These Low Float IPO’s Are Insulting

By: ispeculatornew
Date posted: 07.04.2011 (5:00 am) | Write a Comment  (1 Comment)

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When social network LinkedIn (LNKD) decided to go public, it did what some of its underwriters had suggested; a low float IPO. What is it exactly? When LinkedIn was in advanced discussions to go public, one of the important decisions was how much stock to sell. They could sell 1%, 5%, 10%, or much more of the company to external investors in order to generate cash. All options have their pros and cons but in the end, LinkedIn decided to do a low float IPO; selling only a very small portion of the company.

Why Low Float?

There are many different reasons but one of them was for the company to be valued at a higher price. I hear some of you say that it should not affect the company’s valuation. You would be right in theory. However, the sky high pop in shares following the IPO seems to suggest another story.

It’s Irrational Isn’t It?

Generally, when I buy a stock, I look at different valuation metrics such as the P/E ratio. That means I would value a share of LinkedIn at the same price no matter if they float 1% of the company or 90%. Why? If 90% of the company is sold to the public, they also get a 90% share of the current and future earnings. It’s exactly the same thing as 1% and 1%. I don’t understand how this would not be the case.

Not All Investors Buy On “Valuations”

The crazy part is that many investors will buy stock without even looking at valuation metrics. If you have 10,000 investors that want to buy LinkedIn because it is the next big thing. They will likely buy the stock no matter what the IPO price is. It is similar to putting up a market order with no limit. That skews the market and makes recent IPO’s these days very difficult to buy.

A Concrete Example

Imagine a store that was selling apple pies and had 100 apple pies in its store and thinking about selling them for $5. That would make the merchandise worth $500 right? What if the store knew that 10 of those customers were willing to buy the pie no matter what the price, simply because they think the world of it? Instead of selling 100 pies, it could sell 10 on the first day for $20 each. Not only would those pies get sold (for $200) but it would also let all other potential buyers that the pie is actually worth $20, not $5. It’s all psychological of course but it would mean the company would not only have $200 in cash but also $1800 worth of pie in store that could be sold in the following days.

A similar phenomenon is currently occurring in the markets as LinkedIn (LNKD) sold less than 10% of its shares leaving investors scrambling to buy the rare shares. Soon to be public companies Zynga and Pandora are planning on using the same tactic to receive a higher valuation.

It Only Works With Some Investors

Generally, this strategy works mainly with retail investors that do not study valuations as much. That is why the main companies doing this are strong brands that they expect the “average” retail investor to want to buy without studying the valuation thoroughly. Sign of a bubble? Perhaps. It’s certainly frustrating to see these companies selling for such high prices.

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1 Comment

  1. Comment by Value Indexer — July 5, 2011 @ 6:23 am

    It’s pretty easy to see that when there is a lot of demand and limited supply the price will go up – this might have done to keep more of the company in the hands of private owners though. Maybe they didn’t need more cash, or maybe they thought the share price wouldn’t make it worth selling more. Whatever the reason it’s interesting to note that although it is a public company now, the public simply can’t control that much of it yet.

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