WASHINGTON, November 6, 2013 – If everything goes smoothly, the long-awaited Twitter IPO (proposed symbol: TWTR) will price after the close today and open for trading on the New York Stock Exchange mid-morning, November 7. But given the frenzied and disastrous Facebook (FB) IPO not all that long ago, are we looking for an instant replay with Twitter? Let’s take a look.
Pricing and the “pop”
One of the main issues with the Facebook IPO, NASDAQ technical ineptitude aside, was the sheer greed on all sides of this offering, designed as it was to fleece the daylights out of newbie IPO investors which it promptly did by cratering and staying there for nearly a year. The underwriters shared secret information with their best and biggest clients on Facebook’s underwhelming near-term financial performance while goosing the price of the IPO and trumpeting it to the stars.
The result, of course, once the computer glitches were sorted out, was a stock that was overpriced by $10 or more, profiting only insider-flippers who’d acquired shares of Facebook stock for a song over the previous year via various deals. Along with the offering—which was also super-sized to accommodate the clamor—many of these insiders were in a position to unload, and that’s what they did, leading to a months-long downdraft after a brief initial pop.
Pricing is always an issue in an IPO. Since the broker-underwriters are actually working for the client, not the public, it’s a given that they want their client to get the highest realistic price possible for their new issue of stock. That said, part of the reason for the enduring popularity of IPOs is the treasure hunt: that hope for a first-day “pop” of 1-3 points, which enable those getting in on the deal to “flip” the stock for an instant profit only minutes after it opens for trading—typically 1-2 hours after the market itself opens.Twitter’s underwriters are also starting to play this game. The offering was initially set to be priced under $20 per share. As of this writing, we are seeing that the proposed pricing has been upped to the $23-25 range. Wall Street whispers have the price getting another boost to $27 before it’s all over.
So the trick here is to get the maximum value possible for the client company while still leaving some juice in the stock for that initial surge that makes investors eager to get into most IPOs to begin with.
In truth, the “pop” is the essential appeal of most IPOs. Making 10-20 percent or more on your money in less than five minutes has an understandable appeal. Making things even better, another attraction of an IPO is that there is (technically) no commission on the buy side. So for a quick round trip after a successful pop, you only pay the sell commission, as the buy side is commission free.
Among the many errors committed by greedy underwriters and insiders during the Facebook deal was the fact that the issue’s ever-increasing pricing, plus the addition of millions more shares to the float, absolutely killed any potential for a pop. It also induced mass shorting and selling when the failure became obvious, and eager retail Facebook purchasers got clobbered.
The Twitter IPO underwriters are starting to play this same game, pricing the issue up and up. We’d guess that if they hold this one under $30, hopefully considerably less, they’ll largely avoid the Facebook overpricing issue and give lucky retail investors a bit of fun on the opening trade tomorrow.
It would seem as if the underwriters would have the capacity to learn from the Facebook debacle. Unfortunately, one has to remain skeptical, however. As always on Wall Street, greed generally trumps prudence, a fact exacerbated by the unwillingness of regulators to put most Wall Street miscreants behind bars for their blatant piracy. But in this administration, the moneybags and the regulators seem more comfortable holding hands, so the prosecution dis-incentive is mostly off the table.
Still, we expect that the Twitter offering should go more smoothly than the Facebook textbook mess, offering some hope of a quick profit for those nimble investors lucky enough to get a few shares.
Getting shares: Good luck!
Of course, the preceding discussion is essentially pointless for most small investors in search of Twitter shares. If the offer is any good at all, they’ll be hard to get. In fact, the tip-off on the incoming Facebook disaster was that near the end of the offer period, any Joe Schmo could have gotten a few hundred shares, clear indication that too many shares were being issued.
The Maven put in for 500 shares of Twitter two days ago for an account with Charles Schwab. Unusually, the allocation window closed not long thereafter—it usually closes the day of or the day before pricing. So unless the underwriters decide to expand the number of shares offered at the last minute, Twitter shares will be much scarcer than were those of Facebook.
Which brings us to problem number two: good luck to the Maven or any other little guy out there who’s put in for shares. Schwab has a secret formula for allocating shares, and the Maven has been squeezed out of many a swell offering. But all other brokerages have a secret formula, too, and it’s really not that much of a secret. Those with a lot of money will get the bulk of available shares.
That’s the secondary charm of IPOs. All the brokerages have a pretty good idea with regard to which offerings are hot and which ones are not. And the biggest chunk of the hot ones is allocated to a firm’s biggest clients. It’s sort of a “thank you” present for all that business the big guys bring in to the firm.
This phenomenon is incredibly irritating, clear evidence that the 1% always get more. But frankly, it’s also normal and customary marketing. Your biggest customers, no matter what your business, usually bring you the most revenue and the most profit. So if you can toss them a nifty reward like a hot IPO from time to time, it keeps them happy, and keeps them from heading off to your competitor.
The Maven knows how this works because, back in the day when he was one of those actual evil stockbrokers, the big kahuna broker in his office always got most of that office’s IPO shares to spread around to his happy and very wealthy clients. Junior brokers would get the scraps if there were any, and that was that. Today, it’s just the same.
Things are even dicier if you’re with a discount house like Schwab, since such houses rarely if ever actually underwrite an issue. They’re part of what’s known as the “selling group,” a subset of broker-participants who line up to sell the excess shares that the Goldmans of the world can’t quite handle.
But in a hot IPO, it’s not unheard of for members of the selling group to get stiffed. In other words, at the last minute, they end up with few if any of the IPO shares they’d expected to be allocated. Therefore, few if any of their own customers—even those precious whales—will get any shares.
Again, this is normal and customary and part of the price you pay for trading with a discount house. It’s not a showstopper in the end, but it does get irritating from time to time.
All of which means that, if you’re a little guy with a big firm or a little guy with a discount house and if the Twitter IPO proves to be hot, hot, hot, you won’t get any.
As it stands right now, if you weren’t in line a couple days ago at your friendly local brokerage, there’ll be no shares for you on this IPO. And we’d rate odds as roughly 75-25 that even average, faithful, but small customers of nearly any brokerage won’t get any of the shares they expected to get at all.
So if you can’t get any shares, what then?
Simple. You position right now for a proxy investment. Or two or three. These are companies or entities that might get carried along if the Twitter tide turns into an upside tsunami.
A good bet might be the ETF whose symbol is FPX. Otherwise known as the First Trust IPO Index ETF, FPX is a seasoned ETF that invests only in shares of IPOs, keeps them around for a reasonably lengthy period of time, then sells them, constantly filling its basket with IPOs as they show up. FPX doesn’t buy IPOs on the opening trade. Rather, they pick up the shares about a week later, approximately the time such shares settle down. This means that FPX will not only miss the opening pops. It will also miss the big haircuts taken by IPOs that don’t do so well.
A new competitor for FPX is the Renaissance IPO Index ETF, whose intuitively obvious trading symbol is, you guessed it, IPO. This one came public in the summer, and operates with rules similar to those for FPX except that IPO (the ETF) can buy into new IPO stocks a couple days earlier than FPX’s rules allow. The caveat here is that this new ETF is still lightly traded, and itself stumbled during its own IPO, which was somewhat overpriced.
Keep in mind, of course, that whether you get into an actual IPO or try one of the proxy ETFs we’ve just mentioned, IPOs are always something of a crapshoot in the end. Some work wondrously, while others will take a serious bit out of your portfolio.
For example, let’s take a brief, sorrowful look at the Maven’s chance shot at the IPO of cloud computing platform Endurance International (EIGI). This IPO has indeed been hard to endure. It’s down over ten percent in its first week trading, and, under Schwab rules, we can’t dump this dog for another three weeks lest we ourselves be dropped out of Schwab’s IPO-eligible pool for 90 days.
The Maven has decided to consign this one to the “oh well” department. After all, we did just complete a round trip on the Fireeye (FEYE) IPO, which netted us a cool 106%. In this game, you win some and you lose some.
Which gets us back to FPX. They’re best in class, having been top-rated for years by Morningstar for booking a lot more gains than losses for their investors. And for better or worse, they’ll likely be adding TWTR to their portfolio a bit later this month, good news if there’s more of a ride left in the stock after the open. So the anticipation of this event might make them a pretty good “proxy” for any positive Twitter action we’re not able to get into.
There are other EFT proxies like SOCL (a social networking ETF), and FDN (an ETF that’s a bit broader than SOCL, dealing with physical networking issues as well). But we’re going to hitch at least a temporary ride on FPX this afternoon just in case we get disappointed in our bid for a few Twitter shares.
No guarantees on anything, of course. As the Maven has just related, you win some and you lose some in the IPO derby. But if you’re reasonably careful when choosing which IPOs to get into, you should be able to score on three or four out of five issues, which is really not bad when you think about it.
A final note: As always, if you don’t get lucky on obtaining Twitter shares—assuming there’s a pop in them—we strongly advise not chasing them upward in the open market once the issue starts trading. Statistically, at least, this has proven over time to be very much a loser’s game.
If the stock really looks good, it will still come down a bit at some point. And that’s when smaller investors might want to consider latching onto at least a few shares, assuming that there’s any prospect that Twitter will actually start earning rather than losing money at some point. (It’s reportedly lost some $65 million in its most recent quarter.)
Until and unless real earnings actually happen, Twitter will remain a spec stock. So travel at your own risk.
Disclaimer: The author of this column maintains several active trading and investment portfolios and owns residential and investment real estate. He currently holds a small position in FPX and is attempting to get his hands on a token amount of upcoming IPO Twitter (proposed symbol TWTR).
Positions mentioned above describe this author’s own investment decisions and should not be construed as either buy or sell recommendations. The current market is highly treacherous and all investors travel at their own risk, so caution should be exercised at all times.
Illustrations, charts, commentary, and analysis are only the author’s view of current or historical market activity and don’t constitute a recommendation to buy or sell any security or contract. Views, indications, and analysis aren’t necessarily predictive of any future market or government action. Rather they indicate the author’s opinion as to a range of possibilities that may occur going forward.
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