A debate is raging online about whether or not the LinkedIn initial public offering should have been priced higher by investment banks last week. They offered the shares at $45, but the stock quickly soared to prices exceeding $100 per share. Currently, they've began calming down a bit, selling for around $85 per share as of 10:30 this morning. Still, that's quite a bit higher than their $45 per share initial price. How do we determine whether the banks should have priced it higher?
Last week, I posted a quick take on the argument for why the IPO should have been priced higher, based on a piece by Henry Blodget from Business Insider. The general idea is that LinkedIn would have obtained more proceeds if the stock was priced higher. Instead, the handful of large institutional investors that the banks handpicked to get those shares benefited. These are likely some of these banks' best clients, which is why they got priority. The difference is somewhat significant. If the offering was priced at $70 per share (still low), then the company and existing shareholders would have made an additional $196 million. Instead, investors got that pure profit.
There are (at least) three questions that need to be answered here.
Should banks have priced the LinkedIn IPO higher?
The way to answer this question is really quite simple: what do the interested parties think? First, the investors who purchased the IPO obviously aren't complaining. They made millions of dollars in a couple of hours by sitting at their Bloomberg terminals and watching the demand for LinkedIn's stock grow.
The other interested party, of course, is LinkedIn. Was the company okay with the fact that, by pricing the IPO so low, it left a few hundred million dollars on the table? The best way to figure this out would be to just ask the company. In fact, that's what Bloomberg Television did last week. LinkedIn CEO Jeff Weiner said the company was "very comfortable" with the $45 per share offering price.* He stressed that they spent a lot of time talking with long-term investors and they believe the price was fair. He said he wouldn't read too much into one day's worth of trading.
If all parties are happy here, it's hard to really complain about how the banks priced the IPO.
Should LinkedIn be angry?
It's one thing for the "official word" from LinkedIn to be positive. But maybe the firm isn't thinking straight, still on a high from it's stock's success. From a financial standpoint, should LinkedIn be angry? That couple hundred million dollars seems like a lot of money. In this case, however, it realty isn't.
Last week's offering provided about 7.8 million shares to the public. Of that 4.8 million was sold by the firm and 3.0 million were sold by existing shareholders. Another 86.7 million remained unissued, held by existing shareholders. Put another way, the company itself only sold 5.1% of its shares. Another 3.2% of shares were sold by existing shareholders as a part of the IPO (at $45 per share). The other 91.7% of the firm remained held by existing shareholders.
And those existing shareholders should be ecstatic. Even now, at $85 per share, they are holding $7.4 billion in stock.
The point here is that the vast, vast majority of LinkedIn's stock was unaffected by the IPO price. All those other shares were likely mostly held by the firm's initial investors or other insiders. They now benefit from the upside, and there's a lot of it. Now those additional shares could be issued at that higher price to provide a great deal of capital if the company needs it. Really, that $196 million lost is comparably a drop in the bucket. So there might be a little reason for LinkedIn to be angry, but a big of reason for the company to be pleased.
Should the way that IPOs work be changed?
This is more of a philosophical question. On some level, those IPO investors that happen to be important clients to investment banks often get a pretty good deal. Banks commonly underprice IPOs, because it looks really bad when some shares for an IPO aren't sold. Is this sort of favoritism fair?
Probably not, but it appears to work fairly well. As just mentioned, when an IPO only provides a small amount of a firm's total shares to the public, the firm itself doesn't need to care too much if they are underpriced -- a relatively small amount of money will be lost versus the value of price discovery. And often times, those initial investors are taking a pretty big risk. In this case, we don't have much idea what a social media company is really worth. The upside might be large, but so is the downside.
Technology can afford a better system. One possibility, for example, could be a sort of eBay-like system where any accredited investor can commit to purchasing a certain number of shares at a certain price. At some designated auction close, the investors with the highest bid are granted shares so that all are sold. In this system, some investors might obtain shares at a lower price than others, but ultimately, the firm will obtain the most profit possible.
If such a system was in place on the day LinkedIn offered its IPO, it would likely have worked quite well. Even if bids began at $45 per share, they would have steadily increased throughout the day. The highest bidders accounting for the 7.8 million shares would have got them, and LinkedIn would have got their proceeds, which almost certainly would have been more than the proceeds it obtained at $45 per share.
So should we lament the way that the LinkedIn IPO went down? Ultimately, it's hard to, considering that LinkedIn is -- and probably should be -- happy with the results. Could it have gone better? Sure, but a much better result probably would have required an entirely different mechanism for stock issuance.
*Update: I contacted LinkedIn this morning, and a company spokesperson provided the same response. They are "very comfortable with where the IPO was priced at $45.00."
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