16th December 2011
Previous successes and failures
Linkedin's IPO upped the ante when it comes to social media flotations, as the company more than doubled in value over its first day's trading with shares soaring from $45 to a high of over $120, before settling at $94. At the end of the day the firm was worth a staggering $9bn – making it the biggest flotation since Google in 2004.
However, LinkedIn is a real company with real sales and profits, making it look like a sustainable business model – yet so too did Friends Reunited, and MySpace seems to have disappeared off the social media map. LinkedIn is now trading significantly below the levels its stock reached during its public debut earlier this year.
Yet the success of Google provides a good example of a "post dot-com" company that revolutionised the way that the internet was used and how investors have reaped the rewards. From the initial flotation price of $85, the share price now trades over $500, having peaked at over $700 in 2007.
Silicon Valley start-ups have this year begun to test investor appetite for a new wave of dotcoms. If it does debut in 2012, Facebook's IPO would dwarf that of any other dotcom waiting to go public.
So should you jump at a social IPO with so many uncertainties on the horizon?
Kevin Murphy, co-manager of the Schroder Recovery Fund says on his Mindful Money blog: "A distinctive feature of investors' recent fondness for social networking sites and other technology-oriented stocks, which some commentators have dubbed ‘Tech Bubble 2.0′, is the way many share prices have rocketed up in price on the first day of trading after their initial public offering (IPO) only to fall back dramatically in the weeks and months that follow.
"While IPOs appear irresistible to many investors, we feel they should be treated with caution for a number of reasons. First, the people selling the business know far better than any buyer what it is worth. Since any sale is likely to take place at the time a seller considers most advantageous to them therefore, a decision to buy at that point is quite a statement.
"Second, everybody involved in an IPO – the company, the investment banks and all the other advisers are incentivised to make it happen. As such, the sales machine is turned on full-throttle, which naturally leads to greater emphasis being placed on any positives rather than putting across a more realistic appraisal of the pros and cons of the business.
"Furthermore, the company's management will have spent the previous couple of years preparing it for sale. In many cases, this may lead to their running the business aggressively in order to maximise short-term profits and cash while potentially under-investing in its long-term growth and, where this happens, the company may well struggle versus the competition in the period after the floatation.
"Finally – and crucially – IPO investors have hardly any history on which to base their decision. At best, they will be able to draw on three years' worth of numbers. This means they cannot tell how a business has traded through a full economic cycle and, to muddy the waters further, people involved in IPOs have a habit of focusing on the stellar potential of future profits rather than the more concrete reality of current ones. Once again, that makes it very difficult to appraise the true benefits of the business." Read more here.