itself. 

One anonymous Wall Street investment banker, for example, lashed out at Nocera and me, branding us "ignorant sluts." And he then trotted out some standard sophisticated arguments to defend the LinkedIn mispricing.

These "pro-pop" arguments are nothing new, and they're bogus. But they appear to have again persuaded some smart people that IPO pops are good, so they're worth addressing directly.

I USED TO THINK "IPO POPS" WERE GOOD, TOO...

Before I address these arguments, though, it's also worth providing some background: I worked on Wall Street in the 1990s, as both an investment banker and a stock analyst. I watched hundreds of companies go public, and I participated in the underwriting of dozens of IPOs.  As a banker and analyst, I made some of the same "pro-pop" arguments that the anonymous investment banker is making now. These arguments were self-serving for me and the firms I worked for (the view that big "pops" are good makes life a lot easier for Wall Street bankers), but I also believed them. It wasn't until after I left Wall Street and studied how much the IPO process actually costs companies that I began to realize how "IPO pops" screw the companies bankers are supposed to be acting on behalf of.

Me in my analyst days.

The analogy I used last week to explain why "pops" are bad was that of a real-estate agent who persuades you to sell your house for $1 million and then then next day turns around and sells it to someone else for $2 million. If an agent did that to you, you'd be justifiably furious.

That's similar to what Morgan Stanley and Bank of America just did to LinkedIn.

But the "pop" defenders argue that it's not at all similar because LinkedIn only sold a portion of itself.  They continue this argument by saying that an IPO is a pricing event, not a fundraising event, so the actual amount of money raised is irrelevant. LinkedIn now has a public currency valued at about $90 a share, the pop-defenders say, so it doesn't matter what it sold those 10 million shares for.

This argument is ridiculous.

So what if LinkedIn only sold a "portion" of its stock?  Why should it have sold this portion at a 50% discount to fair market value, when it could have sold it at only a 15% discount?  By selling its stock at a 50% discount to the fair market value instead of a normal--and justifiable--15% IPO discount, LinkedIn and its selling shareholders gave away $200 million. And $200 million is real money, even if there's more where that came from.

IMAGINE YOU ARE SELLING APARTMENTS...

In the interest of fully debunking this "only selling a portion of the stock" argument, let's change our real-estate analogy slightly. Instead of a house, let's say you're selling apartments in a new real-estate development. You have a building with a hundred apartments, all identical. After marketing your building, your real-estate agent proudly informs you that he can sell one of the apartments for $1 million. You say "Go for it!" The agent sells the apartment. And then the next day, the same real-estate agent re-sells the same apartment to someone else for $2 million.

I sold stock for $45 that was actually worth $90 and I'm supposed to say "Thank you"?

On the one hand, you're happy: You still have 99 apartments that you now realize have a fair-market value of $2 million apiece. But you also realize what just happened: The fair-market value of your apartments is $2 million. Your real-estate agent sold that first apartment to a buddy of his for a sweetheart price that will make the buddy forever grateful--and, in so doing, plucked $1 million out of your pocket and gave it to the buddy.

Importantly, your apartments were worth $2 million no matter what that first apartment sold for. Your agent selling your first apartment for $1 million did not affect the fair-market value at all.

So, the "portion" argument is bogus, but there are three other arguments/questions that are worth addressing here.

Continue reading »

Read more: http://www.businessinsider.com/linkedins-ipo-pop-2011-5#ixzz1N8NqsnxP

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