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Marketplace Morning Report

The price is right … or is it? Pricing IPOs is tricky

Apr 1, 2015
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GoDaddy launched its IPO Wednesday, selling its stocks publicly for the first time.It asked for just $20 per share when it sold its very first shares to large investors before trading started, but by the end of its first day of trading, the market price shot up more than 30 percent.  In fact, the price had already shot up when the stock opened as the investors who owned the freshly minted shares sensed a feeding frenzy in the works.

When a company goes public it starts with a price that it thinks is fair. When that price then shoots up on the first day of trading, it’s called “the pop.”

The pop and fizzle

Jay Ritter, professor of finance at the University of Florida, says the average pop is about 18 percent. If there’s a giant pop, a company might have a facepalm moment and regret not pricing higher. The biggest fear for companies is that “they’re not getting as much proceeds as they could have,” says Ritter. 

But think about the opposite of a pop: the fizzle. Let’s say there was a greedy little piggy of a company that priced high to squeeze out every last drop of profit it could. David Menlow, president of IPOFinancial.com, which predicts and researches IPO prices, says a move like that “basically shuts down the pipeline of other people who might want to buy the stock. Investors still need to believe there’s room for more demand on the upside.”

…And the razzle-dazzle

Bill Blais, executive vice president of Loyal3, a registered broker dealer whose mission is to democratize the IPO process, says you need to start with the old “razzle-dazzle.”

“Stocks that don’t pop, that go in the opposite direction, generally have a hard time regaining momentum, and there’s a lot of empirical evidence to back that up,” says Blais.

And the banks are the ones putting on the whole IPO dog-and-pony show to begin with. They want stocks to jump because that’s how they reward their biggest clients — letting them buy undervalued shares before public trading starts, before the pop. 

“Investors are competing to get the underpriced shares” from banks or underwriters of an IPO, says Ritter. “And one of the ways investors compete is by overpaying on commissions on other deals, so that an underwriter or a stockbroker who’s deciding who to give the shares to, who’s allowed to use discretion … will give shares to more profitable customers.”

Editor’s Note: An earlier version of this story used imprecise language in describing the initial pricing of shares in GoDaddy. The text has been changed to reflect the $20 price was for transactions before trading began.

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