IPO mania took over Wall Street last week with Airbnb and DoorDash offering some respite from Covid specific news. Airbnb stole the headlines with its long-awaited stock market debut – with its shares’ technically’ up 115% by close of business on their first day of trading, not bad for a company that has never made a profit. That surge left the travel firm with a market cap of almost 100 billion, an eye-watering valuation for a company with less than $4 billion in annual sales.
Amid the IPO frenzy, two questions cropped up, the first of which was simply, ‘What is an IPO?’
An IPO or initial public offering is when a private company first sells shares of the company to the public. From the date of IPO, the company will begin trading on a stock exchange such as the NASDAQ or NYSE.
When a company needs to raise money, there are two main ways to do so. They can take out a loan, but this will mean taking on debt. Alternatively, they can issue stocks, allowing the company to raise money without going into debt by selling shares of ownership, providing investors with a claim on future earnings.
As investors saw headlines of triple-digit IPO returns, focus turned to understanding ‘Why can’t I invest in the company at its IPO price?’
Unfortunately, the reality is, the headline-grabbing IPO gains are not available to mere mortal retail investors. The media headlines will taunt you and suggest that you missed out. But in a cruel Wall Street induced twist of faith, these gains typically fall into the hands of the privileged few.
What is important to understand here is the difference between the offering price and the opening price.
The offering price of an IPO is the price at which a company decides to sell, usually determined with the help of the investment bank underwriting the IPO. Initial stocks are typically distributed amongst large accredited investors and institutional investors the night before the IPO and purchased in large tranches.
Meanwhile, the opening price is the price at which those shares begin to trade in the open market to public participants. This opening price is set by the supply and demand that surrounds the stock ahead of opening as buy and sell orders flood in. These orders are balanced against each other before determining the opening price. If the demand for shares exceeds the supply, you guessed it, shares open higher than the offering price and vice versa.
In the case of Airbnb, a Black Friday-esque scramble saw demand significantly outweigh supply. The original offering price was settled at $68 a share. However, investor demand for the company saw prices open at $146. So while those in possession of the shares at offering price had more than doubled their money by the end of the day, The opening price actually trended lower, closing out the day 12% below its intraday high.
Airbnb Historical Valuation
With plenty more IPO’s in the pipeline for 2021, be mindful of initial day exuberance. The larger institutions tend to be the big winners here, while many retail investors end up buying the froth.
If you like the company as a long-term play, then by all means invest, but perhaps allow the lock-up periods of the original private shareholder’s laps (90 to 180 days) and listening in on one or two quarterly earnings calls to get a better perspective on the company’s future projections before making your move.
Our one recommendation is that all investors should be wary of new issues—which means, simply, that these should be subjected to careful examination and unusually severe tests before they are purchased. There are two reasons for this double caveat. The first is that new issues [IPO] have special salesmanship behind them, which calls therefore for a special degree of sales resistance. The second is that most new issues are sold under “favorable market conditions”—which means favorable for the seller and consequently less favorable for the buyer. – Benjamin Graham, The Intelligent Investor