WASHINGTON, November 19, 2015 – Shares of Square (symbol: SQ)—the company that makes those little white doo-hickeys small retailers insert into iPhones, iPads and the like to transact credit-card business one swipe at a time—finally went public this morning after its IPO was priced last night at a mere $9.00 per share, down considerably from its announced pricing range of $11-13 per share.
That range, in turn, was lower than its last round of vulture capital funding in which rich guys and investment firms ponied up slightly less than $16.00 per share. Square’s valuation, in fact, has been trending down, likely due at least in part to the sheer weirdness of its corporate situation.
Risks of investing in Square
First of all, the company’s primary business model derives income from a small charge per swipe while still providing many small retailers with a cost-effective credit card solution that bypasses the high processing fees of larger processing firms.
But there’s also a problem with this. With aggressive companies like Apple (AAPL), ahem, getting into this space, how will SQ be able to compete against them in coming years? This could put a serious dent in future earnings, which, by the way, Square doesn’t have now and may not have anytime soon, given the money-losing ways of most tech startup IPOs.
Second of all, weirder still, Square CEO, Jack Dorsey, also happens to be the current CEO of Twitter (TWTR). A co-founder of Twitter, Dorsey moved back into the CEO slot after a corporate shakeup earlier this year ousted his predecessor CEO who proved unable to seriously monetize Twitter’s online presence, unlike other competitors like Facebook (FB) and LinkedIn (LNKD). Dorsey claims he’s working hard for SQ full time. But if he’s done that for TWTR as well, prospective investors reason, well, how can he do that? Understandable skepticism like this doesn’t help in the marketing of an IPO.
Third and perhaps even more problematic, SQ is one of those high-tech, Silicon Valley companies that, while it’s never made a dime of actual profit, is still valued in excess of $1 billion. The current fashionable label for such companies on wall street: “unicorn stocks.” When the market is in a high-tech, go-go mood as it was in the late 1990s dot.com boom and again until fairly recently with regard to online sites, services and apps, investors don’t care about this disparity. Such stocks will only go up and up, right? Because, GROWTH.
If there is no growth, however, or if growth isn’t on the horizon, or if market action sours significantly, as it has in 2015, pie-in-the-sky overvalued “unicorn stocks” can suddenly take a swan dive. 2015 unicorn IPOs like Etsy (ETSY) and several others have taken it on the ear after their respective IPOs and remain significantly below that initial offering price that once looked like such a deal.
Pricing Square for a “pop”
Hence, today’s underpricing of Square. The underwriters know that early IPO investors want to see a “pop” in the stock—that smart 25-50 percent jump up in post-offering price that allows an IPO investor to “flip” the stock within minutes of the opening trade, pocketing that gain in minutes. The deal is even sweeter, since IPO investors don’t pay a commission on the original purchase—only the exit trade.
But not every investor gets to flip away. Such super deals are available pretty much only to the best customers of one of the underwriting investment banks, i.e., Merrill, JP Morgan, Goldman Sachs and so forth. Those like the Maven—individual traders and investors—Jim Cramer calls them “home gamers”—who trade with discount brokerage houses are usually limited in their ability to do those sweet IPO flips.
That’s largely because discount houses are, to the best of the Maven’s knowledge, never underwriters of an IPO. I.e., they don’t have a monetary stake in the issue as do the underwriters that, in fact, actually buy the IPO themselves and then “take it public” by re-selling most of those shares to the public, keeping a small but very significant markup on the stock for themselves, which is how they profit.
Discount houses are generally in what’s called “the selling group.” They have no fiscal stake in the IPO, but are often allocated shares by the underwriters to provide a boost in retail marketing for the shares. The price the discount houses have to pay for getting in on the deal is to put soft limits on when their investors sell the issue, which is what this particular firm’s solution actually is. If all this firm’s many investors flipped IPOs like the rich guys do, it would be hard to establish a stable market in the new company.
Ultimately, a really successful IPO not only gives a lovely “pop” to its early investors. A really successful IPO will also stabilize its price on or above the IPO offering price, making longer-term holders happy and establishing a reasonable “floor” under the new stock’s price, giving future investors more confidence in purchasing shares on the open market.
But one of the best ways of achieving this kind of stability is for the bulk of its early IPO investors not to flip but to hold. This will keep supplies of the stock scarce and cause the existing price to get bid up, which is what every holder of the stock wants anyway. If everyone dumps, the game collapses.
How an IPO is “stabilized.” And why discount house investors like this columnists can be persuaded not to flip their IPO shares
The IPO’s underwriters usually arrange to place a significant number of IPO shares in their own accounts along with one or more large and stable investment houses, like Blackrock (BLK), for example. Companies like these have the wherewithal to sustain hits to these positions and hold out for a better day to exit if needs be.
The other source of early price stability, however, are the array of retail investment houses like the one the Maven uses. That’s because discount houses rarely (to the Prudent Man’s knowledge) are underwriters but instead are enlisted by the underwriters as part of the “selling group.” They’re allocated available shares and essentially help market them to retail buyers that either don’t or can’t afford to do business with full service houses at their higher commission rates.
With regard to Square, as we noted in a previous article,
SQ opened up sharply, trading up roughly 45 percent at Thursday noon, up $4.00 at $13.00 per share. Trading is wild and volatile and who knows where SQ will be at the close? However, our discount brokerage more or less requires us to hold IPOs for 31 days following the IPO, so we can’t flip this puppy anytime soon. And a lot can happen in an IPO’s first month of trading.
The reason why this firm requires to hold, not flip, an IPO for 31 days is similar to the reason why the underwriters arrange to park a batch of shares with firms like Blackrock: stability. If a significant number of shares simply won’t be sold for at least a month, the price of that stock will stabilize and, perhaps, even continue to go up, helping establish a floor for the stock price where none existed before.
The fact that individual investors don’t have the kind of bank accounts that can absorb a big 180 degree turn in a newly issued IPO’s price isn’t relevant to the business case. It’s tough luck. The reason why individual investors IPOs is that they’re hoping, if not always for a lucrative “flip,” at least for a slightly longer turn home-run in fairly short order.
We regularly invest in IPOs here, often make money but occasionally get killed. But these are the chances you take for getting in on the IPO game while lacking the deep pockets of Blackrock.
About that word “required.” We should note that investors who place their business with the particular discount house that we used aren’t actually REQUIRED to hold an IPO for 31 days. But if they don’t, and if they sell early, the firm disqualifies them from getting back into IPOs there for 90 days.
Again, this is because one of the deals this firm has cut with underwriters in order to get shares of an IPO to offer to its customers is that those customers will more than likely hold the investment for those all-important 30 days, helping stabilize the new stock, which is what the underwriters want (as do the IPO companies).
That’s the way it works, at least for us. So having picked up a small position in SQ this morning, just for fun and hopefully profit, we’ll sit here for the next 30+ days and hope we’ll still have at least some profit left in this arguably iffy company before we exit.