Twitter (TWTR) is out and the jury is in: its IPO was a resounding success! The micro-blogging site was tremendous in its debut. And there’s an easy comparison to make if you want to see why: Facebook (FB). Where Twitter succeeded, Facebook did not! Facebook’s IPO was an unmitigated disaster! TWITTER GOOD, FACEBOOK BAD!
That is, at least, the narrative one’s likely to see in the news. And in a certain sense, it’s spot on. At the very least, the series of technical problems that plagued Facebook makes for a pretty stark contrast with Twitter’s smooth rollout. However, some of those focused on the performance of the two stocks on the first day would also have you believe that Twitter’s first day “pop” was another sign of its success. Facebook finished its first day with a slight gain and then watched shares tank over the next month, needing more than a year to return to its IPO price. An indicator of how Twitter was much better at pricing their IPO, right?
Maybe not. It’s ultimately not a question that has a clear answer, but, depending on your perspective, Facebook’s lumbering, shoddy IPO ultimately served the company better in the long run than Twitter’s squeaky-clean, shimmering debut. Why? Because Facebook didn’t leave money on the table.
The methodology that has long gone into pricing high-profile IPOs has called for a first day pop. One wants to price the stock at a level that’s extremely attractive so investors will be clamoring for the shares. With a limited number of shares out there for a highly visible company, demand is already outpacing supply. If you offer the shares at an attractive price, it whips investor fervor to a peak and the stock takes off like a rocket the moment shares hit the open market. You get your picture in the paper, people at water coolers around the country titter about the overnight millionaires, and even the most casual investor considers buying your stock. Who wouldn’t want all that?
And Facebook might, to some, appear like a lesson as to why this approach has been the norm. The stock plunged over 50 percent over the few months following its IPO, with shares that debuted at $38 going for as low as $18.08 apiece. Facebook didn’t get back to $38 a share until August of this year, almost 15 months after its IPO.
We don’t know what will happen to Twitter over the next 3 to 15 months, so it may be a little premature to compare the two, but IPO’s $26 IPO price all but guaranteed that the stock would rocket up 73 percent on the first day of trading.
However, to understand why Facebook might actually have made the smarter play, one has to take a closer look at IPOs and what goes into pricing them. Essentially, taking a company public is a way to raise money. Twitter was selling equity, which ultimately added up to 13 percent of the company. In exchange for that 13 percent (70 million shares), the company was paid $1.8 billion by the investing public. That’s cash that Twitter can now invest into the company — cash that’s important for a growing company that has yet to show a profit.
And in any IPO, these are the important considerations. How much of the business is getting sold and at what price? Every prospective shareholder is thinking about how much this company is really worth and what portion of it they’re buying. Twitter opted to sell a relatively small chunk of the company at a low price. Facebook, by contrast, sold 421.2 million shares, what ultimately came to about 17 percent of the company. But here’s where the strategies start to diverge: 421.2 million shares at $38 a pop comes to $16 billion. That’s what Facebook took home at the end of the day to spend on growing their business. Twitter? $1.8 billion.
Money Left on the Table
And here’s where one could argue that Facebook clearly won out. Twitter’s shares were clearly ready to trade at about $45 a share. By pricing them at $26 a share, Twitter basically gave away about $1 billion in equity to the investors that Goldman Sachs (GS) decided to offer IPO shares to.
So why is that smart? Why are so many people willing to insist on a first day pop being important when it really just means money the company’s not making? If you were running a yard sale and you sold a guy a toaster for $10, and he then walked across the street and sold it to someone else for $17 about an hour later, you would probably feel like you got at least a little screwed on that transaction, right?
Facebook, meanwhile, rather clearly squeezed every last bit of toothpaste out of its IPO tube. If Facebook had priced their shares like Twitter did, that’s almost $6 billion that Facebook wouldn’t have had to spend on Facebook.
“Facebook's IPO was for $16 billion with Goldman & buddies bailing out to the tune of $10 billion,” says Equities.com’s Francis Gaskins. “It was the most perfect bailout I've seen, because the stock priced at $38, went to $44 in the confusion of the first few hours, then tanked to $18 within 3 months. No money left on the table, just the opposite — sock it to the public, that's for sure.
“Twitter was a different story. The range mid-point was upsized from $18.40 to $24, then priced at $26, went to $50, closed the 1st day at $45 and today closed below $42.”
The question of why traditional wisdom has called for a first-day pop despite the fact that it means companies are losing out on cash doesn’t have a simple answer. There are several factors motivating pricing other than simply trying to raise the most capital possible.
For starters, companies preparing to make a public debut are typically getting most of their advice on pricing from investment banks. The banks have experience in such things. What would a bunch of computer nerds know about pricing IPOs, anyway? Makes sense, right?
Except that the banks don’t always have the company’s best interest at heart. They typically favor their best customers in selling the IPO shares; it's a perk they can offer to keep the business of their big whales. So that first-day pop is, in some ways, just a way of taking money the company could have been making for itself and giving it the underwriter's loyal clients. Bill Hambrecht, an investment banker from San Francisco who has helped many tech firms IPO over the years, told NPR’s Morning Edition that big first-day pops are about making money for Wall Street, not the company. He also observed that it was Apple’s (AAPL) Steve Jobs who first started to challenge this model.
“Steve Jobs figured out very quickly how Wall Street worked,” Hambrecht said. “And he really questioned: Hey, why do you price it at 18 when you know it's going to sell at 28? And why do you charge me a 7 percent commission? And, you know, who gets that stock at 18? I mean, you know, why not my friends? Why your friends? I mean, he questioned the whole process.”
However, there are benefits to a big first day that go beyond just making money for the privileged few. For one, investor relations are important, and a reputation for generosity can pay off down the road for future capital raises. And while Facebook ultimately supplied the earnings necessary to shake off the negative sentiment about its stock that grew from the massive IPO valuation, a company like Twitter, which might not be profitable for some time, may need to rely on the patience and goodwill of its investors for the foreseeable future.
“Twitter couldn't afford to have a broken IPO like Facebook,” says Gaskins. “They wanted to be the anti-Facebook. Twitter was taking a lot of flack in the news media because of its losses, and the best way to counter act that negative force was to have an IPO that popped and then retained much of the pop.
“It's all good publicity for them, the kind of good publicity that money can't buy. So all in all I think they are very happy with the way the IPO went. Anything less and they would have been cutting it too close. I'm sure they would rather have an IPO that's up over 50 percent than one that's up only a ho-hum 20 percent (there's no excitement in that).”
Another consideration is just who owns the rest of the company. For both Twitter and Facebook, more than 80 percent of the equity wasn’t even for sale. That’s billions of dollars of wealth effectively created overnight. And who owns that? For the most part, it’s the company’s founders, early employees, and loyal investors who provided seed money early on — people that any company wants to reward. When Facebook debuted, Mark Zuckerberg, who owned about 28 percent of the company, was suddenly worth $28 billion. Of course, that also meant that he lost about $14 billion of net worth over the next three months.
A share price that takes off and holds its gains may mean the company doesn’t raise as much capital as it could, but it also means that the company’s inner circle is making a fortune. One can look at the Twitter IPO and focus on how the first-day pop put $1 billion in the pockets of anyone chummy enough with Goldman Sachs to luck out. But one might also realize that the $1 billion they made meant over $6.5 billion for the loyal Twitter employees and investors who already held 87 percent of the company.
“Those that hold the other 87 percent are very happy,” says Gaskins.
In the end, there’s no clear answer in terms of who priced their IPO better. Facebook certainly did a better job of selling equity at the best price. And with the company’s stock performing well now, it would seem to indicate that eating a nasty fall off the IPO price is worth it in the long term. Why leave money on the table? If you can weather some grumbling out of the gate, you’ll end up with an extra $6 billion or so in cash to invest in the company.
But Facebook also delivered the earnings reports it needed. In the event that the company had stumbled out of the blocks, it would have had a much shorter leash with Wall Street. Twitter, meanwhile, has a lot more room to maneuver in the coming months and even years. What’s more, those closest to Twitter have fared very well. The IPO created 1,600 new millionaires.
In the end, neither company “won.” They employed different strategies, each of which has its own benefits. Facebook’s IPO may have been the source of much controversy at the time, but it’s hard to argue at this point that they made any mistake in their pricing. And while it will take time to determine how Twitter has really fared, it’s clear that they’ve created a mountain of positive sentiment with investors.
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