Markets

The Myth of the Broken IPO

2019 has been a big year for IPOs, and many of them have seen huge swings on their first day of trading.

In this Industry Focus: Tech clip, Fool analyst Joey Solitro explains why he hates the terms "broken IPO" and "mispriced IPO." Tune in to hear why a swing on day one of an IPO doesn't mean much of anything about the company itself, why he looks at companies in 10 to 25 years stretches, what some paradigm shifts in the venture capital world mean for the IPO market today, and more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

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This video was recorded on Sept. 20, 2019.

Dylan Lewis: One thing I did want to get your take on before we wrap up is, people will occasionally look at a company that's gone public and say, "It's trading 15% where shares were offered. That seems like a broken IPO to me." I think that it's worth diving into that and understanding the incentives of a public offering.

Joey Solitro: I hate the term broken IPO or mispricing. If a company's stock drops, it doesn't mean it's a broken company in any way. How I like to always talk about is, say you run a bakery. You spend years sourcing the right ingredients, perfecting your recipes. Then you go to open up shop. But then someone's like, "We'll do that offering to the public. We'll run that front of the shop. We'll buy your pastry for $10 that cost you $3." And you're thinking, "Holy crap, yeah, that's a lot of money. Let's do that." Then you walk out on day one, and you look up at the board, and it's $18. And you're thinking, "How much money did I just leave on the table?

 Now, if you do a secondary offering down the road, or anything like that, you might want that $18, where then they just jack it up to $24, whatever the market's paying for it. That's where I really encourage companies for these direct listings that they can -- now, if they need to raise capital, by all means, price based on what the market's saying. Seeing these big pops doesn't mean it's a great IPO. It just means those investment bankers and their very wealthy clients are now [wealthier]. You can see it as, these companies build themselves up over a decade, and then these investment banks make their clients as much money in one day as those people made over the last 10 years. I'm not a huge fan of these IPO huge pops, because I feel like they left more money on the table. But a company like Smile Direct, I think that is a phenomenal company, I bought it myself because I thought the market reacted incorrectly. To call that one a broken IPO just doesn't make sense. They made more money on that day of the IPO. Sorry the investment banks and their clients don't have as much money in their pocket as they did when they bought on day one. But hey, you have to lose sometime. If you're not focused on the long term, then you shouldn't have bought the company in the first place. But I'm looking 10, 25 years out, and I'm very confident with where I purchased.

Lewis: Yeah, there are different incentives for pretty much everyone along the chain. The one thing I will say with the broken IPO thing is, it's a bummer when shares are finally publicly available, and retail investors get in, and they have a chance to finally buy a company like Lyft or Uber, and so often, those big names are people's first experience with investing. They're like, "Oh, I take Uber all the time! I have to get my hands on this, it's a no-brainer!" And sometimes people get bit by that. And it's unfortunate. It's a painful investing lesson. But when you're thinking about how companies raise capital, yeah, you want to be maxing out the valuation that you're exchanging your equity for.

Solitro: Yeah, that's the issue. Companies used to come public -- I think Amazon came public in the third year of their existence. I think eBay was within the first five years. A lot of these companies used to come public so quick, because that was how they accessed capital. Now, there is so much dumb money in Silicon Valley. You could be raising a billion dollars, and you're two years old. And hey, we can push off an IPO for 10, 13 years. Times have changed with how companies raise capital and where they can access it. It's great for innovation. But for retail investors, we have to wait a very long time, and we might have to pay three, four, five times as much as we would if they would have gone public earlier.

But you always want to focus on the long term. I always say, take that 10-year stance. If you're like me, take that 10-25-year stance. Take Datadog, it's valued around $11 billion. 41X the last 12 months' sales. Pretty hefty. But if they keep these growth rates up, if they can keep it over 60% over the next three years, that's not that bad. If you're focused on the long term, and you're actually invested in the company, not just for the next earnings report, then I think you'll do well.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Dylan Lewis owns shares of Amazon. Joey Solitro owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has the following options: short October 2019 $37 calls on eBay and long January 2021 $18 calls on eBay. The Motley Fool recommends eBay and Uber Technologies. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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