A common mistake among people on the market is naivety. Ingenuity and IPOs are like magnets. Recently the Snapchat IPO occurred. A tremendous success for business owners, lawyers, investment bankers and brokerages. As for the investors … who f****n ‘cares?
“IPOs: It’s Probably Over Priced, Imaginary Profits Only or Insiders’ Private Opportunity.”
1. IPOs are dumb money
A business starts with the freaks who come together and run an idea. In another words: founders/owners. If the business looks promising, then friends and family invest money in exchange for participation (shares). With growth, some Venture Capitalists and Private Equities buy huge participation, dilute most of the initial shareholders and begin to structure the business to be *SOLD* as soon as possible. When the business is ready to be skipped out, they hire the investment banks for the IPO.
Did you realize that the IPO is the last step? All the people who have invested until then will want a return. That’s why the prices of an IPO are probably over priced. It’s time to collect the money. Smart money needs dumb money just as the Earth needs the sun.
When banks, brokers and investment agents offer an IPO opportunity it is basically the hairdresser talking that you need to cut your hair. A visible conflict of interest.
2. IPOs fail most of the time
Investors are human and we all have an emotional side that if not controlled can become a real money dredge. Investors get excited by something new, especially if it holds the promise of making them a whole lot richer. Who invest in IPOs believe that it is the chance to buy shares of the company early in their public life. In fact, the company has been around for a long time and you are not getting into the beginning. You are entering the crest of the wave.
It’s important to understand that the investment bankers and underwriters of IPO are simply salesmen. Those who work in investment banks have their bonuses proportional to the revenue they bring to the company. And IPO is a HUGE source of revenue. It is the opportunity of many investment bankers’ lives. And they will do their best to earn as much as possible. And that includes telling stories and hiring the best marketers possible to illustrate a perfect setting to attract more and more people.
Although it is the ideal opportunity to fill the pocket for the seller side it is necessary to understand that on the buyer side the scenario is more somber: “The long-run performance of initial public offerings is dreadful, even if you are lucky enough to get the stock at the initial offering price. From 1968 through 2001, there were only 4 years when the long-term returns on a portfolio of IPOs bought at their offer price beat a comparable small stock index. Returns for investors who bought IPOs once they actually start trading do even worse.” – Jeremy Siegel
a) It’s hard enough to analyze the fundamentals and technicals of an established company. An company about to IPO is even trickier to analyze since there is virtually no historical information to draw on.
b) A public company is born after an entrepreneur grows the business and along the way, gets capital to grow via bank loans, investments by family members or private investors such as venture capital firms or private equity firms. Each time the company raises new money, new investors are willing to pay more for the stakes, so long as the company is performing well. The IPO is the moment they want the return on the invested capital. Probably the price is above any reasonable estimate of the ideal value.
c) Investment Banks loves IPOs. Investment Bankers are just salesmen and earn a huge commission for launching companies to the public. The underwriters (IPO underwriters are normally investment banks that have IPO specialists on staff) buy the shares and re-sell them to other investors will get paid whether the stock soars or tanks when it opens on the exchange (called the secondary market). Underwriters’ fees typically range from 5 to 7 percent of the gross IPO proceeds.
d) “It’s almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors).” – Warren Buffet