by Mitch Feierstein about 2 years 11 months ago
At yet another select committee recently – they’ve been doing a good job – Vince Cable was grilled about the huge leap in the Royal Mail’s stock market value. As you’ll remember, the firm was floated at 330p a share and traded as high as 600p in November, a rise of 82% in a few months.
Cable defended the launch price, saying that they considered adding 20 pence to the IPO price but decided against it because of worries that a threatened bout of pre-Christmas industrial action might scare investors away. I’ve no doubt in my mind that Cable was doing his honest best for his country. That he took the best available advice. That he thought long and hard about the right thing to do.
I’m also in no doubt that he was stolen from. That you were. That companies and company owners are stolen from as a matter of routine.
The reason? Alas, it’s yet another grubby secret to do with the way the finance industry – and investment banking in particular – is keen to rip off everyone they come into contact with. In particular, Wall Street and their buddies in the City of London have successfully perpetuated a myth about what constitutes a successful IPO: the myth of the ‘pop’.
A ‘pop’ is the slang name for the traditional increase in a company’s share price in the day or so post-IPO. So, for example, LinkedIn was launched onto the markets at $45, and the first shares started trading at $83, a massive 84% above the launch price. That might be a fairly extreme example, but pops of 20-30% are common and are widely viewed as the signs of a successful launch.
The Wall Street arguments in favour of such a strategy are that you need to reward your launch investors and you need to get positive stories about the company circulating from the off. A positive market sentiment is born and, if the company management lives up to expectations, you have a stockmarket success story.
Those are the arguments, and they’re self-serving lies that fall apart as soon as you start to analyse them. Sure, it’s probably true that a launch investor is taking a little more risk than an investor who is purchasing a company with a stock market history, with plenty of research coverage, with a larger pool of established buyers and sellers. So offering those launch investors a little kicker makes sense. That’s common practice in a host of industries. The first airline to take a new type of airliner normally gets fat discounts to compensate for that bet on the unknown. It makes sense.
But with most IPOs, any added risk isn’t that huge. A company like Royal Mail is hardly an unknown quantity, nor does it operate in a hard-to-understand industry. The company’s sheer size means that pretty much every large institutional investor will have to end up owning a piece of it. So an IPO pop of about 5% would be ample – that’s one heck of an overnight return on your money, after all. And if the pop was 10%, well, that’s probably a little too much, but one also has to accept that stock valuation isn’t a perfect science.
So what’s the justification for a pop bigger than 5-10%? The Wall Street story is about positive sentiment. Strong momentum. Selling a great story. In effect, the Wall Street spin is about PR. And that PR is, I suppose, worth something. If you could simply go out and buy that kind of news coverage, I guess you’d find corporate CFOs willing to splurge maybe half a million dollars, three hundred thousand pounds, that kind of money.
But the actual cost is eye-watering. Take the Royal Mail. If the shares had been launched at 540p (about 10% from its actual high), the taxpayer – you – would have collected £2 billion more than you actually did. That’s a lot of cash to pay for a temporary good-news story.
What’s more, the long-term value of that pop is essentially nil. A few years back, a company came to market, valued at about $500 million. It set a testing price for its shares and sure enough had a ‘broken IPO’, where the price set in early trading fell below the offer price. That company was slated for the failure of its introduction to the market.
But what a failure it was. The company in question was Amazon, whose stock market value is now around $175 billion. Company values are set by the strength of their business and the effectiveness of their management. Anything else, in the long run, is just hooey.
Wall Street will want to interject at this point. Will want to remind you that buyers and sellers need consideration. That their job as middleman is to strike the appropriate balance between the interests of the two.
And that’s also nonsense. The banks paid to manage an IPO are paid hefty fees by the company and its pre-IPO owners. The banks should have no other interests in mind. What’s more, the owners of the company pre-IPO are the ones who have built the business – from scratch in many cases. They are the ones who deserve to reap the value. The IPO-buyers are financial investors for whom stock price rises and falls are an ordinary and unremarkable part of their business. Sure, they’d prefer a pop to a fall in price, but either way they wouldn’t really care all that much. It’s just part of what they do.
Since all this is, essentially, obvious and since it’s not just poor old Vince Cable who gets ripped off by the IPO market but pretty much every corporate at pretty much every stock market launch, it’s worth asking what then heck is going on, and why.
The answer, of course, is that banks are ripping their clients off, as usual. The big investment banks will handle a major equity issue for a particular company perhaps once in a generation, and often just once in a corporation’s lifespan. On the other hand, they do business with the big institutional investors all the time: investors on whose good favour those banks absolutely rely. And given that banks can choose who to reward with a sweetly under-priced IPO deal, the opportunity for undisclosed conflicts and kickbacks is simply extraordinary.
Nor is it just the equity market where these things happen. The percentage pops in the corporate bond issuance market are similar, but they still rip off corporates to the benefit of banks, by screwing the very customers whom it is their duty to protect. Given that investigators have found collusion and corruption in pretty much every corner of the banking industry thus far isn’t it time to explore the issuance markets too? What they’d find is a grubby cartel of banks and lead investors handing buckets of cash to each other in some back alley – cash stolen from the companies on whom our economy depends. The sight might be unedifying, but look on the bright side. The fines would go a good way to paying back Vince Cable’s lost £2 billion.