Yesterday was stapled to another cruel reminder that underwriters continue to place the wealth of their prized clients over the companies that they take public.
Russia's Yandex (Nasdaq: YNDX) was a hot debut. Underwriters priced Eastern Europe's top search engine at $25, even though a source tells Reuters that the offering was subscribed 17 times over. In other words, it was an obvious oversubscription scenario where underwriters should have jacked the price even higher.
Instead of increasing its offering price to give Yandex more money, the underwriters let Mr. Market bid up the shares in the open market to reward the IPO buyers instead.
Yandex opened roughly 40% higher.
If you think that's bad, let's revisit last week's LinkedIn (Nasdaq: LNKD) introduction. Underwriters bumped up the corporate social networking website's IPO to $45, but it wasn't nearly enough. The stock opened at $83 and just kept moving higher.
LinkedIn's catapult shot was enough to get some of cyberspace's biggest analysts fuming.
"LinkedIn's underwriters, Morgan Stanley, Bank of America, et al, just screwed the company and its shareholders to the tune of an astounding $175 million," writes Henry Blodget. "How? By wildly underpricing the deal and selling LinkedIn's stock to institutional clients way too cheaply."
"LinkedIn hired bankers to gauge public interest and properly price an offering," writes our own Morgan Housel. "They failed."
Did they?
Sleep on it, venom flingers
I hate underwriters throwing mispriced bones to institutional clients as much as the next guy that didn't get in on either IPO, but it doesn't mean that investment bankers are evil.
Have you seen where some of these hot IPOs ultimately settle?
Tesla Motors (Nasdaq: TSLA) was one of last summer's most anticipated offerings. The electric car hipster went public at $17, closing 40% higher on its first day, and doing a chin-up above the $30 bar during the following trading day. A week later it fell back below $17.
The problem with taking underwriters to task is that we all know where to draw the starting line, but we all can't seem to agree on where the finish line is exactly. Where should Tesla have been priced?
Tesla's been rolling along nicely since bottoming out. It's in the mid-$20s now. Is it now fair to say that $17 was too cheap for Tesla's first public investors, or is the argument moot because ordinary investors like you and me had the opportunity to buy in for even less on the open market a few days later?
If you want a more recent example, there was no shortage of hype when Renren (Nasdaq: RENN) went public at $14 earlier this month. The shares hit an intraday high of $24 in its debut, but closed yesterday as a busted IPO at $12.26.
We also don't have to leave this month -- or China -- for another example that went the other way. Chinese dating website Jiayuan (Nasdaq: DATE) picked a bad day to go public at $11. It wrapped up its debut at an uninspiring price of $10.52. Investors had a change of heart a few days later. It was one of last week's hottest stocks after climbing 34%.
The fallacy of democratization
A common argument is that companies wouldn't be leaving so much money on the table if they let lay investors in on the IPO. That sounds realistic in theory, but have you seen what happens when companies try to democratize the process?
Google (Nasdaq: GOOG) went public in 2004 by combining a traditional underwriter-led offering with a Dutch auction for individual investors. Google was initially expected to price its IPO as high as $135, but by the time that investment bankers and ordinary investors could agree on a price, the world's leading search engine had to settle for an IPO price of $85.
Vonage (NYSE: VG) thought it was doing a cool thing by letting its customers get in on its IPO. It didn't turn out so well when the stock tanked in its first few days of trading. Things got particularly hairy when some customers refused to pay for their marked-down shares.
Let's not read too much into whether a stock is overpriced or underpriced by investment bankers. Wall Street has a "do over" here, and it's called a secondary offering. How many hot and sustainable IPOs come out with a secondary offering at a much higher price a few months after going public? A lot. I'm sure that some conspiracy theorists will argue that underwriters do this by design, allowing them to cash in on a pair of offerings, but it's ultimately about the ability of companies to take back the pricing process if they feel that they were cheated the first time around.
Just because a system is broken doesn't mean that it needs to be fixed.
Have you ever bought a stock the day it went public? Share your thoughts in the comment box below.
