IPO valuations and the role of bankers – By Aravind G.R

The Business Insider’s Henry Blodget asks ‘how would you feel if your real estate broker sold your house one day for $1 million to someone (a friend of his, presumably) who turned around and sold it the next day for $2 million.’ You’d be pissed, right, and feel betrayed? Of course you would.

To put it simply, LinkedIn execs sold their shares to ‘some people’ at $45 on Wednesday night, while these people sold it $100 on Thursday morning. Obviously, finger(s) was pointed at the Ibankers who simply “screwed their client out of $130 mn” and charged them $25-30mn to do it.

Before we hang the Ibankers in the middle of the street (while a massive protest at wallstreet continues), lets listen to some of their most probable excuses/arguments and try to debunk them:

1. Mr Banker: How in the world can you expect us to know that the stock price would double to 90+? When we priced at 45, we were told by the same pundits that it was unreal and that we had ‘lost it’

My Take: Agreed, it is very difficult to ‘value’ internet & tech companies, especially lightspeeders like LinkedIn. If you remember, a few years ago Google had no idea about their correct value either, but they pioneered a best practice of ‘Dutch Auction’ to clearly put the ball in investors court and ask them-‘tell me how much you want to buy us at’.

So, Mr Banker’s job would have been easier if he’d trusted his institutional investor buddies to come up with the ‘value’ rather than taking a shot at it in the dark.

2. Mr Banker: No two people value a high growth technology company the same way. Our valuation was close to $45. Live with it.

My Take: We Ibankers are hired to solve this exact problem; we are supposed to get the valuation close to what the market is willing to pay. I understand that underpricing has an inherent advantage and has become sort of an ‘expectation’ from IPO investors. The process of Dutch auction addresses this problem as well.  The fact that you are setting a price band is keeping you in control of pricing rather than the buyer who is bidding against thousands of other bidders for the same share. Price discovery is being stifled a bit, isn’t it?

We boutiques face the same problem, we don’t know if our client should be valued at 10X or 30X of something. But, in the name of god, I wish we had 10 VC funds bidding for the current round. We have done so much better to get closer to a ‘fair’ valuation with just 3-4 VC’s jostling for the same opportunity. Lets face it, we all know how much of termsheet shopping gets done and what a couple of termsheets on the table means to a fund which is looking at the opportunity for the first time.

 

3. Mr Banker: These pundits will be on my case if the price comes down after listing. I’m being ‘just’ to everyone!

My Take: There are enough instances where Ibankers have been accused of screwing the ‘unsuspecting investors’ by selling them a crappy stock at a ridiculous valuation. Can Mr Banker really help this? In India, he is ‘paid’ to ‘maintain’ the price for a few weeks/months after listing. But it is not Mr Banker’s job to see that the stock price is always above the IPO price.  Well, buyers beware, right?

4. Mr Banker: Aha, I’m way more intelligent than you think. I’m doing this to ‘bait’ investors (future ones as well) into believing that the stock is ‘hot’. Investors will not support a stock if it did not ‘pop’ on the listing day; I’m attracting a lot more bids in the IPO because of this and investors will continue to be drawn to stock after Meanwhile this also helps

My Take: Please, diligent investors understand that magical ‘pop’ on listing is not a sudden spike in valuation, but rather a bouncing spring that you had suppressed. The only folks who’d be fooled by this ‘act’ are the media and may be some retail investors. This baiting game will eventually make sure someone bites your hand off, Mr Banker

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About Deepak
Venture Capital and M&A advisor, Entrepreneur, Startup enthusiast..

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