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Economics novice here. How did we get such a huge difference (40%!) between the IPO price and the current price, when both sides had $3.4 billion at stake on ge

Economics novice here. How did we get such a huge difference (40%!) between the IPO price and the current price, when both sides had $3.4 billion at stake on getting that price "right"? Is there some huge information disparity here? Moreover, if investors feel that $24 a share is a fair price, why weren't they swooping in before the IPO and, say, offering $20 a share for the whole chunk? Sorry if this seems like a ridiculous question, but it seems to me like there should be some extremely large free market force (on the order of $1.4 billion) preventing the founders and employees from missing out on all that money. Am I wrong?

johnrob 10y ago
If they priced the stock accurately, there would be a 50% chance the stock would go down on the first day. They want it to go up and thus under price it.
- asher_ 10y ago
  Can someone explain this to me? If I own something, I want to sell it for as much as the market will bear. I don't want to sell it and have someone flip it for a huge margin almost immediately. How is a large first-day bump not considered a failure for an IPO? What is it about the situation that reverses a common sense understanding?
  - vecter 10y ago
    Perception and uncertainty. Humans are irrational emotional beings. Somethings feels hot because it popped on its first day trading from $18 to $24. Humans don't know the counterfactual, which is that the stock could have been initially priced at $30 and then dropped to $24. Both result in the exact same value of the company, but the first is definitely perceived as better. Also, it's hard to say what the "true" value of a stock or company is. In practice, it's what people are willing to pay for some shares of it, and we then as an industry standard take that last traded price, multiply it by the number of extant shares, and then come to a "market capitalization" value. So therefore, people depend on signals such as whether a stock goes up or down to determine whether or not it's hot, since people don't know what a "true" price for the stock really is anyway.
kevando 10y ago
From what I understand, IPOs are very complex, but an ELI5 goes something like this: They want to open the stock to the public without crazy volatility in price, so there is a "pre-IPO" where brokers get access to buy it at $17, then $18, etc. and when people stop grabbing - they open it to the public. I think the underwriter basically buys all the stock for $17/share and then they broker it out to everyone, so anyone that buys over $17 is profit to GS. And GS assumes the risk that they priced it correctly and Snap is happy with $17/share so they're cool with GS profiting
- cangencer 10y ago
  AFAIK the underwriters typically don't buy and sell the stock themselves - but offer it to their clients, who can buy the shares at the IPO price instead of the opening price. The underwriters then charge a fee based on the size of the IPO.
  - acchow 10y ago
    They do have to buy them if they can't sell the shares to others - hence "underwriters"
chimeracoder 10y ago
> Moreover, if investors feel that $24 a share is a fair price, why weren't they swooping in before the IPO and, say, offering $20 a share for the whole chunk? Well, they were. When a company IPOs, it doesn't sell its stock directly on the market - it sells it to intermediary bankers, who buy it at a price that they think will lock in profit for them when they sell it at the opening bell. (In addition, the early purchasers are also other bankers and trading firms - as an individual, there's zero chance that you'll get the IPO price unless the stock flatlines when it opens). So, from the company's perspective, the ideal situation is to price that as high as possible, and actually overshoot the market price - that way, they leave no money on the table, and they can raise as much as possible for the number of shares they're selling. In that case, the share price will drop a few minutes after the opening bell, and it'll close trading that day somewhere below the opening price. Note that that's exactly what happened with Facebook ($FB), and the bankers were pissed off. That's why you saw so many articles about the Facebook IPO being a "failure" at the time. It wasn't a failure for Facebook - they made a ton of money! It was a failure for the bankers who wanted to make a profit on the resale, and instead sold those shares at a loss. I'm oversimplifying, because there was a lot of other stuff that went into the Facebook IPO that complicated it[0], but that's the general idea. [0] a lot of people learned the meaning of the "reverse greenshoe" that day!
- unholiness 10y ago
  Hmm. To me that just shifts the questions to the bankers. If people (who don't know anything the bankers don't know) value the stock at $24, shouldn't there also be competing bankers willing to offer $20 a share for the whole lot, igniting a bidding war that converges roughly near the real price? Obviously bankers need to make some money. But I don't see how this kind of deal has anywhere near a $1.4 billion dollar overhead, and I'm just boggled by the scale of the disparity.
  - chimeracoder 10y ago
    > If people (who don't know anything the bankers don't know) value the stock at $24, shouldn't there also be competing bankers willing to offer $20 a share for the whole lot, igniting a bidding war that converges roughly near the real price? Yes, though with a discount factor applied due to the risk involved. And particularly for a high-profile IPO like $SNAP, and one in which a lot of the sellers on Day 1 will be casual retail investors placing market orders[0], it's hard to gauge exactly how much hype there will be. [0] ie, as opposed to limit orders
abhi3 10y ago
Why would investors pull out $3.4 billion of capital from other assets to invest in Snap if the issue was accurately priced? As an investor I wouldn't pay 100 to buy something worth ...100. Price it below its fair value and we might talk. When trying to mobilize capital on this scale and at this risk level (no revenue, stalled growth), the required undervaluation is significant.
bhalperin 10y ago
Matt Levine explains this well https://www.bloomberg.com/view/articles/2016-11-25/appeals-court-concludes-that-ipos-are-legal https://www.bloomberg.com/view/articles/2016-11-25/appeals-c...
edblarney 10y ago
1) They try to be a shade conservative when pricing for IPO because the stock going down on day 1 is a very bad. 2) The underwriters are invented to keep it low because they basically keep the upside - i.e. they buy from Snap at the low price and will sell the next day on the pop. 3) It's volatile because there's little basis for the valuation - they're making almost no money and have a massive, massive valuation = it's hard to establish what they are worth = more variation. 4) Retail investor hype. Every dentist, doctor and retired guy wants a piece to feel like they are 'getting part of the IPO' and there's irrational exuberance which pushes the prices around.
harryh 10y ago
A big % of the shares purchased at the IPO price came with a requirement to hold the shares for at least 6 months. The people that bought on the open market today can sell whenever they feel like it. Not having that requirement is worth something. That explains part of the delta.
lordnacho 10y ago
You've found an interesting corner of the market. I was partner in a hedge fund that hired a equity trader once. He's the only trader I've ever met who begged a broker to be nice to him. So how does it work? Why on earth do IPOs pop so reliably on the first day? (FB is an interesting exception) The company is only going to be a market virgin once. They don't have a lot of experience as a public company, of course. They certainly don't have a list of funds who are going to buy their stock, that's why they hire an investment bank to help them. So what does the IB do? Well, they are most definitely not IPO virgins. They do however need to maintain relationships, so that they can tout their relationships to future IPO firms. So how do you do that? Of course you price the offering so that shares are scarce. That way you get two things. One, a reputation for presenting fund clients with almost sure winners. Two, a reputation for having ample access to buyers for your IPO firms. Three, funds will listen to your sales pitches (across many lines of business) because they know that now and again the IB will hand out goodies to their friends. For instance a lot of Hedge Funds have backup prime broker accounts just in case bad things happen. The PB folks love to sign up funds because it's a foot in the door in case you get angry with the primary PB. So what do they do? They make strong hints that you should open an account so you can get some free money now and again. The amount of free money can be quite substantial per client, in the tens of millions for the largest funds. Ordinary desks will likewise say "hey trade with us, we'll see to it you get something in return from our IPO guys". Now naturally not everything promised can be delivered. Why does the stock always pop on IPO? Why don't people who aren't allocated shares just walk away? I think this is psychological but seeded by the low-pricing dynamic. If you know the bank knows how many people are interested at different prices, and that they'll price it low, you know the price will go up. But everyone buying is going to augment that, especially if missing out on an allocation means you have to make up that PnL by jumping on the obvious trend. BTW, rights issues are a similar dynamic, driven by access to shares that can be lent out for short selling. Free money for people who get the shares, bank decides who they want to do business with in the future.

johnrob 10y ago

If they priced the stock accurately, there would be a 50% chance the stock would go down on the first day. They want it to go up and thus under price it.

asher_ 10y ago
Can someone explain this to me? If I own something, I want to sell it for as much as the market will bear. I don't want to sell it and have someone flip it for a huge margin almost immediately. How is a large first-day bump not considered a failure for an IPO? What is it about the situation that reverses a common sense understanding?
- vecter 10y ago
  Perception and uncertainty. Humans are irrational emotional beings. Somethings feels hot because it popped on its first day trading from $18 to $24. Humans don't know the counterfactual, which is that the stock could have been initially priced at $30 and then dropped to $24. Both result in the exact same value of the company, but the first is definitely perceived as better. Also, it's hard to say what the "true" value of a stock or company is. In practice, it's what people are willing to pay for some shares of it, and we then as an industry standard take that last traded price, multiply it by the number of extant shares, and then come to a "market capitalization" value. So therefore, people depend on signals such as whether a stock goes up or down to determine whether or not it's hot, since people don't know what a "true" price for the stock really is anyway.

kevando 10y ago

From what I understand, IPOs are very complex, but an ELI5 goes something like this: They want to open the stock to the public without crazy volatility in price, so there is a "pre-IPO" where brokers get access to buy it at $17, then $18, etc. and when people stop grabbing - they open it to the public. I think the underwriter basically buys all the stock for $17/share and then they broker it out to everyone, so anyone that buys over $17 is profit to GS. And GS assumes the risk that they priced it correctly and Snap is happy with $17/share so they're cool with GS profiting

cangencer 10y ago
AFAIK the underwriters typically don't buy and sell the stock themselves - but offer it to their clients, who can buy the shares at the IPO price instead of the opening price. The underwriters then charge a fee based on the size of the IPO.
- acchow 10y ago
  They do have to buy them if they can't sell the shares to others - hence "underwriters"

chimeracoder 10y ago

> Moreover, if investors feel that $24 a share is a fair price, why weren't they swooping in before the IPO and, say, offering $20 a share for the whole chunk? Well, they were. When a company IPOs, it doesn't sell its stock directly on the market - it sells it to intermediary bankers, who buy it at a price that they think will lock in profit for them when they sell it at the opening bell. (In addition, the early purchasers are also other bankers and trading firms - as an individual, there's zero chance that you'll get the IPO price unless the stock flatlines when it opens). So, from the company's perspective, the ideal situation is to price that as high as possible, and actually overshoot the market price - that way, they leave no money on the table, and they can raise as much as possible for the number of shares they're selling. In that case, the share price will drop a few minutes after the opening bell, and it'll close trading that day somewhere below the opening price. Note that that's exactly what happened with Facebook ($FB), and the bankers were pissed off. That's why you saw so many articles about the Facebook IPO being a "failure" at the time. It wasn't a failure for Facebook - they made a ton of money! It was a failure for the bankers who wanted to make a profit on the resale, and instead sold those shares at a loss. I'm oversimplifying, because there was a lot of other stuff that went into the Facebook IPO that complicated it[0], but that's the general idea. [0] a lot of people learned the meaning of the "reverse greenshoe" that day!

unholiness 10y ago
Hmm. To me that just shifts the questions to the bankers. If people (who don't know anything the bankers don't know) value the stock at $24, shouldn't there also be competing bankers willing to offer $20 a share for the whole lot, igniting a bidding war that converges roughly near the real price? Obviously bankers need to make some money. But I don't see how this kind of deal has anywhere near a $1.4 billion dollar overhead, and I'm just boggled by the scale of the disparity.
- chimeracoder 10y ago
  > If people (who don't know anything the bankers don't know) value the stock at $24, shouldn't there also be competing bankers willing to offer $20 a share for the whole lot, igniting a bidding war that converges roughly near the real price? Yes, though with a discount factor applied due to the risk involved. And particularly for a high-profile IPO like $SNAP, and one in which a lot of the sellers on Day 1 will be casual retail investors placing market orders[0], it's hard to gauge exactly how much hype there will be. [0] ie, as opposed to limit orders

abhi3 10y ago

Why would investors pull out $3.4 billion of capital from other assets to invest in Snap if the issue was accurately priced? As an investor I wouldn't pay 100 to buy something worth ...100. Price it below its fair value and we might talk. When trying to mobilize capital on this scale and at this risk level (no revenue, stalled growth), the required undervaluation is significant.

bhalperin 10y ago

Matt Levine explains this well https://www.bloomberg.com/view/articles/2016-11-25/appeals-court-concludes-that-ipos-are-legal https://www.bloomberg.com/view/articles/2016-11-25/appeals-c...

edblarney 10y ago

1) They try to be a shade conservative when pricing for IPO because the stock going down on day 1 is a very bad. 2) The underwriters are invented to keep it low because they basically keep the upside - i.e. they buy from Snap at the low price and will sell the next day on the pop. 3) It's volatile because there's little basis for the valuation - they're making almost no money and have a massive, massive valuation = it's hard to establish what they are worth = more variation. 4) Retail investor hype. Every dentist, doctor and retired guy wants a piece to feel like they are 'getting part of the IPO' and there's irrational exuberance which pushes the prices around.

harryh 10y ago

A big % of the shares purchased at the IPO price came with a requirement to hold the shares for at least 6 months. The people that bought on the open market today can sell whenever they feel like it. Not having that requirement is worth something. That explains part of the delta.

lordnacho 10y ago

You've found an interesting corner of the market. I was partner in a hedge fund that hired a equity trader once. He's the only trader I've ever met who begged a broker to be nice to him. So how does it work? Why on earth do IPOs pop so reliably on the first day? (FB is an interesting exception) The company is only going to be a market virgin once. They don't have a lot of experience as a public company, of course. They certainly don't have a list of funds who are going to buy their stock, that's why they hire an investment bank to help them. So what does the IB do? Well, they are most definitely not IPO virgins. They do however need to maintain relationships, so that they can tout their relationships to future IPO firms. So how do you do that? Of course you price the offering so that shares are scarce. That way you get two things. One, a reputation for presenting fund clients with almost sure winners. Two, a reputation for having ample access to buyers for your IPO firms. Three, funds will listen to your sales pitches (across many lines of business) because they know that now and again the IB will hand out goodies to their friends. For instance a lot of Hedge Funds have backup prime broker accounts just in case bad things happen. The PB folks love to sign up funds because it's a foot in the door in case you get angry with the primary PB. So what do they do? They make strong hints that you should open an account so you can get some free money now and again. The amount of free money can be quite substantial per client, in the tens of millions for the largest funds. Ordinary desks will likewise say "hey trade with us, we'll see to it you get something in return from our IPO guys". Now naturally not everything promised can be delivered. Why does the stock always pop on IPO? Why don't people who aren't allocated shares just walk away? I think this is psychological but seeded by the low-pricing dynamic. If you know the bank knows how many people are interested at different prices, and that they'll price it low, you know the price will go up. But everyone buying is going to augment that, especially if missing out on an allocation means you have to make up that PnL by jumping on the obvious trend. BTW, rights issues are a similar dynamic, driven by access to shares that can be lent out for short selling. Free money for people who get the shares, bank decides who they want to do business with in the future.