Macy’s and International Paper brought in twenty-eight billion dollars in revenue in their most recent fiscal years, while Adidas took in twenty billion dollars. Twitter, the virtual corkboard for one-liners, brought in less than half a billion dollars last year. Those who felt the company was overpriced even at the initial price it proposed, which would have valued it at eleven billion dollars, should be forgiven for the misjudgment. (If this sounds self-serving—I was among the misjudgers—mea culpa.)
The tone of the coverage of Twitter’s I.P.O. has been strikingly cheerful. David Gelles of the Times said Twitter had “managed to avoid the missteps that marred Facebook’s initial public offering last year.” Alistair Barr of USA Today called the I.P.O. “a huge success.” Telis Demos, Chris Dieterich, and Yoree Koh of the Wall Street Journal quoted a five-character Tweet (“Phew!”) by the lead Goldman Sachs banker on the deal, Anthony Noto, to capture the sentiment.
This makes sense. We were waiting to see if Twitter would make missteps like the ones that Facebook made—and it didn’t. Facebook overpriced its I.P.O., after which the company’s shares lost much of their value. A person familiar with Twitter’s thinking told me last month that the company was doing all that it could to avoid mistakes like Facebook’s overpricing—and, by all accounts, it did. That makes Twitter look great: “See, everyone likes us!” its executives can tell people.
But in the rush to congratulate Twitter for avoiding Facebook’s mistakes, many seem to be overlooking the fact that Twitter made a different error by underpricing its I.P.O. Twitter’s mistake, actually, might have been worse. Companies go public to make some money that they can invest in their business; an underpriced I.P.O. means the company is bringing in less than it could have for every share it sold.
Here’s the math: Twitter sold seventy million shares for twenty-six dollars apiece, when it could have sold them for forty-five dollars. It made less than two billion dollars when it could have made more than three billion dollars; that billion-dollar gap amounts to more than the cumulative sum of all the revenue it has ever earned.
There are, of course, beneficiaries when I.P.O.s are underpriced—most directly, the early investors who buy shares at the offer price and then can sell when the price goes up. Bankers offer first dibs on those shares to favored investors, often their own clients.
The banks that underwrite the offering can also reap rewards. In direct revenue from the Twitter I.P.O., Goldman Sachs and other underwriters will share nearly sixty million dollars. But they may also benefit indirectly from the underpricing, if happy clients return the favor in the form of new business.
Underwriters have sometimes benefited more directly from helping clients invest in underpriced I.P.O.s. The S.E.C. in 2002 charged Credit Suisse First Boston for helping clients invest in underpriced I.P.O.s that the bank underwrote, and then demanding that those clients return a portion of their I.P.O.s profits in the form of commissions. In March of this year, the Times columnist Joe Nocera uncovered documents from a lawsuit related to a failed dot-com-era startup called eToys, whose I.P.O. was underwritten by Goldman Sachs, which appear to show that the bank’s representatives pressured investors to return part of the proceeds.
It’s unclear whether practices like this have persisted, or were in play in the Twitter I.P.O., but the culture that produced them remains strong. Jay Ritter, a professor at the University of Florida who studies public offerings and has researched such commissions, told me that even if underwriters don’t extract higher commissions from clients explicitly—which he believes they sometimes do—they benefit in the form of good will from happy clients. “The underwriter,” he said, “is getting revenue from two places.”
I don’t mean to suggest that Twitter’s underwriters deliberately underpriced the I.P.O. to help their clients and themselves. Twitter’s meager revenue and lack of profits suggest to me that Twitter’s valuation should be much lower. Twitter’s bankers could easily have believed that investors would feel the same.
The point, rather, is that in Twitter’s case, the company lost out, while investors—and, perhaps, bankers—gained. What would Twitter have done with the funds? Invested in its business—which would likely have translated to hiring and infrastructure purchases that would, in turn, have boosted the broader economy. When investors and bankers earn higher profits, that, too, can have a broader economic impact. But I’d venture to guess that a dollar invested to expand an innovative, fast-growing business goes further than a dollar of profit for hedge funds and banks.
Michael DuVally, a spokesman for Goldman Sachs, told me, “Our sales teams naturally make an effort to understand how client trading strategies perform over time. That’s an essential part of good client service, and clients, of course, consider their investment results when deciding whether to do more business with Goldman Sachs or any other firm. However, we do not engage in quid pro quos for allocations of IPOs.”
Morgan Stanley and JPMorgan Chase, which also underwrote the Twitter I.P.O., didn’t immediately respond to requests for comment, nor did Twitter. According to the Wall Street Journal, Twitter and its advisers “judged that the additional money wasn’t worth what could have been sacrificed had they priced it higher, namely good will with long-term investors who they hope will buy more shares in future offerings.”
Ritter, who has analyzed I.P.O. data going back several decades, has found that the average first-day returns of offerings has been higher this year than at any time since 2000. This year, shares of newly public companies have risen twenty-one per cent, on average, on the day of their I.P.Os. That compares with eighteen per cent in 2012 and thirteen per cent in 2011. (Ritter maintains a trove of fascinating I.P.O. data on his Web site.) In other words: by one measure, I.P.O.s are now more underpriced than they’ve been since the dot-com boom.
The first-day spikes are nowhere near their size during the Internet bubble when eToys went public, Ritter said (the average first-day return in 2000 was fifty-six per cent)—but it does indicate a level of enthusiasm for I.P.O.s that companies and their underwriters aren’t doing a good job of building into their offer prices. For Twitter, that means less funds to invest in things like research and hiring. But for Twitter’s lucky early investors, the company’s bankers did a good job, indeed.
Original Article
Source: newyorker.com
Author: Vauhini Vara
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