The Wall Street Journal recently had a piece on investing in the Facebook IPO. They admit, “most retail investors will be shut out of the offering and won't get the IPO price, meaning they likely will have to pay more in the days that follow if they want an early piece of the action”.
To see what’s going on here, let’s take a closer look at what happens on the day of the IPO. In pricing the IPO, there are two prices to consider: the offer price, and the open price. The offer price is set by the company and underwriters. This is the stock price that the company receives in its IPO sale. The open price is set by the publicly traded market on the day the company goes public.
As an example, Linkedin went public in May of 2011. Their offering price was $45 per share, and the stock’s open price was $83 per share. On opening day, the stock went up to over $120 per share, and had a low of $80 per share. Linkedin sold approximately 7.8 million shares of stock in its IPO, so on opening day the value of these shares ranged from $624 million (at $80 per share) to $957 million ($122.70 per share). Had Linkedin and their underwriters set the offer price to closer to $80 per share, Linkedin could have made an additional $273 million during its IPO sale.
Let’s consider the difference in offer price vs open price among the six tech companies mentioned in the WSJ article:
Company Offer Open (low) Raised Loss
Linkedin $45 $80.00 $351M $273M
Groupon $20 $26.11 $700M $214M
Yandex $25 $30.55 $1.4B $310M
Zynga $10 $9.00 $1B ($100M)
Renren $14 $12.30 $743M ($90M)
Pandora $16 $17.35 $235M $20M
TOTAL $4.4B $627M
Had these six company and their underwriters set the offer price closer to the open price, they could have raised an additional $627 million. This value was instead realized by institutional investors and select individuals who were able to participate in the IPO at offering price. They bought a total of $4.43 billion in stock at the IPO, and this stock immediately increased to $5.06 billion when the stock traded publicly that very same day.
Unfortunately, as the WSJ says, most retail investors have no access to IPOs at the offer price. As for the company, they have no access to IPOs at the open price. So who’s getting really getting rich off of these IPOs? The underwriters and their insiders.