Wall Street never ceases to amaze in its greed and hypocrisy. The latest example is Morgan Stanley’s downgrade July 11 of Snap, Inc. the parent company of Snapchat.
You may ask why this matters. Wall Street analysts downgrade and upgrade companies all the time.
Well just over four months ago Morgan Stanley was one of the lead underwriters, along with Goldman Sachs, that brought Snap public at $17 per share, with the first actual opening trade at $24 per share. (A good explanation of the IPO process can be found HERE). That means if you were an institutional or super-high-net-worth client of either firm, you may have been allocated shares priced at $17. However, if you were Joe or Jane Blow and you wanted to buy SNAP you’d have to pay $24 at the opening.
At that time Morgan Stanley had an outperform rating and a price target of $28. Amazing how in such a short period of time their opinion can change so much because it now has an equal-rating weight and price target of $16. They don’t like the stock at this point, but they don’t dislike it enough to tell you to sell it; that would be bad for their business because Snap is an investment banking client.
Why Companies Go Public
So why do companies go public? The business purpose is to raise capital, which can be used to expand operations, hopefully increasing revenue and income growth. That is why you want to own stock – to own a portion of the increasing profits.
However, a non-business result of going public is the creation of a public market for the previously private shares of founders and early investors. While this is a natural result of going public, Main Street should tread carefully when investing in IPOs if not allocated shares by a broker.
If the insiders are selling, do you want to be buying at the opening bell? If it is a good company, maybe. Heck, maybe even Snap will turn out to be a good company/investment in the future, but the moral of this story, and others that came before it is that Main Street likely shouldn’t pile into IPOs on the first trading day. It may not be best to invest until the insider lockup period ends.
Every IPO is different, but after an initial block is sold during the initial offering, insiders are not permitted to sell any additional shares for a certain amount of time, called the lockup period. In the case of Snap, after the IPO, insiders had lockup periods of 150 days, 180 days, and one year.
Main Street Investors Better Off Waiting
The largest slug of shares that can be sold will be at the end of July and end of August. With that much supply flooding the market, will the shares fall more? Maybe, or maybe insiders won’t be happy with the price at that time and they will hold onto shares hoping the price goes up. Either way, studies have shown that Main Street would be better waiting to find out, as opposed to piling into shares the first day of trading.
Professor Jay Ritter at the University of Florida has done some amazing research on investing in IPOs and the resulting performance. I suggest reading his work HERE before making any IPO purchase decisions.
Our public markets are important. They allow companies to find capital to expand, and allow us ownership in those companies, which can increase our net worth and standard of living. However, there are flaws in this system that we need to be aware of. By understanding these flaws we become better investors and give ourselves the best opportunity to achieve our financial goals.
If you do own Snap, take solace in the fact Goldman still maintains a buy rating and a price target of $27.