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The incredible first-day action in the stock prices of recent technology IPOs — particularly DoorDash Inc and Airbnb last week — has reignited a debate that goes back to the dot-com era over whether the process is broken. Critics are blaming bankers for vastly mispricing the offerings, resulting in companies’ missing out on money they could have pocketed at a higher valuation. There’s something to that, but it’s not just about pricing. In fact, there is a simple solution that can bring better results for all stakeholders. And it explains why two promising IPO candidates have now pressed pause on their plans.
DoorDash and Airbnb soared in their trading day debuts, rallying 86% and 113%, respectively, from the IPO prices at which they raised funds. The spikes happened even after underwriters tried to get a more accurate assessment of demand by using a new online system that allowed institutional investors to enter order details. But it didn’t work as it failed to anticipate the overwhelming demand from the Robinhood set of retail investors.
The giddy reception was exciting to watch, but it has downsides that go beyond leaving money on the table. The elevated price levels after the first day of trading will likely mean more volatility going forward, which could distract management and employees from doing their jobs. Also, it becomes more difficult to hire new talent as stock-option grants are set at frothy levels. For these reasons,
it’s perhaps understandable that two companies originally on this year’s IPO
calendar — video-game platform Roblox and fintech startup Affirm Holdings — reacted to last week’s big pops by delaying their offerings to assess their options.
The holdups can’t be attributed to a lack of demand; both Roblox and Affirm are growth stories, and investors were looking forward to the offerings. Instead, the delay comes as both companies consider selling a larger amount of shares from employees and other investors, according to the Wall Street Journal. They are on to something. While price is an important input in the IPO equation, a main driver of the volatility in new stock listings is the scarcity of tradable shares. In most traditional IPOs, including for DoorDash and Airbnb, companies sell 10% or less of their shares with the remainder not becoming available to sell for another six months under insider “lockup†agreements. And because the average retail investor isn’t doing a careful valuation analysis on IPOs these days, it creates a supply-demand imbalance, resulting in those initial surges.
How can companies mitigate this issue? The first and easiest solution is to offer more shares. Lockups are an anachronism from decades past when bankers believed new offerings required time before the market could handle insiders selling their shares. But it mechanically exacerbates volatility for the six-month lockup period, limiting price discovery to the more accurate supply-demand market-based price.
—Bloomberg