At Goldman Sachs, they are back in the office and playing drunken games of pin the tail on the donkey.
At least, that is one explanation for the apparent mispricing of the world’s biggest ever software IPO this week. Snowflake, backed by Warren Buffett and whose lead underwriter was Goldman, was priced at $120 a share before surging to close the first day at $253.93, 111.6 per cent higher.
The large “pop” incited Bill Gurley, general partner at Benchmark Capital, to rail against the process. Mr Gurley, along with Spotify’s former chief financial officer Barry McCarthy, have influenced thinking in Silicon Valley with their disdain for traditional IPOs and belief that original investors are short-changed by banks that dole out underpriced stock to favoured buyers.
Snowflake, a cloud computing company that raised $3.4bn and is now worth more than $60bn, certainly did record an unusually large first-day price swing. The average pop, according to a study of 1,155 US IPOs by Jay Ritter, a University of Florida professor, is 16 per cent. Only a tiny fraction double.
But Snowflake is not unique. LinkedIn doubled in value in the first day after its 2011 IPO. Back in the dotcom boom of 1999, there were more than 100 examples.
More important is whether founders and early backers are left dismayed at the money supposedly left on the table. In reality, the fact their retained shares are worth vastly more than expected is a powerful antidote.
In any case, Snowflake’s management chose the IPO structure, the investors and the price. They are experienced, and backed by sophisticated venture capitalists, not some naifs being hoodwinked by Wall Street.
Another software company, Unity, listed on Friday — again with Goldman as lead underwriter but using an auction. Snowflake considered other options, including a direct listing, but decided to raise money to bolster its balance sheet, which cannot be achieved (yet) via that route.
The management also wanted to choose their investors, an idea Mr Gurley dismisses as “ludicrous”, pointing out that a huge volume in Snowflake share trading suggests some institutions flipped their allocation for a quick profit. At the margin, some probably did. But most will have stuck with the stock.
The high volume came from retail investors furiously trading the same limited number of shares. This phenomenon — and the associated bubble behaviour among tech stocks — is the final reason why Snowflake’s management, assisted by Goldman and the other underwriters, did not make a stupid error.
Snowflake might have achieved a higher price — but then you have to live with it. In the twin ride-hailing IPOs last year, Lyft shares closed up 9 per cent on their first day while rival Uber’s fell 8 per cent. Bankers priced much closer to the real demand but they drew no praise: the IPOs were dismissed as “duds”. More dispiriting for the companies and their employees, both have spent almost all their subsequent life below the IPO price.
For Snowflake, the valuation was already mind-bogglingly high for a company that has to compete with the likes of Amazon and Microsoft. It was priced at 35 times next year’s expected revenues.
What management and their advisers knew is that a higher valuation is unrealistic because the earnings might not be there to support them. We are in a bubble. A one-day share price gain is not the only pop.