Did Zynga Flop? Irrational Judgement  -  Tech IPOs in 2011* This is an update to the article: “Why is Money Left on the Table?” continuing my series on corporate finance in the technology sector. Last week there were two more technology IPOs, Jive and Zynga. Since there was an incredible amount of hype for Zynga’s launch and it ended up down 5% on its first day, a quick scan of business headlines reveals phrases like: Fizzled. Ended with a whimper. Disappointing. Fell flat. So this is bad right? Maybe not. By the numbers, Zynga is the only company to have lost value during its first day of trading when compared with our technology IPO group of 2011 as shown above. Excluding Zynga, the average first day return is positive 40%. Of note, Jive had a 25% return in its IPO earlier in the week.  This also means that Zynga left no money on the table, unlike the rest of our comparison group which left an average of $174 million (excluding Zynga). Remember, the goal for the issuer (the company going public) is to price the IPO as high as possible in order to raise the maximum amount of capital for the company for the minimum amount of equity. And that’s exactly what Zynga did. At the time of the IPO pricing (the night before the IPO launch), the Zynga shareholders consisted of VCs and insiders to the company. So after running an extensive roadshow and considering interest from institutional investors, Mark Pincus (CEO of Zynga) protected his shareholders’ interest (at that time) by getting the highest price for their IPO.  But what about the shareholders who invested at $10 or even higher during the first day of trading only to see the stock drop to $9.50? Perhaps they can be assured that they are now invested in a company where the CEO has historically been protective of his shareholders’ wealth. Prior to the IPO, Zynga owed no loyalty to this group of potential investors - and priced its IPO as high as possible accordingly.  The negative media coverage is also classically irrational. If a stock goes up and “pops” on day one, it is covered as a success. But clearly a first day dramatic pop is not related to the fundamentals of the business so what are we cheering about? It’s either underpricing on the company side or irrational demand on the investor side. Why is it rational to judge a stock on its one day performance? Zynga minimized dilution and maximized price for their IPO, leaving no money on the table unlike everyone else. As far as the stock performance going forward, maybe now investors will focus on the business fundamentals instead of how the stock trades on one day.   Follow me @nathanmachine. * [See article disclaimers here]

Did Zynga Flop? Irrational Judgement  -  Tech IPOs in 2011*

This is an update to the article: “Why is Money Left on the Table?” continuing my series on corporate finance in the technology sector.

Last week there were two more technology IPOs, Jive and Zynga. Since there was an incredible amount of hype for Zynga’s launch and it ended up down 5% on its first day, a quick scan of business headlines reveals phrases like: Fizzled. Ended with a whimper. Disappointing. Fell flat.

So this is bad right? Maybe not.

By the numbers, Zynga is the only company to have lost value during its first day of trading when compared with our technology IPO group of 2011 as shown above. Excluding Zynga, the average first day return is positive 40%. Of note, Jive had a 25% return in its IPO earlier in the week. 

This also means that Zynga left no money on the table, unlike the rest of our comparison group which left an average of $174 million (excluding Zynga). Remember, the goal for the issuer (the company going public) is to price the IPO as high as possible in order to raise the maximum amount of capital for the company for the minimum amount of equity. And that’s exactly what Zynga did.

At the time of the IPO pricing (the night before the IPO launch), the Zynga shareholders consisted of VCs and insiders to the company. So after running an extensive roadshow and considering interest from institutional investors, Mark Pincus (CEO of Zynga) protected his shareholders’ interest (at that time) by getting the highest price for their IPO. 

But what about the shareholders who invested at $10 or even higher during the first day of trading only to see the stock drop to $9.50? Perhaps they can be assured that they are now invested in a company where the CEO has historically been protective of his shareholders’ wealth. Prior to the IPO, Zynga owed no loyalty to this group of potential investors - and priced its IPO as high as possible accordingly. 

The negative media coverage is also classically irrational. If a stock goes up and “pops” on day one, it is covered as a success. But clearly a first day dramatic pop is not related to the fundamentals of the business so what are we cheering about? It’s either underpricing on the company side or irrational demand on the investor side. Why is it rational to judge a stock on its one day performance?

Zynga minimized dilution and maximized price for their IPO, leaving no money on the table unlike everyone else. As far as the stock performance going forward, maybe now investors will focus on the business fundamentals instead of how the stock trades on one day. 

 Follow me @nathanmachine.

* [See article disclaimers here]

From the introduction of Endangered Animals: As we travel through life, we experience the idea that as humans, we can be anything we want to be and do anything we want to do. We are magnificent creatures and we stretch the boundaries of our world and the natural laws of the universe. But as we search for our own success and follow our dreams, we may be destroying the dreams of our other brothers and sisters, as we ignore the destruction of the environments where rare and beautiful animals dwell. The natural habitats of endangered species are most radically altered by human activity, both through deliberate destruction and accidental events such as forest fires. Lack of restrictions in the commercial trade of animals has also resulted in severe decimation of hundreds of species. The precarious ecological balance can easily be disrupted by other factors such as the introduction of exotic or non-native species into natural environments. Once this balance is tipped and species become extinct, they are lost forever, and the way of our human existence, which depends on healthy ecosystems, is also endangered. From blistering deserts to shallow coastal waters to labyrinth rainforests, the true jewels of the earth are the magnificent creatures that reside within. Endangered Animals is a book that reminds us that although we may not think of them day to day, these gentle creatures are there - and they are in danger.

From the introduction of Endangered Animals:

As we travel through life, we experience the idea that as humans, we can be anything we want to be and do anything we want to do. We are magnificent creatures and we stretch the boundaries of our world and the natural laws of the universe. But as we search for our own success and follow our dreams, we may be destroying the dreams of our other brothers and sisters, as we ignore the destruction of the environments where rare and beautiful animals dwell.

The natural habitats of endangered species are most radically altered by human activity, both through deliberate destruction and accidental events such as forest fires. Lack of restrictions in the commercial trade of animals has also resulted in severe decimation of hundreds of species. The precarious ecological balance can easily be disrupted by other factors such as the introduction of exotic or non-native species into natural environments.

Once this balance is tipped and species become extinct, they are lost forever, and the way of our human existence, which depends on healthy ecosystems, is also endangered.

From blistering deserts to shallow coastal waters to labyrinth rainforests, the true jewels of the earth are the magnificent creatures that reside within. Endangered Animals is a book that reminds us that although we may not think of them day to day, these gentle creatures are there - and they are in danger.

Tech IPOs in 2011 - Why is Money Left on the Table?* This is the first in a series of articles on corporate finance in the technology sector. 2011 has been an important year for tech companies even though the performances of the dozen high profile tech IPOs in the kitty have been mercurial (as shown in the table above) with an average return of negative 4%, bracketed by LinkedIn at 58% and RenRen at -74%. With the launch of Jive’s IPO today and three high profile companies looking to make it out soon (Zynga, Yelp, and Facebook), it might make sense to revisit the topic of Money Left on the Table - which is the amount of money that could have theoretically been raised by a company if it priced its IPO correctly/higher. A quick primer on the mechanics of IPO pricing: After drafting an S-1 prospectus, the lead underwriters (investment bankers managing the IPO) estimate an initial price range for the company. The goal for the issuer (the company going public) is to price the IPO as high as possible. This accomplishes two things - it values the equity of the existing investors (VCs and insiders) at the highest level, and second, raises the maximum amount of capital for the company for the minimum amount of equity (minimizes dilution). However, there is a history of underwriters underpricing IPOs measured by first-day returns (first day closing price compared to the IPO price) and not just for technology stocks. Studies have shown average first-day returns of 7% in the 1980s and nearly 15% from 1990-98, before skyrocketing to 65% during 1999-2000 (the height of the previous tech bubble), and declining to 12% from 2001-2003. My analysis of 2011 tech IPOs above shows that so far they have all had positive first-day returns, with large premiums on average: a mean of 41% and a median of 32%. Looking at the numbers another way, a study of the 1990s showed $27 billion left on the table versus bankers fees of $13 billion, a ratio of 2:1. The 2011 tech IPOs I analyzed show between $2.1 - $1.7 billion left on the table versus $296 million in banking fees, which is 7:1 or 6:1 (depending on whether first day or average first week closing prices are used).  Keep in mind that the underwriting syndicate (group of investment banks) are being paid as a percentage of the amount raised, so one would think that if they could price it higher, then they would (assuming competent valuation capabilities). But corporate valuation is part art and part science (more on book-building & valuation methodologies in a forthcoming article) so it is a difficult balance to get right (assuming motivation to avoid underpricing).  Aside from systematic investor overreaction to tech IPOs on first day trading (investor mistakes), there are many theories of why underpricing might happen including deliberate underpricing by the issuer so the stock pops and favorable media coverage generates widespread interest in the company.  Other explanations include deliberate underpricing by underwriters: In order to give favors to its important brokerage clients and to make marketing the issue easier. Overcompensation to avoid the reputational problems of overpricing an IPO and failing to secure commitments from institutional investors (can’t build the book). To avoid mistakes due to asymmetric information (between the issuer, the underwriter, and investors) such as the Winner’s Curse (better informed investors can avoid overvalued IPOs therefore less informed investors end up participating in sub-par issues) which can be countered by lowering the price.   To compensate better-informed investors for truthfully revealing their information during the book-building process, thus reducing the expected variability of amount of money left on the table. So where are the disgruntled tech companies that have IPO’d successfully? Nowhere. Since corporations are not people, corporate finance theory of a theoretical transfer of wealth to the allocated buyers (who then can flip the stock quickly for a profit since it was underpriced to begin with) is not really that meaningful when everyone (company insiders & pre-IPO investors) is making money that previously existed only in their imagination. A further behavioral finance explanation for this is that people are happy to think about the actual change in their wealth (due to the IPO) rather than focus on the relative level of their newfound wealth and whether it could have been maximized. A second and more cynical idea is that insiders, who cannot sell their shares in the open market immediately following an IPO due to lock-up restrictions (more on this topic in a forthcoming article), may deliberately underprice the IPO in order to generate stock momentum during the 180 day lockup period in order to maximize their wealth from selling shares at the expiration of the lock-up.  Nevertheless, startup technology companies should keep their eyes on M&A, since we’re looking at around a dozen serious technology IPOs in 2011 compared to an estimated 3,100 technology mergers & acquisitions by year-end (2,330 transactions in the first three quarters so far). As an M&A guy, I’m feeling pretty comfortable that’s where the exit focus should remain for young technology companies.  If this is interesting to you, follow me @nathanmachine or send me an email as there is more to come. * [See article disclaimers here]

Tech IPOs in 2011 - Why is Money Left on the Table?*

This is the first in a series of articles on corporate finance in the technology sector.

2011 has been an important year for tech companies even though the performances of the dozen high profile tech IPOs in the kitty have been mercurial (as shown in the table above) with an average return of negative 4%, bracketed by LinkedIn at 58% and RenRen at -74%.

With the launch of Jive’s IPO today and three high profile companies looking to make it out soon (Zynga, Yelp, and Facebook), it might make sense to revisit the topic of Money Left on the Table - which is the amount of money that could have theoretically been raised by a company if it priced its IPO correctly/higher.

A quick primer on the mechanics of IPO pricing: After drafting an S-1 prospectus, the lead underwriters (investment bankers managing the IPO) estimate an initial price range for the company. The goal for the issuer (the company going public) is to price the IPO as high as possible. This accomplishes two things - it values the equity of the existing investors (VCs and insiders) at the highest level, and second, raises the maximum amount of capital for the company for the minimum amount of equity (minimizes dilution).

However, there is a history of underwriters underpricing IPOs measured by first-day returns (first day closing price compared to the IPO price) and not just for technology stocks. Studies have shown average first-day returns of 7% in the 1980s and nearly 15% from 1990-98, before skyrocketing to 65% during 1999-2000 (the height of the previous tech bubble), and declining to 12% from 2001-2003. My analysis of 2011 tech IPOs above shows that so far they have all had positive first-day returns, with large premiums on average: a mean of 41% and a median of 32%.

Looking at the numbers another way, a study of the 1990s showed $27 billion left on the table versus bankers fees of $13 billion, a ratio of 2:1. The 2011 tech IPOs I analyzed show between $2.1 - $1.7 billion left on the table versus $296 million in banking fees, which is 7:1 or 6:1 (depending on whether first day or average first week closing prices are used). 

Keep in mind that the underwriting syndicate (group of investment banks) are being paid as a percentage of the amount raised, so one would think that if they could price it higher, then they would (assuming competent valuation capabilities). But corporate valuation is part art and part science (more on book-building & valuation methodologies in a forthcoming article) so it is a difficult balance to get right (assuming motivation to avoid underpricing). 

Aside from systematic investor overreaction to tech IPOs on first day trading (investor mistakes), there are many theories of why underpricing might happen including deliberate underpricing by the issuer so the stock pops and favorable media coverage generates widespread interest in the company. 

Other explanations include deliberate underpricing by underwriters:

  1. In order to give favors to its important brokerage clients and to make marketing the issue easier.
  2. Overcompensation to avoid the reputational problems of overpricing an IPO and failing to secure commitments from institutional investors (can’t build the book).
  3. To avoid mistakes due to asymmetric information (between the issuer, the underwriter, and investors) such as the Winner’s Curse (better informed investors can avoid overvalued IPOs therefore less informed investors end up participating in sub-par issues) which can be countered by lowering the price.  
  4. To compensate better-informed investors for truthfully revealing their information during the book-building process, thus reducing the expected variability of amount of money left on the table.

So where are the disgruntled tech companies that have IPO’d successfully? Nowhere. Since corporations are not people, corporate finance theory of a theoretical transfer of wealth to the allocated buyers (who then can flip the stock quickly for a profit since it was underpriced to begin with) is not really that meaningful when everyone (company insiders & pre-IPO investors) is making money that previously existed only in their imagination.

A further behavioral finance explanation for this is that people are happy to think about the actual change in their wealth (due to the IPO) rather than focus on the relative level of their newfound wealth and whether it could have been maximized.

A second and more cynical idea is that insiders, who cannot sell their shares in the open market immediately following an IPO due to lock-up restrictions (more on this topic in a forthcoming article), may deliberately underprice the IPO in order to generate stock momentum during the 180 day lockup period in order to maximize their wealth from selling shares at the expiration of the lock-up. 

Nevertheless, startup technology companies should keep their eyes on M&A, since we’re looking at around a dozen serious technology IPOs in 2011 compared to an estimated 3,100 technology mergers & acquisitions by year-end (2,330 transactions in the first three quarters so far). As an M&A guy, I’m feeling pretty comfortable that’s where the exit focus should remain for young technology companies. 

If this is interesting to you, follow me @nathanmachine or send me an email as there is more to come.

* [See article disclaimers here]

Announcing the release of Screens, a new EP from Shebandowan, one of the members of Autobot City! This solo music project is a three song collection of indie pop with an electronica feel. These songs are available for free streaming or downloading so check it out or follow @shebpop to stay informed of his new music.

Announcing the release of Screens, a new EP from Shebandowan, one of the members of Autobot City!

This solo music project is a three song collection of indie pop with an electronica feel. These songs are available for free streaming or downloading so check it out or follow @shebpop to stay informed of his new music.

Autobot City is a New York based noise rock band. 

After two albums (2004/1999) and sustaining heavy damage in 2005, its integrity was compromised and it was put on hiatus.

Autobot City is currently being modified and rebuilt into a more conventional humanoid mode with new music to come in 2012.

Android from Autobot City II

Android by Autobot City

(Soundcloud: Nathan Machine)