By: Aleph Blog
June 07, 2012 at 03:58 AM EDT
On the Facebook IPO
If you are a manager of corporate bonds, you get to learn the speculation cycle. New IPOs may close in weeks if things are cold, and close in minutes if things are hot. When things are hot in bonds, eventually the syndicate (“Wall Street”) decides that it is time to test the bullishness of buyers. [...]
If you are a manager of corporate bonds, you get to learn the speculation cycle. New IPOs may close in weeks if things are cold, and close in minutes if things are hot.
When things are hot in bonds, eventually the syndicate (“Wall Street”) decides that it is time to test the bullishness of buyers. At such a time, they extend the time of the offering, and either lower the yield spread (raise the price), or increase the size of the deal.
When I was a corporate bond manager, if a deal was upsized by a large amount during a period while the market was hot, I would not buy. Tough decision, but cutting against the grain is usually a good thing. My brokers marveled that I was not participating in these large “benchmark” deals. More often then not, they failed, and I smiled on the sidelines. The brokers “stuffed” the ignorant buy-side that was all too willing to take risk. Typically after that, corporate investors were more careful.
I don’t know the right value for Facebook, and I don’t think anyone does. Too much of the value depends on future decisions, competitor actions, and economic conditions. Valuing stocks where the positive cash flows are far out into the future is tough, should the cash flows materialize.
The last IPO I bought was Assurant [AIZ] where I was buying the company for <90% of book value, and 9x earnings. I’m a value buyer, so I buy companies where prospects are not fairly calculated by the market, but I avoid new issues where the price is outlandish.
Look, Wall Street works on two levels: distribute paper at a slight discount price, until buyers take it for granted and bid aggressively, leading to a mini-crisis, like it is for Facebook now.
Did Wall Street get the best price for Facebook’s current shareholders at the IPO? Probably yes.
Was that the right price? For recent investors, the answer is no. But in any IPO process there were a wide number of ways to protect themselves:
1) Don’t participate in IPOs. When general valuations in the market are high, IPO valuations are higher.
2) Avoid buying IPOs in hot sectors, they are often overvalued. Only go for IPOs in sectors no one cares about, like insurance, where I offer you Assurant [AIZ} and Safety Insurance [SAFT], among others. (I don’t suppose it helps you to learn that insurers return better than almost any other industry? Didn’t think so… because it is a boring yet complicated business. Even Buffett said about Assurant — “too complicated,” and he is one of the greatest insurance executives of all time.)
3) Avoid IPOs where the deal size is upsized. When a deal is upsized that often means the underwriters are taking advantage of demand, which diminishes the likelihood of any short-term outperformance. For this point, in the bond market, I would cut my bid, unless I really liked the credit, together with my analyst.
4) Avoid IPOs where the price talk is raised, which also limits the likelihood of any short-term outperformance. Same thing as a bond manager, I would drop out out if the new yield did not meet my yield needs.
5) Buy IPOs when they are forced to occur and are hated, like my experience with the Prudential “C” bonds, and most mutual insurer conversions. IPOs are like the market on steroids, you want to avoid them when things a hot, but they are interesting when things are cold. After all, who wants to IPO when things are cold? There are occasional situations where legal matters force a company to go public, and that can be an interesting time to be an opportunistic buyer.
6) Avid IPOs where the valuation is stretched. It may be a great business concept, but can it grow into that fancy valuation? Unlike Dr. Damodaran, I don’t go in for fancy reasoning that justifies high valuations. Most investors are better off avoiding high valuation situations, and focus on more down-to-earth types of businesses. (My recent purchases include: Crude Oil Refining & Transport, Integrated Oil Major, two basic technology companies with forward P/Es under 10, a specialty retailer that is the strongest in its category, and two insurers, one that is a holding company, and one that is a hedge fund.)
7) Finally, avoid IPOs where those that know nothing about investing are interested. Facebook is a perfect example here, with a large number of users who love the company, but have little idea of how profits are made, or how they will grow.
IPOs are tough, I think tougher than ordinary investing, so avoid them unless you have an edge that justifies participation. Be tough on yourself here — what is your edge? Share it with a friend who has expertise, and see if he agrees with you. This is not easy stuff, it only seems easy when the market is running hot, and that is a bad place to be when it goes cold.
Full disclosure: long AIZ, for me and clients
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