Is This IPO Tactic Creating the Next Bubble?

The following video is part of our "Motley Fool Conversations" series, in which Motley Fool editors Austin Smith and Andrew Tonner discuss emerging trends in their favorite companies.

In today's edition, Austin and Andrew discuss the recently popular (and dangerous) strategy newly public tech companies are using called the "low float" strategy. Under this strategy, companies release a low percentage of their company to the market, which can easily result in a highly inflated market cap. As evidence, consider that 20 of the 25 most recent tech IPOs are already below their IPO offer price.  

To read about a Motley Fool favorite stock that IPO'd this year and didn't use the low float strategy, check out our special free report: "The Hottest IPO of 2011." In it you'll get a recent IPO we love that's cashing in on the emerging market. You can access your copy today at no cost at all. To get instant access to the IPO we love, click here -- it's free!

Neither Austin Smith nor Andrew Tonner owns any shares of the companies mentioned above. The Motley Fool owns shares of Google. Motley Fool newsletter services have recommended buying shares of Google and Zillow. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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  • Report this Comment On November 30, 2011, at 5:53 AM, jsalex000 wrote:

    Austin Smith is unduly harsh on the low-float strategy.

    Having advised companies as a business strategist and Corporate Development specialist which have SUCCESSFULLY used low-float strategies, let me explain.

    Companies, especially those with a great deal of marketing buzz and popularity, are typically offering low-float to fund expansion and/or liquidation event for some private investors while capital markets are favorable, yet corporate leadership and current equity owners think holding onto shares will create more value in long-run than liquidation in near-term.

    Additionally, this aligns Investment Bankers to set offering share price with integrity. Companies using a low-float strategy reduce the extent that Investment Bankers will gain from the deal to the detriment of Company and its original investors. Investment bankers and large institutional traders make a fortune on IPOs. They commit upfront to purchase/place shares, they purchase at offering price and as price offers bid up in the first day(s) a share trades, they flip those shares. So, Investment Bankers and Institutional Traders who realize a substantial profit, rather than the issuing company. I-Bankers and their firms receive fees from issuing company for advising on and underwriting the transaction. Generally, they want to be chosen again to handle secondary offering ... not only for the fees, but also for the opportunity to acquire shares at offering price that they can then, again, distribute for a nice profit. So, if I-Bankers are perceived to be self-dealing by pricing shares too low, so low that the closing price on Day 1 is double or triple or more than the IPO share price, those I-Bankers will not get a second chance to drink from the same trough.

    Further, while share prices in first few days and weeks after IPO may be higher than if all shares were released, the likelihood of LinkedIn employees taking actions which enhance enterprise 's intrinsic value (which, ultimately is likely to translate into at least maintaining if not increasing stockholder value) is more likely when a substantially majority of the shares are held by the company execs and other employees than it would if shares were widely held predominantly by company outsiders. What (prospective) investors should watch out for is a flood of new shares hitting the market without a secondary offering being issued and what happens to share price. Should that happen, it likely means insiders are concurrently liquidating. This typically occurs when insiders believe share price is substantially overvalued.

    Lastly, most companies shares trade at prices less than IPO value, and many companies which IPO fail within 3 years as the cash went to investors and no into running the business. It would not surprise me if a greater proportion of issuing companies which used low-float strategy succeed as compared to those issuing companies which offered majority of company shares.

  • Report this Comment On November 30, 2011, at 6:43 AM, TMFBWItime wrote:


    Thank you very much for you comment! I truly appreciate the perspective of an industry insider like yourself. I’m glad to hear you have advised companies which have successfully used the low-float strategy, please note that in the video I state that the low-float strategy does not guarantee a company’s demise, only that it has the potential to, and often does, greatly distort market cap.

    First, it is clear that you have worked in the industry, as most of your comment circles around the motivation of the investment bankers, not the view from the individual investor. Personally I disagree with the point you make about I-bankers not being able to drink from the same trough if they price too low. You clearly point out the motivation to price low, and to some extent that is a built in expectation now they aim for first day pops and handsome returns. I highly doubt the investment bankers from Citi, BOFA, Morgan Stanley, and Allen & Co who brought the likes of Zillow and Skullcandy to market are at any risk of not being invited back to the table to underwrite more companies in the future.

    Also, to your point about LinkedIn employees, I totally disagree. Having a stock double in value in one day does not give them motivation to enhance enterprise value, it gives them a calendar to watch their holding restrictions expire so they can sell at a handsome profit. To anyone who holds a substantial part of the company, a doubling in your shares value over a short period sounds more like “early retirement” than it does “long-term commitment”, personally. Also, even a modest selling by insiders when a company has a low float strategy is likely to depress share price by flooding share supply.

    Ultimately I think we’re looking at this from two different seats. Whereas you come at this from the motivation of the underwriters to act honestly, I look at it from the perspective of the guy who is trying to decide if he should click “buy” or not on his e-trade account. As an individual investor I’m still wary of the low-float because it has the potential to distort market cap, and a large run-up in price can act as a motivator for insiders to sell shares at a large profit when they can, and thus send the stock price lower.

    I really appreciate your perspective and well-reasoned analysis, but for me, condition that “should” encourage a fair IPO by underwriters is too nebulous an idea to invest on.

  • Report this Comment On November 30, 2011, at 7:13 AM, jsalex000 wrote:

    Actually, my perspective is that of the issuing company executives, not underwriters. As such, I do know of times when the boardroom discussion has been not to work with XYZ I-Banking firm because of such self-dealing.

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