WASHINGTON, October 11, 2017 – After getting shut out of last week’s Switch IPO (symbol: SWCH) offering, we’ve decided to try for IPO nirvana once again tonight by requesting shares of the new CarGurus IPO, scheduled to price tonight. Here’s a quick rundown on this IPO, courtesy of a recent Seeking Alpha piece on the company and its offering:
“[CarGurus, Inc.] has begun building a presence outside the U.S. including Canada, United Kingdom, and Germany. The firm generates revenue by selling advertising and premium subscriptions to dealers.
“A premium subscription enables a dealer to better position its vehicle listings and communicate more effectively with buyers. CARG has been very successful at increasing both the number of paying dealerships and the average revenue per dealership. CARG established its market leading position through solid execution of a sound strategy that focuses on the following:
- Aggregating data that helps car buyers make a more informed decision.
- Attracting a large inventory of vehicles for sale.
- Establishing trust with car buyers.
- Creating value-added products for dealers.”
If you’re not familiar with how the CarGurus site works, here’s the Alpha rundown:
“Users logging into Cargurus.com can search for new and used vehicles via a wide range of the usual search parameters – make, model, price, etc. From this search, users are taken to a listings marketplace with all the cars available in their area. In addition, CarGurus’ proprietary valuation algorithm automatically prices each car and gives it a ranking, from ‘Overpriced’ to ‘Great Deal,’ to help consumers peg down a value for the car they’re looking at.”
What follows is our own scoop on tonight’s IPO. En route, we’re also including a quick primer as to how an IPO actually works, and why, for retail investors, an IPO may not always work its occasional magic for your portfolio.
Currently expected to price tonight between $13-15, the IPO shares of Cambridge, Massachusetts-based online car-selling platform CarGurus, Inc. (proposed NASDAQ symbol: CARG) are said to be “hot.” If that’s true, odds of our getting in on the offering could range from awful to non-existent.
On the other hand, if the issue is already oversubscribed – meaning there are more buyers for the shares than the amount of shares offered – we might not want them after all.
Figuring out whether an IPO is worth pursuing
It’s often hard to tell which way an IPO is going until you actually see the final pricing. That number often materializes somewhere between dinner time ET and midnight on “pricing night,” which, as we’ve already noted, happens to be tonight for CARG.
These days, if the new shares are finally priced above the top of their proposed price range – in this case, $15 per share – that’s a pretty good sign that they’re oversubscribed, meaning they’ll likely have a nice initial “pop” when they open for trading, sometime after the next day’s opening bell. In practice, new IPO shares generally begin to trade somewhere between 10 a.m. and 11:30 a.m. ET.
On the other hand, if the new shares are priced tonight below the proposed price range, i.e., below $13-15 per share in the case of CARG, that generally means the IPO shares are not in high demand, or at least are getting a lukewarm reception.
In many but not all cases, you want IPO shares, particularly in any issue that even looks like it’s tech (such as this one), to be priced above the top of the proposed range, which is generally a clue that too many investors and/or institutions are chasing too few shares. That’s usually our cue to follow through and “affirm” our share request with our brokerage, since we, like everyone else clamoring for the shares, expect to see a nice “pop” in the share price once the new stock opens for trading.
If the new stock prices below range, however, that usually, though not always, means we’ll take a pass, since this indicates a low level of interest and/or confidence in these shares.
However, if the IPO prices considerably below the low end of the range, we might decide to try for the shares anyway. That’s because the underwriting brokerage houses – the firms that are actually bringing the deal public – as well as the company issuing the shares, really want people to buy the stock and are willing to tempt the unwilling with an unexpectedly low entry point.
This is generally how we puzzle out that eternal, Hamlet-like question – “To buy, or not to buy” – when it comes to making our final move on an IPO.
The olden days
Interestingly, the parameters we use to arrive at an IPO buy-or-pass decision these days are generally different from what they used to be back in this writer’s days as a stock broker in the early 1980s. Then, investors would want to go “all-in” if the offering brokerage houses, known as the “underwriters” or the “underwriting syndicate,” were underpricing the stock.
In those days, IPOs that priced below range were often a strong signal that the issue would get that “pop.”
But things change.
Our observations and criteria, of course, can prove to be wrong. Nasty surprises and bitter regret will inevitably ensue if we’ve missed something when making our final decision. But that’s the way the cookie crumbles when you’re rolling the dice in the Wonderful World of IPOs.
What happens next after the IPO is priced
Of course, as we’ve mentioned many times before, even if all systems are go, and we affirm our request for shares tonight, that doesn’t mean we’ll get any shares at all tomorrow (Friday) morning.
In the first place, the customers of the full-service brokerage houses involved in the underwriting syndicate (this one headlined by Goldman Sachs [GS]) obviously get first dibs when it comes to IPO shares. (The other underwriters in the CarGurus syndicate are Allen & Co., JMP Securities, Raymond James & Associates and William Blair & Co.)
From a functional standpoint, it’s the underwriting syndicate that actually buys the entire offering from the new company, at which point they offer it to the investing public. The confidential discount the underwriters get for buying all the shares of the offering will be a big part of their profit. And they need that profit, too, along with their underwriting fees. That’s because IPO shares are sold to the public without commission – an added inducement for investors who love to get in on a decent IPO deal.
But if you’re a little guy (or a big one) who works with a smaller brokerage or a discount brokerage that’s not in the syndicate – like yours truly – your brokerage firm has been engaged by the syndicate as part of the “selling group.” The selling group consists of brokerage houses that haven’t put up money for the deal but are willing to assist the syndicate in placing the shares.
Brokerages in the selling group give their customers the same price and the same no-commission deal that syndicate customers get. The big difference is this: If the offering is really hot, the syndicate will pull back some or all of the shares requested by the selling group in order to have more shares available to sell to their own customers. This may seem unfair. But before we indulge in a pity party, we have to remember that brokerage houses in the selling group haven’t put up the money for the deal. The underwriters have.
One way the rich really get richer
There is one remaining and quite irritating IPO fact that makes this writer-investor perpetually unhappy. Whether you’re a small investor working with a member brokerage in the syndicate or trade through a discount house in the selling group, one thing is certain: If the new IPO is “hot,” you likely won’t get any shares, no matter how many or how few you request.
Or – somewhat better – you may not get all the shares you requested.
The reason for this is quite simple. It’s the richest customers of the underwriting brokerage houses that get first crack at “hot” IPO shares. Given that they’re priced to pop, such shares are first allocated by the underwriting syndicate essentially as gifts to those same rich customers in appreciation for the outsized level of business they conduct with the firm.
While this is galling to people like you and me, it’s normal and customary and legal in the industry. In its own way, this practice is not unlike any other business that offers special pricing on “customer appreciation days.” It’s just that from a moral standpoint to the average dude and dudette this customary practice seems truly evil and rotten. Getting first crack at hot IPOs is another way the rich get richer. At the same time, this practice serves to minimize the participation of average traders and investors in a (usually) lucrative deal.
While we’ve often stated in our columns that capitalism is the still the best economic system for any democracy, we’ve never claimed the system is entirely fair or perfect. But since we’ve been trading on our own for many years, and have frequently picked the IPO winners despite the obstacles, we’ve determined that participating in select IPO offerings can add a bit of profit pizazz to anyone’s portfolio.
7:30 p.m. ET UPDATE: The CarGurus IPO has priced $1 above range at $16 per share, and we’ve affirmed our request for shares. Read tomorrow’s column to see what happens next. Fingers crossed.