The concept of buying low and selling high is one of the most basic principles of making money in the stockmarket. Apart from harvesting dividends, it is the only way.
Investors in IPOs grasp the idea: they are adept at haggling issuers down to get the stock priced as cheaply as possible.
But as soon as the IPO begins to trade, investors seem to forget the principle altogether.
When a company goes public and trades down 5% in the immediate aftermarket, that makes the stock cheaper, and ought to make it more attractive.
But all too often, what happens is the opposite. Newly floated companies that dip in trading in their the first few days often become “orphan stocks”. They get abandoned, and a 5% dip quickly turns into a 15% slump.
This does not happen just with IPOs whose bookbuilds were weak. Deals like that often get pulled, or they are reduced in size or cheapened to get them done.
An IPO can appear to go extremely well, with a popular bookbuild, demand covering the deal several times throughout the price range, and be priced at a level investors see as sensible and attractive. Yet the first prices in the aftermarket are red, and then the stock keeps tumbling.
A company that has freshly floated is more vulnerable to technical breaks in investor behaviour, rather than company fundamentals, than it will ever be.
This is one of the reasons why the greenshoe option exists as a price stabilisation technique.
Slipping up
Douglas, the German cosmetics retailer, priced its €889m IPO in March after tightening its price range towards the bottom of the range. The deal was priced at €26, the bottom of the range.
During the bookbuild, all the investors that engaged in the process generally acknowledged that the price range was reasonably attractive, said a banker close to the deal.
So when the shares slipped 7% from their offer price in the early morning of their market debut on March 21, you would think that, since they were now a few percentage points cheaper, they would look that much more appealing to the investors who suggested €26 in the first place.
But as of Tuesday afternoon, the shares were at €21, down 19%.
Investors do not see an IPO that trades down as a buying opportunity. This is odd behaviour, compared with how any investor would trade established companies in the stockmarket.
When trading begins, IPO investors' mentality shifts from seeking a bargain to avoiding a risk.
Regardless of how cheap the stock is relative to other comparable listed companies, an investor in an IPO that has dipped on the first day of trading does not want to be the first person who steps in to buy it, in case there is a crowd of other investors starting to sell.
The $370m London IPO of Air Astana in February suffered a similar fate. The sale was so much oversubscribed it was increased by 20%.But by 11.45am on its first day of trading in February, the global depositary receipts had fallen 4.7%. On Tuesday this week, they closed at $7.95, 16% below the IPO price.
The £290m London flotation of CAB Payments, which famously fell 80% in the first three months after its market debut, also tripped up on entry. The shares fell 9.7% on their first morning. The worst damage came when it issued a profit warning at its maiden results in October. It has slightly recovered since and is trading down 54% from the IPO price.
Deep hole to climb out of
The point is not that this always happens. It is that if an IPO breaks below its offer price, much more often than seems justified, it will take months rather than days to recover, if it ever does.
A mild example was the €600m IPO of Lottomatica last May. It was priced at the bottom of its range and plunged 11% on the first day of trading. Two months later, the price recovered to the flotation price of €9. Since then it has behaved normally, and is now at €10.50.
Things can go wrong the other way, too. Thyssenkrupp Nucera, the German producer of electrolysis equipment, traded up 9% on its first day of trading in Frankfurt last July, but since then it has been downhill nearly all the way, and the company has halved in value.
Equity capital markets bankers often say the IPO product works as long as there is a match between buyers' and sellers' expectations. But this is only true for IPOs to get over the line.
After that, ironically, IPOs can only work in the aftermarket and in the long term when buyers are willing to buy at prices more expensive than the seller had accepted, by buying the stock higher and higher.
The unreliability of early trading is a big problem for IPOs. A weak start can define the rest of the stock’s life, sometimes regardless of fundamentals. One hint of doubt can create a self-fulfilling slippery slope, depriving the company of the chance to shine.
That fragility undermines the entire purpose of IPOs: to generate capital for growing companies.
At a time when European ECM specialists are fretting that their markets are being whittled away by private equity buyouts and emigration to NYSE and Nasdaq, the riskiness of an IPO also does not help to attract new companies to float.
Of course a newly listed company will have fewer fundamental followers than one that has been in the market for years.
But that means its friends and believers need to look after it until it is fully fledged.
Only investors can remedy this problem. They need to see the bigger opportunity the IPO market offers them, and take advantage.
Or, of course, they can carry on running away from bargains, and not daring to buy low, sell high. It’s not like the entire stockmarket revolves around that or anything.