Felix Salmon

The rational Candy Crush IPO

Felix Salmon
Mar 10, 2014 17:40 UTC

Jim Surowiecki is absolutely right about the IPO of King Digital Entertainment, the makers of Candy Crush Saga. The point of an IPO is to raise permanent capital for a company which intends to exist in perpetuity, while King will realistically last only as long as the Candy Crush fad. King will probably never again make the kind of money ($568 million) it made last year, and yet it issued options in January at a crazy $9.4 billion valuation.

Surowiecki writes:

It’s easy to see why King’s founders want to go public: money. But the money isn’t worth the hassle. As a public company, King will have to show shareholders consistent results and ever-growing profits. Such expectations are, frankly, silly in crazily competitive, hit-driven industries, and trying to meet them is a recipe for frustration. If King stayed private, it could milk its cash cow and build games without having to worry overmuch about hatching a new cultural juggernaut. We expect companies to constantly be in search of the next big thing. But, for one-hit wonders, the smartest strategy might be to just enjoy it while it lasts.

There are two different pieces of advice here. The first is entirely sensible: if you have a business throwing off massive amounts of cash, and you have no real assurance that you can build a similar business or replicate your past success, then probably the best thing to do is to just pocket the cash, rather than trying to reinvest it. After all, Candy Crush Saga itself was not the product of hundreds of millions of dollars of investment: it was the product of good luck, basically.

The second piece of advice is that if you’re just going to cash checks from Candy Crush, you’re better off doing that as a private company, rather than having to deal with public shareholders. This is probably also true. Public companies are bad at managing decline: they always want to show growth. The result is all manner of attempts at “pivots”, or at investing cashflow into longshot attempts to build a new business from scratch (for a prime example, see the way that AOL took the hundreds of millions of dollars flowing from its dialup service and poured them into Patch). Which, needless to say, rarely works.

But here’s the problem: all companies have a valuation, and right now the market is placing a valuation on King which is somewhere in the $10 billion range. If the present value of Candy Crush Saga’s cashflows is less than $10 billion (which it almost certainly is), then it is entirely rational for anybody who might be inclined to live on those cashflows to instead sell the company to people who think it’s worth more than that.

And there’s another great reason to go public: it gives King’s current shareholders — employees and VCs — the ability to cash out easily, rather than just waiting for a ever-diminishing series of dividend checks. Like it or not, this is the way of the current technology world: you start up a company, you sell it, you get rich. Even if going public sucks.

The main reason to go public, however, could just be that the IPO market is so frothy right now that companies have to have the credible threat of an IPO in order to get the best possible price from a strategic acquirer. Right until the day before the IPO, King is going to retain the option to simply sell itself to some company which wants proven expertise at making enormous profits in the world of mobile-native apps. By moving towards an IPO, King is forcing those companies to get serious about making an offer — both in terms of timing (they’d better do it quick) and in terms of valuation (they’d better meet the likely IPO share price). Because buying King after it’s gone public is going to be a lot more difficult.

Sometimes, capital markets are inefficient at allocating capital. When debt markets are frothy you see a lot of debt issuance; when equity markets are frothy, you see a lot of IPOs. We’re seeing a lot of IPOs right now, including some pretty crazy ones. And if you sell into a frothy market, you’re being rational, not stupid. Let the buyers of King shares worry about where their return is going to come from: no one is twisting their arm. So long as there are people out there willing to buy at a $10 billion valuation, markets demand that the current owners should be able to sell.


This is just another in a series of examples of why I stopped investing in equities some time ago Felix. Plug Power is another very recent example.

I know, I know, let the buyer beware…..When I contemplate making money that way it just doesn’t feel very good. It feels like cheating. Like ripping off people who aren’t that smart.

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Facebook’s SecondMarket muppets

Felix Salmon
May 30, 2012 21:57 UTC


Remember how excited SecondMarket was about the Facebook IPO? I’ll bet they’re not nearly as excited any more. Because if anything demonstrates that there’s a venture-capital bubble in Silicon Valley right now, it’s Facebook.

The chart above shows the valuation of Facebook on SecondMarket, every month from January 2011 through April 2012; the red bar shows the valuation of Facebook at the close of trade today.

Now it’s true that if you bought Facebook shares on SecondMarket before 2011, then you’re in the money right now. But the chances are, you didn’t:


This chart, from SecondMarket, shows that fully 78% of all transactions in Facebook took place in 2011 or 2012. What’s more, pretty much everybody who bought Facebook shares on SecondMarket is still locked up. They never got the opportunity to exit at the IPO price of $38; indeed, they’re going to have to wait long painful months before they can sell at all. (They can of course now short the stock, or buy puts, to try to protect their downside from here on out; that in turn is only going to further depress the price of the stock.)

Mary Meeker explained the consequences, today:

Valuations in the private market are going to make it “difficult to go public.” The valuations make it “difficult to justify the goals.” The prices are going up and up. And the businesses are not keeping up.

So, when these companies start to look for public market exits, there’s a good chance the “private market will lose money.”

When Meeker’s talking about the private market, she means investors like her own firm, Kleiner Perkins, rather than the kind of people who buy shares on SecondMarket. But the principle is the same. An IPO can be looked at as another fundraising round, and no one likes a down round. In the case of Facebook, it seems as though Facebook’s share price is still just higher than its last official capital-raising round, when it raised $1.5 billion at a $50 billion valuation. But that’s going to come as little solace to anybody who bought Facebook shares in the past 16 months.

What’s more, I can easily see how the frothy Facebook valuations being seen on SecondMarket contributed to the debacle that was the Facebook IPO. Facebook executives with vested equity had the opportunity to sell their Facebook stock in early 2012 at valuations north of $80 billion; at the peak of Facebook fever, just before the IPO, the shares traded as high as $44 each. Given that Facebook was by far the most liquid stock on SecondMarket, and had weekly auctions from November 2010 onwards, it was pretty reasonable to consider SecondMarket to be a reliable price discovery mechanism.

What’s more, basic economic theory suggests that if a stock has buyers at $44 privately, then its public value will be higher than that, since the universe of potential buyers expands enormously. Given that theory, it would have been really hard, I think, for Morgan Stanley to price the IPO below the levels seen on SecondMarket for most of the previous year — a valuation of $80 billion or so.

In reality, however, it’s increasingly looking as though shares in private tech-companies are a bit like fine art prices: a place for the rich to spend lots of money and feel great about owning something very few other people can have. The minute they become public and democratic, they lose their cachet. And a lot of their value.


Amazingly, today, after such a long time has passed since the FB IPO, I read an article on Reuters in which the author said that FB was used by 900 million people, and Rob Cox, from Reuters, said a similar thing in a video…
Get real, please, and take the time to learn the difference between ‘users’ in the sense that facebook and other social media companies use the term, which just means ‘online entity’, and real people, who can each create hundreds of such (immortal) user entities for every site they use.
Over the years, I’ve created numerous ‘user’ accounts on Reuters, but I’m still one guy.
I know people who use facebook who’ve created hundreds of ‘users’ over the years.
has anyone ever audited facebook in order to find the actual number of people (persons) who use it?
My guesstimate, based on 10 years of using social media and advertising on it, is that the end figure would fall between 1 and 2 orders of magnitude below the 900 million figure.

Posted by reality-again | Report as abusive

Chart of the day: Do IPOs create jobs?

Felix Salmon
May 29, 2012 21:37 UTC

In the wake of its fabulous report about how investors in VC funds are stupid, the Kauffman foundation has released another report, this time about IPOs. This one comes with a very bad press release, which says in breathless fashion that “nearly 1.9 million new jobs forfeited in the past decade as fewer entrepreneurial firms join ranks of public companies”. In fact, the report itself is much less alarmist, and a single chart does a very good job of debunking the idea that if we had more IPOs, we’d automagically have much more employment.


What this chart shows is that during the dot-com bubble, companies like Amazon and eBay would go public and promptly reinvest the proceeds, using them to grow as fast as they could. Both of them were just three years old at IPO, and used their equity capital to carve out dominant positions in their respective corners of the internet. As the report says, the market’s mantra during the dot-com bubble was “grow rapidly or fail”, and so all companies which went to market adopted pretty much that strategy.

With hindsight, many of those companies would have been better off conserving their capital, preserving a bunch of liquidity for a rainy day, and going for sustainability over growth. But that didn’t happen, and what you can see in the chart is a spectacular failure of public companies to create jobs after the dot-com bubble burst. The older companies certainly didn’t: total employment in companies which went public in 1996, for instance, actually fell significantly between 2000 and 2003. And even newly-public companies, if they went public in 2001 onwards, basically gained no jobs at all; the only exception was 2004, the year Google and Salesforce went public.

So yes, the number of companies going public after the dot-com bubble burst was lower than the number of companies which went public during the bubble, when equity capital was dirt cheap. That doesn’t mean that jobs were forfeited as a result: if more companies had gone public, there’s no way they would have grown their payrolls at the rate that the cohorts of 1996 and 1997 did.

Indeed, the report itself explains very clearly that the 1.9 million number is not remotely something to be taken literally:

Since the number of years in which to grow would have been shorter than for the firms that went public in the late 1990s, the jobs created through 2010 probably would be lower. Second, there is an assumption that the average quality of firms going public would remain the same as those that actually did go public. In other words, that there would have been additional eBays, Amazon.coms, and Googles if there had just been more IPOs. Third, that the people that would have been hired would not have been doing something else. In other words, there is an implicit assumption that a mass army of would-be engineers, scientists, and marketing experts is sitting at home watching television. And fourth, that the capital invested when a company raises funds in an IPO would not otherwise have been invested in job-creating activities. The average company that conducted an IPO during our sample period raised $162 million in inflation-adjusted dollars, and if there were 2,288 more IPOs of the same average size, $370 billion of capital would have been pulled from other uses.

Instead, the point of the 1.9 million jobs number is that it’s low, not high: it’s being presented in order to contrast with insanely overinflated figures elsewhere, such as Grant Thornton report which says (slide 15) that the decrease in IPOs “may have cost the United States 22 million jobs over the last decade”.

In fact, what has happened over the past decade or so is that companies have been getting older and older at IPO, and have been able to raise, in some cases, billions of dollars in venture capital before going public. As such, IPOs have not been a way of raising growth capital, so much as a way of creating an exit for VC funders. Or, to put it another way, there are still lots of hot 3-year-old technology companies raising huge amounts of equity and using it to hire loads of people. They’re just doing it in the private markets rather than the public markets.

What’s more, the fast-growing technology companies which are going public now, or which have gone public in recent years, are hiring precisely the one group of people where there’s no unemployment problem at all: computer engineers in general, and Silicon Valley computer engineers in particular.

Once upon a time, when IPOs were primarily ways for young, fast-growing companies to raise the capital they needed to continue to grow, there was a strong case to be made that they helped create jobs. Today, however, IPOs are something else entirely. If there were more IPOs, that might be a good thing, but it’s silly to believe that we’d have more jobs that way. IPOs, like leveraged buyouts, are financial tools used by financial professionals to make money. Those financial professionals surely like to think of themselves as job creators. But their real job is to make money, not jobs. And so while there are reasons to bemoan the lack of IPOs in recent years, this idea — that we’d have many more jobs right now if there had only been more IPOs — isn’t one of them.


This data appears to make passing of the JOBS act even worse. Companies, broadly, are not having any trouble raising funds in the private market and fail to create many jobs once going public. Now VCs can more easily cash out in the public market and accounting controls are even more lax.

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Morgan Stanley’s $2.4 billion Facebook short

Felix Salmon
May 21, 2012 19:19 UTC

Matt Levine had a very wonky post on Friday afternoon about the dynamics of the Facebook IPO in general and of the very misunderstood greenshoe option in particular. Now that we’ve all had a nice relaxing weekend, it’s maybe worth revisiting that greenshoe, because it’s actually possible, given Facebook’s tumbling share price today, that Morgan Stanley will make a substantial amount of money on it.

First, it’s worth explaining how the greenshoe option is meant to work. In the IPO, the underwriting banks — there were lots of them, but let’s just call them all “Morgan Stanley”, for simplicity’s sake — sold 484 million shares of Facebook at $38 each. At the same time, they bought 421 million shares of Facebook from the company and its investors, at $37.582 each. The underwriter’s fee of 1.1% is the difference between those two numbers: if you buy at $37.582 and sell at $38, then you end up creaming off 1.1% of the total amount raised.

You’ll note that Morgan Stanley sold more shares than it bought. That’s the greenshoe. When you sell more shares than you buy, you’re short that stock, so when a bank exercises its greenshoe option, as Morgan Stanley did in this case, it is going short the stock in question.

Why would a company like Facebook want its banks to be short its own stock? Partly because when there’s a big short in the market, that provides upward pressure on the share price. Shorts need to cover their short position — which means they need to buy stock. But more generally, the greenshoe is a way to provide the market with a nice extra slug of shares, which everybody wants if the stock trades substantially higher than its IPO price.

The greenshoe does, however, raise certain existential questions — not least, how can 484 million shares be sold, if only 421 million shares have been issued? Do those extra 63 million shares exist?

It’s a good question, and the answer is that they’re in a kind of quantum limbo, a bit like Schrödinger’s cat. In one possible world the shares trade happily on the open market, in which case Morgan Stanley will exercise its option, and force Facebook and its investors* to cough up the last 63 million shares; at that point, they certainly do exist. In another possible world, Morgan Stanley ends up buying back those 63 million shares on the open market, thereby reducing the number of shares actually trading to the original 421 million. In that world, the 63 million shares never had much of an existence: they were sold by Morgan Stanley and then bought back by Morgan Stanley, and all that’s left at the end of the day is nothing.

Given where Facebook is trading right now, you can be sure that Morgan Stanley will not exercise its option, Facebook and its investors will not issue those extra 63 million shares, and that in a few days’ time, the free float of Facebook shares will be 421 million, not 484 million.

Which in turn means that over the course of the first two or three trading sessions, Morgan Stanley will have ended up buying 63 million shares of Facebook on the open market. It sold those shares at $38, remember. So its total profit on the greenshoe operation will be zero if it bought all 63 million shares at $38 exactly. If it bought some of the shares above $38, then it could end up making a loss. And if it ends up buying a slug of shares below $38, then it’ll end up making a profit. That’s what happens, when you go short at $38 and then buy back at, say, $34.

This is a very big trade: 63 million shares at $38 each comes to $2.4 billion. On the other hand, there’s very little doubt that Morgan Stanley was doing a lot of buying on Friday. 43 million shares were bought at $38.00 exactly, and another 28.5 million shares were bought at $38.01. It’s reasonable to assume that most if not all of that buying came from Morgan Stanley, supporting the share price.

So the chances are that at the end of the day, Morgan Stanley is going to end up pretty flat on its trade, selling the shares at $38 and then buying them back at $38. But if it bought more than 63 million shares on Friday, then it is sitting on a substantial mark-to-market loss right now. And similarly, if it bought back fewer than 63 million shares on Friday, then it’s actually making a profit on its greenshoe short.

Chances are, no one outside the company will ever know for sure what Morgan Stanley’s P&L on the Facebook IPO ends up looking like. But it would make sense, if Morgan Stanley saw a lot of selling pressure on Friday, for the bank to keep onto at least a little bit of its short position into Monday morning. At which point it could make a tidy profit on that plunging share price.

*In this case, it’s actually just the investors: Facebook wasn’t participating in the greenshoe scheme. But it could have, if it had wanted to.

Update: Levine has a great response. A taster:

The greenshoe is a non-zero-sum way of adding value with optimal risk-shifting: it takes some uncertainty about aftermarket performance from skittish investors and gives it, in the form of uncertainty about deal size, to an issuer who is probably better able to bear it (because selling 15% more shares at the price you agreed on three days ago is rarely a tragedy). The structure of the greenshoe, though, adds an additional conflict, in that banks can hoard the value of the greenshoe for themselves rather than spending it on their investor clients. The fact that they basically don’t do that suggests that motive and opportunity aren’t everything: sometimes banks just do the right thing for capital allocation and risk shifting, even when they could make more money doing the wrong thing.


“I think they’re rarely “stable”, just because it’s new, and will be that way, with or without the manipulation.”

Absolutely. Doesn’t mean that the manipulation can’t take the edge off it. Even if it was an utter failure in this case.

“there are probably better ways to figure out a reasonable price than asking totally conflicted brokers driven by self-interest.”

Sure, you are welcome to consider those alternatives for your next IPO. I would be interested in seeing something like that happen. Surely the SEC can’t mandate the present process?

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Chart of the day, tech-stock edition

Felix Salmon
Nov 23, 2011 22:22 UTC


Paul Kedrosky reckons that Groupon’s the worst-performing internet IPO since Netflix, in 2002. He’s wrong: Groupon is doing even worse than Netflix did. It’s now trading at 85% of its IPO price; Netflix, by contrast, was still a tiny bit above its IPO price at this stage in its volatile history. (The chart above shows how Netflix performed in its first year as a public company, compared to its IPO price.)

If Netflix is any indication, Groupon is going to trade significantly lower than its current level before it ever recovers. Netflix went public at $15 per share, at the end of May 2002; on October 9 of that year it closed at just $5.22. Which is $2.61 in current prices, since it subsequently had a 2-for-1 stock split. That makes today’s closing price of $68.50 look positively healthy, the stock’s precipitous recent drops notwithstanding.

What this chart really shows, of course, is just how difficult the stock market’s job of price discovery is. In the early days of a technology company’s life as a public company, the stock price can move quite violently.

And with Groupon we should expect especially violent moves, for two reasons. Firstly, the float is tiny; and secondly, there’s a very loud and vehement class of Groupon bears who are desperate to short the stock and are convinced it’s going to zero. They might even be right. But my main point here is that looking at the Groupon share price on a day-to-day basis is a very good way to go slightly mad.

Groupon’s share price doesn’t reflect new news about the company; it’s more akin to a volatile random-number generator. If it goes down, that doesn’t mean that Groupon is a bad company; and if it goes up, that doesn’t mean Groupon is a good company.

This is one reason why technology companies hate going public: they start getting judged,first and foremost, on the one thing they have no control over, which is their share price. And tech-company share prices in general have been doing very badly in the post-IPO period of late. Why on earth would anybody want to join the likes of Demand Media or Renren, both of which are far below their IPO price? Some companies, like Facebook, have so many shareholders that they’re forced to go public. Others have VC backers twisting their arms. But if you have a choice in the matter, most sensible tech-company CEOs are likely to put off an IPO as long as they possibly can.


In this case, Seth, the basis for comparison is the IPO price. It isn’t intended as an IRR graph.

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The US IPO cartel

Felix Salmon
Jun 7, 2011 21:51 UTC

Mark Abrahamson, Tim Jenkinson, and Howard Jones, of Oxford University, have an utterly compelling paper out proving that there’s collusion among investment banks in the US — it doesn’t matter whether they’re European or American banks — to keep IPO proceeds set at 7%. Using a very high-quality new dataset, they compare US and European IPOs, and get the following result:


This chart just shows IPO fees for deals between $25 million and $100 million (in 2007 dollars). But the pattern is universal:

Between 1998 and 2007, 95.4% of U.S. IPOs between $25m and $100m had gross spreads of exactly 7%. The comparable figure between 1989 and 199… While Chen and Ritter showed virtually no IPOs over $150m with a 7% gross spread, we find that 77% of all offerings between $100 and $250m charge exactly 7%.

European IPO fees do not cluster, and only 1% of offerings raising $25m or more experience gross spreads as high as 7%. Within the $25m-$100m range, fees for European IPOs average just over 4%. Indeed, European IPOs are always cheaper: we find that there is a “3% wedge” between European and U.S. IPOs after controlling for size, issue characteristics, syndicate structure and time or country effects. Fourth, whilst gross spreads are lower for the larger offerings in both regions, our multivariate analysis indicates that fees for the larger U.S. IPOs have tended to increase in our sample period, while European IPOs have been getting cheaper.

The paper runs down a list of possible reasons why US IPOs might be so much more expensive than their European counterparts, and finds none of them convincing; their conclusion — the correct conclusion, I think — is that there’s an implicit cartel in the US, devoted to keeping IPO fees artificially high. (The term of art is “strategic pricing”: although it might be in any bank’s short-term interest to compete on price for any given deal, it’s in all of their long-term interest not to ever do so.)

The cost to issuers of this collusion is huge:

Our best estimates suggest that had these IPOs been conducted at European fee levels the savings to U.S. issuers over the period would have totaled $11.4 billion – or over $1 billion per year.

But are there other reasons why the US might have such high fees? I can think of two possible ones. The first is simply cultural: New York bankers won’t haggle on such fees, while their European counterparts do. But that reason is fundamentally circular: it basically just restates the question rather than providing the answer.

The second possibility is that US IPOs are much less important, when it comes to capital raising, than European IPOs. If US IPOs are used mainly to provide pricing, with most capital raised in follow-ons or convertibles, then the fees associated with the IPOs would be less important than in European IPOs, if those were actually used to provide important operating capital.

Here are two charts I just put together, with data from Thomson Reuters’s SDC Platinum:



If there’s a difference here, it isn’t a big one. European IPOs are maybe a little bit more important for capital raising, but nothing to explain the kind of discrepancies found in the paper. There’s an IPO cartel in the US, and now that Europe has moved to a US-style bookrunning model for IPOs, it’s more obvious and blatant than ever in comparison to Europe. Not that anybody’s going to do anything about it.


some options for companies seeking capital might be:
- perform a “reverse tender offer” where unlike a takeover artist seeking control of a target company by asking people to tender their shares for a set price, they could register securities and go directly to the public through an auction process. If they want to sell X share respresting x% of their capital, get prospective buyers to submit bids

- or acquire a publicly traded company and do a reverse merger. Practically fee-free compared to an IPO. But doesn’t generate a lot of publicity.

Probably the companies are really after publicity more than the investment capital… so they can say “advised by Goldman Sachs” etc. etc.

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The LinkedIn pop

Felix Salmon
May 19, 2011 16:27 UTC

Why is LinkedIn doing so well on the stock exchange today? At $100 per share, by one measure it’s the most expensive stock in America. Evan Newmark has one theory: it’s because the IPO price was raised, by Morgan Stanley, by $10 per share shortly before the offering was launched. By doing that, he says, they increased the size of the pop:

Strangely, jacking the price by 30% made the offering even more enticing for lots of prospective IPO buyers.

The laws of supply and demand may say the higher the price, the less the demand. But again, that’s common sense and this is Wall Street, where a higher price equals more demand, where if the other guy wants something, then you want it even more.

Does this explain why the shares rose as high as $122 apiece this morning? No: that’s mainly just a function of the fact that it’s all in the hands of the day traders and the speculators right now. And the fact that if you buy the right hot internet stock even at the very top tick of the day, you can still make a fortune over the long term.

Take Baidu, for instance, the post-bubble record holder when it comes to first-day pops. It went public in 2005 at $27 per share, and closed that day at $122.54 — a gain of more than 350%. Today, it’s trading at $134 per share. Which might not seem like much of a gain, until you realize that there was a ten-for-one stock split last year: it’s up more than ten times from that IPO-day high point.

My feeling is that LinkedIn is going to remain hot until Facebook goes public and it’s no longer the only way for most investors to buy shares in a social network. I’ve had two conversations with LinkedIn fans over the past couple of days, and I still don’t really understand what they see in the company, or the website, beyond the fact that it’s a good way of finding and vetting possible employees or business partners. Which, admittedly, is a great niche to be in, if you can monetize it somehow.

And even at a capitalization of $10 billion, LinkedIn could still be acquired quite easily by Facebook, especially after Facebook goes public. And that is going to be a hot IPO. Maybe if they price it at a $70 billion valuation, it’ll be worth $150 billion by the time the day is out.


uh – tiger4 – work on your game….very obvious.

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