Investment bankers are concerned that the IPO of Uber Technologies illustrates how little control they can have over a key factor in the success of any IPO: just how many shares will flood the market in early trading.
The problem is two-fold. First, bankers found it hard to identify major investors who had not already been offered the chance to invest in Uber at a lower level, and second the breadth of the shareholder base meant there were more secondary shares up for sale than the primary shares the banks had to allocate in the IPO.
The concern is that as heavily loss-making companies remain private for longer, more IPOs will be challenged by these issues.
For years Uber vacuumed up investments from every corner of the globe, selling shares in private rounds for as little as US$10 apiece in the early years, rising to US$48 before the IPO.
“The most important thing in an IPO is scarcity value,” said one ECM banker. “It’s the ability to buy something that most investors have not had access to.”
With Uber, and a number of other recent IPOs including Pinterest and Lyft, too many investors had already had plenty of chance to buy when they were private, the banker said.
“There was no scarcity value.”
The fact that there are a host of similar companies that will eventually come to the IPO market is creating existential angst across ECM.
To take two examples: CrowdStrike, a cybersecurity software company, recently raised US$460m privately at a US$3bn valuation, while WeWork, the new-age real estate company, has secured a fresh US$1bn of private funding and will eventually need to provide liquidity to investors that have funded it with some US$13bn.
Bankers are now attempting to lock such investors into holding shares beyond the IPO but doing so is tricky.
Indeed, having witnessed the selling pressure caused by early investors after Lyft’s IPO, Uber’s lawyers made an effort to lock-up as many shareholders as possible. While the underwriting banks could not account for all shareholders under a lock-up, they at least gain cover from the fact that they disclosed their existence.
“Uber didn’t really float 11% on its IPO,” said another ECM banker. “It was effectively 20%–25% once you factor in the grey-market shares and others that purchased privately.”
He said that when WeWork does come to market a lot of analysis will be around the real float size, not just the IPO. The incentive for private investors to take profits, regardless of where an IPO is priced, is an “unanswerable” dilemma, he said.
Lyft and Uber are currently 23.7% and 6.8% below offer respectively. That works out to US$1.1bn of paper losses combined.
Private investors who invested at much lower valuations used the Lyft and Uber IPOs to lock-in profits, either by selling directly in the open market or by short-selling through alternative means – at last count there were 17.6m shares of Lyft sold short and 12.8m of Uber sold short, according to Refinitiv data, amounting to about US$1.5bn in total.
The Uber IPO, led by Morgan Stanley and Goldman Sachs, had priced at US$45, near the low end of its marketed range and quickly sank – falling as low as US$36 a share. The rebound in the shares to close at US$43 on Thursday was followed by another dip on Friday morning.
Morgan Stanley bore the brunt of withering criticism for a variety of perceived missteps surrounding the offering. The original sin was setting the expectation more than a year ago that Uber would get a valuation of US$120bn.
“It’s a heavy lift to move insiders off early valuation, especially if it’s below a recent funding round,” said a lawyer who works on IPOs.
Uber was valued at US$85.3bn at the IPO versus the US$82bn in its final private round. Both Uber and Lyft are now valued below their final private rounds.
“It’s hard to go to a big fund and convince them that while they bought previous rounds at ‘X’ you want to go out with a 30% discount,” the lawyer said.
“If they had not valued it at that price maybe you would have been free to pick another price for the IPO.”
Investors who had been buying Uber shares in private transactions in the run up to the offering were expecting a blockbuster IPO. The valuation was whittled down to about US$85bn the week ahead of the IPO, deflating excitement among the horde of existing Uber holders.
“It’s a dance. Especially for a big tech company that has a lot of pull,” added the lawyer. “A company like Uber is not simply going to dance to the tune banks name. It’s a dialogue and they come to what they think is the right price.”
While Morgan Stanley is suffering public criticism for Uber, it is not likely to damage its ability to win mandates from the next big tech company.
“Within these companies they understand that the IPO is a multifaceted process and they choose banks to lead the IPO not simply on the perception of the last deal but the total package,” said the lawyer.