DealBook: Pandora I.P.O. Underwriters Got It Right (Sort Of)

Richard Drew/Associated PressPandora executives at the New York Stock Exchange on Wednesday.

5:37 p.m. | Updated

With the post-I.P.O. Pandora halo fading, it is time to grade the underwriters of the initial public offering: Morgan Stanley, JPMorgan Chase and Citigroup.

In a nutshell, Pandora managed to sidestep the LinkedIn debate over I.P.O. underpricing.

As the offering approached, the underwriters raised the target price to a final sale price of $16, from a range of $7 to $9.The stock finished the day at $17.42 after hitting a high of $26. First-day returns were 8.9 percent. This is in the average range for I.P.O.’s and a particularly good result considering the recent broad decline in the stock market. (On Thursday, Pandora’s shares fell nearly 24 percent, to $13.26, well below the I.P.O. price.)

The muted first-day pop was possible only because the underwriters used a now-standard formula for hyping these tech I.P.O.’s. It goes like this: Offer a very small number of shares. then retail investors, hungry for Internet riches, will drive up the price by bidding on the small number of shares offered in the market.

Bigger, more experienced investors will then also buy these shares in the offering in order to resell them quickly to retail shareholders.

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In Pandora’s case, only about 14.7 million shares were sold. This is about 9.2 percent of Pandora’s outstanding shares. The company itself sold only six million shares, with the rest sold by current stockholders. This type of sale is usually frowned upon because investors prefer to see I.P.O. proceeds go to the company rather than selling stockholders. Shareholder sales are seen as a lack of commitment to the company’s prospects, although in this case, the sales were small compared with the amount being retained so the negative impact was limited.

In this light, the Pandora I.P.O. was really a success, in no small part because of an underwriter sleight of hand in capitalizing on excessive, perhaps ill-advised demand. And the valuation — $2.78 billion — is a product of that. The company has never recorded a profit and posted revenue of only $44 million last quarter.

As a DealBook reporter, Susanne Craig (@susannecraig), noted in a Twitter message, compare this with Sirius, which had revenue of $724 million last quarter and a market capitalization of about $9.26 billion.

At this point I could simply retype the story language from the tech bubble, comparing Internet media companies and their heady valuations with old-line companies and their much lower ones. Analysts were certainly quick to make the comparison with Pandora, noting that its valuation seemed out of line with its prospects and historical results.

Still, the chance to grab Internet riches is a real draw for shareholders. And, hey, you never know, the opportunity to be the next Google is always a possibility, however small. This could be true even if you are in the declining business like the music one.

In this light, the underwriters did a stellar job of building expectations for an I.P.O. that has uncertain prospects. The lack of a big first-day bounce is evidence.

But of course, they also sold a product in a manner that may have led it to be overpriced because of failures in the market. If you buy into the argument that underwriters should serve a gate-keeping function, the subject of my column on Tuesday, then this affects their final grade. As gatekeepers, underwriters have a responsibility to bring companies to market that are appropriate for an I.P.O.

You can argue whether I have a too optimistic and unrealistic view of the I.P.O. market. In addition, it is unclear what investors expectations are for underwriters here. Investors themselves may disagree with my view. And of course, caveat emptor.

But the Pandora I.P.O. again shows that the underwriting process is about how to sell shares in these types of companies rather than whether they should be sold.

So the underwriters deserve a solid A- for selling this risky I.P.O. so successfully. But for stoking demand in a manner intended to sell a chancy product, I am lowering their final grade to a gentleman’s C, subject to future revision. And yes, this shows how subjective grading can be.

Article source: http://feeds.nytimes.com/click.phdo?i=f042d38cfe58cb71da23f568200721ef