There’s a provocative column by Joe Nocera in today’s NYTimes about LinkedIn’s IPO last week. Nocera thinks that the investment banks Morgan Stanley and Merrill Lynch — which LinkedIn hired to take it public — essentially stole hundreds of millions of dollars that should have gone to LinkedIn’s treasury.
Here’s how it works. The investment banks gauge demand for the shares, which are sold by the company’s treasury, and set what they believe is a fair-market price. Proceeds of those initial sales go to the company. In LinkedIn’s case, Morgan and Merrill set a price for the shares three times, the last and highest being $45. LinkedIn took in $352 million for 7.5 million shares. The investment banks get 7 percent of that.
But once the shares are out, they can be — and are — traded freely. On its first day, LinkedIn traded as high as $122 per share, closing at $94.25, more than twice the initial price. LinkedIn got none of that money.
Who did? The people to whom Morgan and Merrill sold the initial shares. That’s usually their best customers, people with connections, or other BFFs. A 100 percent gain in one day is a nice day’s work.
Nocera says it’s a scam. It’s the investment banks’ job to know what the market sentiment is, he says, and it’s their fiduciary duty to price the coming-out shares as close to what they think the market will pay. And at the end of the day (literally), the market was apparently willing to pay $90. LinkedIn should have collected not $352 million but $700 million, Nocera argues. And their investment banks should have been paid $49 million, not a mere $25 million or so.
Why would the banks leave $25 million on the table by underpricing? After all, taking a company public is hard work. Maybe they traded some of their own stock and gained more than that. Maybe they were willing to chalk up the $25 million as a cost of doing business to appeal to their best customers. Promotional expense, you know.
Is this something that should be — or can be — fixed? I’m not so sure. I don’t know that it’s an investment bank’s responsibility to take into account a market gone nuts. Maybe a best effort is all that’s truly called for. though how you’d judge that is a mystery for smarter minds than mine. I know I don’t want the SEC putting its thumb on the IPO scale.
Maybe a Dutch auction, which is how Google went public, is the right anwer. (The Street hated it, but it doesn’t seem to have hurt Google’s prospects any.) Maybe there should be a rule that a percentage of all first-day sales — say, 7 percent, same as the banks’ take — be funneled back to the company issuing the shares. It might make for a more orderly coming out, or it might just move the madness to Day 2.
This may just be one of those things that Just Isn’t Fair. One thing Nocera’s inarguably correct about: it looks like hell at a time when the financial business ought not to be resorting to Old Tricks of the Internet Bubble.