Very few investors are lucky enough to get in on the ground floor of an initial public offering, particularly one for a hot Internet company. (It’s easier, though not simple, to find IPO shares for a cold aluminum company.) Most Internet IPOs are small in terms of the number of shares offered, and most of these are immediately snapped up by institutional investors and by the favored clients of the investment banks underwriting the IPO.
This wouldn’t be a problem if these companies went public at prices that reflected market demand, but for a variety of reasons, most of these companies don’t. Yesterday, for instance, TheStreet.com was priced at $19 a share. In other words, that’s the price at which those institutional investors and favored clients were able to buy the stock. That price had been raised more than 50 percent from the original intended offering price, reflecting the fact that people wanted in on the deal. But even so, the first trade–that is, the first price at which someone bought TheStreet.com shares from someone else on the open market–was $59 a share, a jump of more than 200 percent.
I’ve written before about the way mispricing takes money out of the hands of the company and puts it into the hands of those inner-circle investors. But pricing these things is difficult, given the fact that the reason so many people want to buy TheStreet at $19 is precisely that they know–to a rather remarkable degree of certainty at this point–that they’ll be able to sell those shares at $57. If the shares were offered at $35, it’s possible that there would be no demand at all. The market is not operating here in perfect rationality, in other words. But let’s set mispricing aside and instead ask: Why would you buy the stock at $59?
Buying an Internet IPO at its offering price, after all, has become about as risk-free a way of making a tidy profit as you can imagine. But the same isn’t true of buying Internet stocks in general. That may seem dubious, given the remarkable performance of stocks like Amazon, eBay, and AOL. But the vast majority of Net stocks are not Amazon or AOL. And although the performance of many of these other, less well-established stocks looks impressive, in general that’s because that performance is being measured from the opening price, not from the first trade. In other words, if you want to know how investors have really done with TheStreet’s stock going forward, you’ve got to measure it from $59 a share, not $19 a share.
TheStreet closed today at $53 3/4, which means that in two days it’s down 8.9 percent. The stock did spike as high as $73 yesterday, so presumably anyone who bought it at $59 with the intent of flipping it as soon as possible was able to do so. But in the unlikely event that someone actually purchased shares in the company as a long-term holding–and it’s unlikely because 13.5 million shares of TheStreet traded yesterday, even though there are only 5.5 million shares out there–they’ve now lost almost 10 percent of their money (assuming they were able to buy at the first trade).
Now, this may mean nothing about the company’s long-term prospects. TheStreet is an excellent site, with tens of thousands of paying subscribers, and editor-in-chief Dave Kansas has assembled a staff of more than 50 reporters who turn out lots of valuable content every day. More than that, the site fills a rather obvious niche, given the fact that finance is one of the key reasons people use the Internet. And for what’s it’s worth, I read TheStreet regularly. So if a content-driven site is going to be profitable and successful over the long haul, and is going to be a winning stock, TheStreet probably has as good a shot as any. (At least until Slate goes public, of course.)
But that is a big “if,” which is exactly the information the market has been conveying over the past couple of days. Unless you stretch the definition of “content” to include a portal site like Yahoo, there are no present examples of content sites that have really succeeded. The Internet titans are in e-commerce, the portal arena, or infrastructure. And without exception, if you look at the underlying financials of those titans, you can see realistic prospects for immense future free cash flow. In general, the same is not true if you look at the underlying financials of smaller Net companies, including TheStreet.
TheStreet is still valued at a none-too-shabby $1.3 billion by the market, and company co-founder and sometime Slate columnist Jim Cramer is, on paper at least, still a centimillionaire. But it’s worth remembering that the key question will not be whether the people who had stock options at $0.25 or who bought into the IPO at $19 made money from owning TheStreet. The question is whether the average investor, who couldn’t get in until $59, did.