Too Much Left on the Table

Is IPO low-balling finally coming to an end? No way, Jim Seymour says.
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Lots of comments in the press over the weekend about the soaring



IPO on Friday. The stock closed its first day at 280, up 483% from its offering price of 48.

That was the second day in a row -- and just the second time in U.S. markets history -- that a stock,


stock, closed up over 200% on its first day of trading. (

VA Linux


was, of course, the bottle rocket

du jour

on Thursday, closing at 239 and change, up nearly 700% from its offering price.)

Q&A with Jim Seymour Wednesday on


Message Boards.

Agreed, that little bit of history was worth commenting on. And agreed, impressive results. But the most interesting thing about the FreeMarkets IPO wasn't its closing price, nor the two days of record-setting IPO gains, but the

offering price finally set by FreeMarkets' lead underwriters,

Goldman Sachs


Morgan Stanley Dean Witter


After bumping the proposed offering price up by a factor of 3 from the originally announced price -- to 48 from 16 -- the sale of 3.6 million shares produced $172.8 million for FreeMarkets. Not bad for just 11% of a company that's still not profitable.

And to be sure, the $172.8 million FreeMarkets got from the offering is dwarfed by the new riches of founder Glenn Meakam. He holds a little over 10% of the firm, now worth about $1.6 billion.

But we're accustomed to founders, CEOs and board members of new dot-coms walking away from IPOs with riches once beyond their wildest dreams. What we're not used to is a company doing so well for


, thanks to the disgracefully low-ball offering prices that have become commonplace this year.

No one knows how much money has been left on the table by newly public companies during 1999, but it's into the billions and billions. (Forgive me,

Carl Sagan


It's as if Wall Street forgot that the basic reason for a company to come public -- in theory, at least -- is to raise capital. By setting an IPO offering price at, say, 16, investment bankers forfeit (into the hands of insiders, speculators and those lucky few who get IPO shares) the majority of the capital invested in the company by the end of the day.

If, instead of being priced at 16, it's offered at 32, the company gains twice as much new capital from the offering. (I'm rounding here, ignoring the effects of investment bankers' fees.) Make the offering price 48 instead of 16 -- as Goldman and Morgan Stanley did here -- and you triple, roughly speaking, the net gain for the new company.

Yet bankers continue to set low-ball offering prices. Clearly there are self-serving reasons for doing so, and though there are a few reasons why they might do so -- beyond their own greed (keep reading) -- the substantial loss of capital to a new company can really hurt.

What do the investment bankers say in defense of knowingly low-balling offering prices? Three things:

  • First, they say the big splash a newly public company makes when its shares triple or quadruple on opening day is well worth forfeiting some potential working capital for the company. Your call on this one: Sure, there's some halo effect from a big opening, but it's the division of the proceeds that interests me (and, presumably, the company going public), not the fireworks. I just want the company to get more of that first-day dough, and the speculators (including, from time to time, me) a little less.
  • Second, they say that avoiding the risk of an IPO that only gains slightly over its offering price -- or, gasp, actually falls below it that day or very shortly after (remember (BNBN) ?) -- is worth giving up some of that initial capital for the new company. Yes, yes. But is that a real risk with very many of these companies? Clearly, in the cases of VA Linux and FreeMarkets, would-be investors had been lining up for weeks.
  • Third, we all tacitly acknowledge the ugliest truth of all: Many of these IPOs aren't staged because a company needs the additional capital, nor because it needs to establish itself as a rich and powerful publicly traded company. Rather, the IPOs' main purpose is to enrich its founders and executives. Anything that can drive that opening-day close higher -- at whatever cost to the company -- is considered a good thing here because it drives the value of those nickel-and-dime options up to $100, $200, even $300 each. And it makes a few people -- and the company's investment bankers -- very rich very fast.

I'm not much impressed by any of those arguments. Even taken together, they don't persuade me that selling chunks of a company for half, or a third, or a fourth or less, of what people are willing to pay is good business. At least not for the supposed primary beneficiary of the IPO -- the company itself.

Jim Seymour is president of Seymour Group, an information-strategies consulting firm working with corporate clients in the U.S., Europe and Asia, and a longtime columnist for PC Magazine. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. At time of publication, neither Seymour nor Seymour Group held positions in any securities mentioned in this column, although holdings can change at any time. Seymour does not write about companies that are current or recent consulting clients of Seymour Group. While Seymour cannot provide investment advice or recommendations, he invites your feedback at