That's the consistent reaction that I've gotten from investors and non-investors alike when I've given them two numbers from Facebook's (Nasdaq: FB ) IPO.
There have been plenty of interesting numbers associated with this ill-fated offering. For instance:
- $38 was the IPO price that Morgan Stanley (NYSE: MS ) fought desperately to maintain on the first day of trading.
- 15% is the amount of Facebook revenue that's attributable to Zynga (Nasdaq: ZNGA ) .
- $104 billion was the rough valuation of the entire company at the IPO price.
- $31.91 -- down 16% -- is where Facebook closed its full week of trading.
And I could go on.
But the two numbers that I've had the most fun with are these: $1.1 billion and 3%. What are they? The $1.1 billion is the value of the stock that Mark Zuckerberg sold in the IPO. And the 3% is the increase in direct voting power that Zuckerberg gained from the IPO.
Yes, you read that correctly, he sold $1.1 billion in stock and saw his voting power increase.
This outcome resulted from the dual-class share structure that gives Facebook insiders like Zuckerberg far more voting power than retail investors -- an issue that has been well-covered. Yet when we sit down and really think about those two numbers, it's hard to overlook a very simple fact: This IPO wasn't meant to benefit you, the individual investor. But it's really more than that, because we could safely say that no IPO is meant to benefit you.
Why do they need to go public?
To understand why you're unlikely to find great deals among IPOs, a good starting point is understanding why a company goes public in the first place.
There are two primary reasons that a company sells stock to the public. The first is to get new capital for the business, and the second is to allow insiders either immediate or future ability to sell their shares.
Of the two, public investors should have more opportunity to do well when a company goes public because it needs financing. In theory, this situation puts the bargaining advantage in the hands of buyers rather than sellers.
But this situation is increasingly rare. With deep capital pools available through angel investors, venture capital, private equity, and hedge funds, there are plenty of sources of financing that don't require companies to jump through the hoops of going public. By the time a company like Facebook does go public, it may be selling new stock and raising money for itself -- as Facebook did -- but the company is no longer in a position where it needs the capital.
And when you do find a company going public because it absolutely needs capital? In this day and age, that probably means that it's exhausted or been turned away from all other sources of funding and is desperate. That's probably not the kind of company you want to rush to buy.
There's not necessarily anything inherently wrong with insiders wanting to sell some of their stake in a company. Perhaps they want to enjoy some of the fruits of their labor or maybe they're just practicing good personal financial management and diversifying their wealth. The insiders may also be venture capital or private equity interests that invested early and are realizing the gains of a good investment.
But the question is this: When insiders -- who know a heck of a lot about the business -- are selling, do you want to be on the other side buying?
Furthermore -- and this applies to an IPO that's for primarily capital-raising purposes or insider selling -- the job of the investment banks working on the IPO is figuring out the highest price that buyers will pay while absorbing the full amount of shares that the company wants to sell.
LinkedIn (Nasdaq: LNKD ) priced its shares at $45, and the stock closed its first day of trading at more than $94. Yelp (Nasdaq: YELP ) priced its shares at $15 and they closed up 64% on the first day of trading. In both cases, it was a bungle on the part of the bankers -- the companies and the selling shareholders could have gotten a lot more money for selling the same number of shares.
In other words, when you buy an IPO, you're betting against company insiders, Wall Street bankers, and maybe also venture capital and private equity interests. If you're expecting quick gains, you're essentially betting that they all screwed up. It does happen -- as with LinkedIn and Yelp -- but is that a bet you want to consistently make?
Your better bet
To many average Joes who rushed to buy Facebook shares, none of this logic mattered. Everyone that doesn't live under a rock has heard of Facebook, and the media turned its IPO into the biggest thing since the Kim Kardashian wedding.
However, for investors that want substance, rather than "cool factor," in their investments, then a different approach is warranted. What kind of approach? The Motley Fool's free special report, "Secure Your Future With 9 Rock-Solid Dividend Stocks," isn't a bad place to start. Get your copy by clicking here.