Another headline showing record-breaking results this week: “’Avengers: Endgame’ Sets Box-Office Record at $1.2 Billion.” Eye-popping numbers, for sure, with an added “shown on 4,662 screens in the U.S. and Canada, the most ever.” That’s a lot of people shelling out a lot of money for a new thing. Blockbuster films and IPOs (Initial Public Offerings) share a common theme: they are the public’s first opportunity to participate in them. The IPO calendar this year has been rife with its own set of headline-grabbing attention: Lyft ($2.3 billion), Pinterest ($1.6 billion), Tradeweb Markets ($1.2 billion), Zoom Video Communications ($864 million), Levi Strauss ($717 million) to name the biggest so far this year. The granddaddy of them all, Uber, will make these pale in comparison, and will likely raise $9 billion out of the gate. Given the blaring headlines and endless talking-head rantings, how does a rational, sober investor approach the IPO game? What is our winning strategy for IPOs?
Movie “IPOs” are democratic: anybody can buy a ticket and see the movie on opening night. If tickets are sold out, they can see it the next day for the same price. Stock IPOs are not so democratic. They are often controlled releases: In its IPO, Lyft sold 32.5 million “tickets” or shares, out of a total 273 million, only about 12%. Pinterest, on the other hand, sold 100% of its Class-A shares. The problem here, as we see it, is the company is controlled by its Class-B shareholders, with 52 times the number of shares and 105 times the voting rights. In our view, public shareholders will never exert any substantial influence on the company. This is not the typical arrangement we look for. Further, with IPO candidates controlling the scarcity factor in their traded shares, the public is more susceptible to higher volatility in share prices.
Emotion and the “Fear of Missing Out,” or FOMO, play a large role in the IPO calendar. Pinterest gains +28% in first day of trading! Levi Strauss up +31% day one! Zoom Video up +72% on open! Who doesn’t want free money? Unfortunately, public investors aren’t the ones who gain from those get-rich-quick returns. The public is the group that BUYS the shares at those prices, giving the institutional participants—who are high enough in the pecking order to get an allocation at the IPO price—those instant returns. Again, this is a highly controlled environment where relationships are rewarded and the public does not participate. The headline mills and the talking heads love IPOs: they capture a lot of attention and boost viewership. Sometimes, insiders even lament the enormous percentage gains: Zoom CEO Eric Yuan described his stock’s valuation as “crazy” in an interview on Bloomberg. This is not a rational, sober environment.
Public participation in IPOs has not proven to be a market-beating strategy. According to research by Jay Ritter at the University of Florida, since 1980, IPOs have underperformed the broad market by over 18 percentage points. If sober investors are trying to find value, why would they stack the deck against themselves by playing the IPO game?
Maintaining a calm, rational, long-term approach fits our investment strategy, not manic headlines. Do IPOs work out for investors? Undoubtedly yes, for some. For us, however, we prefer to borrow a strategy from an enduring cinematic masterpiece, WarGames (1983, remember that one?). The closing scene:
Greetings, Professor Falken.
The only winning move is not to play.
How about a nice game of chess?
In a nutshell, we’ll win the IPO game by not playing. And you won’t find lotto tickets in your portfolio, either.