Here we go again.
On its Friday, January 23rd debut, Box Inc (BOX) did what Wall Street keeps telling us IPOs are supposed to do: Its stock soared.
Box’s underwriters pre-sold the shares at $14, mainly to mutual funds and other institutional investors. By the end of its first day of trading—defying a sharp drop in the S&P—the stock finished at $23.15, a gain of $9.15 or 68%.
Folks who aren’t steeped in Wall Street-think might wonder how any stock that didn’t just receive a sumptuous, totally unexpected takeover offer could jump 70% in a single day. They might also question why big powerful investors got most of the shares at a fabulous insider price, and the great unwashed are mainly relegated to buying Box at a marked-up, post IPO price. As a CEO who went through the process once told me, “In IPOs, the fat cats get the rich cream.”
This is the blueprint that investment banks keep selling to companies that want to go public: Let the stock make a big, big pop. It’s the way to go. You’ll generate great publicity and secure the loyalty of the funds that pocket gigantic, guaranteed gains in a single day. Out of gratitude, they’ll hold your shares through good times and bad. That “loyalty” is mostly ephemeral, but the issuer’s belief in those assurances seems eternal.
Here’s the price Box paid for pre-selling its stock at far less than what investors were paying virtually from the opening bell to the end of the trading day. Box sold 12.5 million shares; so the total gross proceeds were $175 million. Fees and expenses amounted to $17 million, so it will collect $158 million in cash ($175 million less $17 million) from the offering.
But what if Box had resisted the Wall Street pitch and auctioned its shares to the highest bidders? Or what if it had prodded underwriters to pay full price, as Facebook (FB) did? If Box had gotten total value for those 12.5 million shares, it would have put around $280 million—an additional $120 million or so than it actually collected—on its balance sheet. So it really “cost” Box around $120 million in underpricing, to raise $157 million. It “paid” 76 cents in foregone proceeds for every dollar it collected.
The $120 million Box left on the table equals over 70% of its cash holdings prior to the IPO. An extra $120 million in assets would have raised its net worth by over 40% after the offering.
Those are big numbers. So why do brilliant venture capitalists and brainiac founding teams keep falling for the investment banks’ assurances that raising less money is actually good for them? Hint: It’s usually good for employees, especially the top managers, who are able to secure options and other stock grants at the super-bargain IPO grant price. They then get to take part in the same guaranteed windfall as the institutional investors.
IPOs are one of the great, mysterious Wall Street spectacles. The praise is overwhelming, the definition of “success” is baffling, and anyone who questions the system is taken for a dullard.
