One of my favorite lines has always been, “Show me a great bubble and I’ll help you find a very clever banker behind it.” Well, clearly some of the smartest bankers in NY got bored the last few years and have now developed a new trick – the Sliver1 IPO. We’ve seen one tech IPO after another approach the market in this fashion the last few months, and even the controversial and rehashed Caesers’ deal was able to make it into the public markets this way. A Sliver IPO effectively manipulates the demand curve and artificially outsizes demand by limiting the supply of stock that’s sold at the IPO to only 5-12% of the shares outstanding.
The attraction here (beyond, dare I say it, forcing out a deal that you couldn’t do with a more normal allotment of shares) is to create the banker’s “IPO pop.” This initial positive reaction (or “pop”) in the market is believed to bring positive media coverage to the deal and create immediately happy shareholders. I’m actually ambivalent to the need for the “pop.” The IPO process is inherently flawed as it’s not focused on matching up the right kind of investors with the right kind of stock. But the reality is our IPO process does work and our investment bankers do a great job at feeding America’s engine and entrepreneurial spirit by driving a process that, at the end of the day, funds some our best ideas. So the point of this piece is not to attack the “pop” or traditional process, but rather the dangerous greed that circles the Sliver IPO and more importantly, the potential longer-term ramifications that this greed might have on those companies that choose to employ it.
The bottom line is that the creation of artificial demand, supported by momentum investors and limited float, will not be healthy for any company long-term unless it grows like Apple. First, visibility to quality investors will ultimately become limited if the stock retains a multiple that it doesn’t deserve. Second, the stock’s appreciation causes sell-side analysts to creep their estimates up to justify inflated valuation targets. All of this raises the pressure on corporate managers and IR teams to raise performance guidance and thus, expectations can get away from the new company fairly quickly. Eventually, this vicious cycle will clearly test the communications skills of these new CEOs and CFOs, many of whom may have never dealt with public shareholders before.
At the end of the day, a CEO’s and CFO’s credibility is one of the most important investment appeals that any company has, and it is absolutely critical that it’s protected at all costs. For smaller companies this is even more important as their pool of investors is significantly smaller. So if you’re a company considering an IPO this year or next, I implore you to ignore today’s latest version of greed, and don’t let your banker roll the credibility dice of your senior executives by executing one of these deals. Your IPO will be successful the old fashioned way, and you won’t trade short-term success for long-term failure.
1This is actually Jim Cramer’s term and even he’s rallied against it this process as “shady” for investors.