News outlets tend to report high-profile IPOs using sensational headlines such as, “Uber may be the biggest IPO bust ever,” or “Beyond Meat is most successful IPO of 2019 so far.” These headlines highlight an issue: how should the success of an IPO be measured? There is no single right answer, because an IPO affects multiple stakeholders—each with different goals. This article explores several ways stakeholders can measure the success or failure of an IPO.
Realization of Strategic Objectives
When a company goes public, each stakeholder develops strategic objectives. The extent to which these objectives are realized plays a large role in determining an IPO’s success. A board of directors may be looking to enhance its company’s brand recognition and secure long-term equity financing before its preferred financing from private investors dries up. Early-stage investors and founders may be seeking liquidity, late-stage investors may be focused on a high return, and institutional investors may simply want a consistent return for their portfolios. Investment bankers, who only get paid if the IPO is successful, will prioritize completing the IPO in a way that also bolsters their reputation.
Some IPO objectives are publicly stated, and success is easily measured. For example, Pinnacle Foods was undoubtedly successful in meeting its objective in the “Use of Proceeds” section of its 2013 S-1 filing, which stated that all $520 million of its expected IPO proceeds would be used to repay debt. When it went public, Pinnacle raised $580 million—more than enough to fulfill this promise to creditors.
Other objectives, such as the expected return for investors, are not publicly disclosed. However, the extent to which these implicit objectives are realized can be measured by commonly reported metrics, such as a company’s first day pop, relative market multiple, offer-to-current return, and ability to meet analysts’ forecasts. Other measurements are more qualitative in nature, such as whether an IPO was well executed or the extent to which an IPO enhances a company’s brand awareness, reputation, and credibility. The following six sections will highlight the pros and cons of these measures of success and illustrate how they can help stakeholders determine whether their strategic goals have been realized.
1. First Day Pop
One of the most cited indicators of success is the “first day pop”—i.e., the increase between a company’s opening and closing trading prices. This phenomenon, known as underpricing, reveals the extent to which a stock’s IPO price is undervalued.1 Ironically, even though news outlets often hail IPOs with high “pops” as successful, first day jumps in stock price also represent lost capital for the company. For example, when LinkedIn went public in 2011, it experienced a first day pop of 109 percent. However, if LinkedIn’s shares had not been underpriced, it could have raised an additional $380 million.
Although a large first day pop could be bad news for an IPO company seeking to maximize fundraising, underpricing can provide several indirect benefits. For example, a high first day pop strengthens company-investor relations because IPO investors benefit most from the increased stock price. These relationships are particularly important for a successful follow-on2 or secondary3 offering. A high first day pop also tends to generate more positive publicity—something that LinkedIn took advantage of by growing its user base more than 60 percent in the year of its IPO.
Although underwriters are usually paid a percentage of IPO proceeds, which are reduced in the event of underpricing, they too can indirectly benefit from a first day pop. Because both underwriters and their clients often anticipate underpricing, underwriters can more easily fully subscribe or even oversubscribe an IPO, which can boost their reputation in the IPO market. Furthermore, underwriters can reward favored clients with a larger portion of the offering, after which these clients are more likely to refer others to the underwriter for future deals.
Despite reducing both the IPO proceeds raised by the company and the fees collected by underwriters, underpricing remains pervasive in practice.4 This fact indicates that the indirect benefits of underpricing often outweigh the direct costs. Therefore, companies should carefully analyze the potential benefits of underpricing when pricing their offering.
2. Multiple Relative to Market
Another way to measure the success of a company’s IPO is its valuation multiple, as derived from its offering price, relative to the valuation multiples of comparable companies. In the following chart, CB Insights compared the valuations of Snap, Facebook, and Twitter at the time of each company’s respective IPO using a trailing price-to-sales multiple.5
Valuation multiples like the one above help gauge investor expectations for a company. A higher multiple generally indicates greater expectations for growth in the future. Therefore, companies or even investors may set specific multiple targets leading up to an IPO based on the multiples of similar companies. However, comparisons of one company to another are often difficult because companies choose to go public during varying stages of growth, economic conditions, or levels of profitability. As we can see, Facebook, Twitter, and Snap—all social media companies—were clearly at different stages of growth and profitability when they went public. The following table compares their age, sales, and profitability at the time of IPO:
The contrast in company performance alone clearly differentiates these companies, even if the economic condition surrounding their IPOs is assumed to be identical. Facebook was relatively mature compared to Snap when it went public and was more profitable than either Snap or Twitter. A higher valuation multiple, therefore, may not be capable of indicating a successful IPO on its own, but it can still convey market expectations to investors and provide benchmarks for the company in achieving a desired valuation before and after an IPO.
3. Offer-to-current Return
The offer-to-current return offers a long-term measure of success, in contrast to the methods above. This measure represents the cumulative return captured in the growth from the initial IPO price to the current market price. It is most useful in the years following an IPO to determine how well a company capitalized on its IPO. For example, both Fitbit and Ferrari went public in 2015 with first day jumps of nearly 50 and 13 percent, respectively. Given that information, most news outlets would claim that Fitbit had the more successful IPO. However, the graph below tells a different story.
In the years following their IPOs, Ferrari clearly outperformed Fitbit, which may indicate that its IPO was actually the more successful of the two.
Because of its long-term perspective, the offer-to-current return is a helpful measure for institutional investors who bought into an IPO expecting a long-term return on investment. Furthermore, the measure is relatively easy to modify for risk if investors wish to evaluate a company’s performance on a risk-adjusted basis. Investors may use varying methods to adjust for risk, but the purpose of the adjustment is to capture a company’s return relative to its volatility. Common measures of risk-adjusted return include the Sharpe ratio6 and Treynor ratio.7
Regardless of how investors measure a company’s post-IPO return, it may be difficult to pinpoint the time at which a company’s performance is no longer linked to the outcome of its IPO. What could be an extremely successful IPO by any other measure may become irrelevant to company performance ten years later as market conditions shift, or as the company goes through other transformative transactions. Another issue is that the offer-to-current ratio requires the passage of time before it can be used to measure an IPO’s performance. Investors who desire more immediate feedback may therefore prefer a different measure.
4. Meeting Analyst Forecasts
In May of 2019, Pinterest suffered bigger losses than expected in its first post-IPO earnings report—its stock price immediately plunged 14.1 percent. In August of 2019, Uber also released its first post-IPO earnings report and was likewise unable to meet expectations—its stock price fell by 12 percent. Failing to meet analyst forecasts is not always punished so harshly, but when such a failure comes immediately after an IPO, companies should expect a strong reaction from the market. In part, this reaction occurs because forecasts are set by the company itself during the company’s roadshow, when company executives present to investors and lay out expected performance for the next eight quarters. Investors who buy into an IPO do so with the expectation that these targets will be met. If the company fails to meet these forecasts, future performance is cast into doubt and investors feel betrayed.
Since failing to meet analyst forecasts is one of the worst things a company can do immediately after its IPO, an important measure of IPO success is a company’s ability to meet analyst forecasts for at least eight quarters following its IPO. These two years are a testing period during which a company proves itself to the public market and gains credibility in the sight of investors and analysts. Pinterest and Uber failed in this respect, and both companies are still trying to regain the trust of the market.
5. IPO Execution
Generally, an IPO is considered successful when it goes according to plan; unfortunately, many companies run into problems during the IPO process that—even if nonfatal to the IPO—can certainly harm a company’s image or at least curtail the excitement of stakeholders. The following examples illustrate this concept:
- In 2006, Vonage created a platform that allowed existing customers to buy stock prior to its IPO. However, as reported by the Wall Street Journal, a system glitch led many customers to believe their orders did not go through. After the IPO, when the share price had already dropped 30 percent, these customers were notified that their orders had been fulfilled at the IPO price. The consequent class-action lawsuit was later settled in 2009.
- In 2012, the Nasdaq exchange experienced technical problems during Facebook’s IPO that delayed trading and filled some orders at incorrect prices. Soon after the technical glitches, news emerged that large investors may have been informed of a decline in Facebook’s internal growth estimates, and Facebook was accused of trading insider financial information. These troubles may partially explain Facebook’s rough first year of trading.
- In the weeks leading up to its scheduled IPO, WeWork’s valuation dropped from $47 billion to under $5 billion after its corporate governance policies and potential for future profitability were brought into question. As a result, WeWork eventually canceled its IPO, and its founder, Adam Neumann, stepped down as CEO.
Even with unexpected challenges, companies can still have a successful IPO. For instance, just weeks before its anticipated IPO in October of 2018, Tencent Music chose to delay its IPO until December due to market downturns and trade tensions between the U.S. and China. Despite the delay, Tencent raised $1.1 billion in its IPO, which was largely considered a success.
6. Improved Visibility, Reputation, and Credibility
Visibility. Prior to going public, many private companies remain relatively unknown to the broader market. This makes improved visibility a major benefit to going public. The extent to which a company’s visibility increases could be a measure of the IPO’s success. For example, Google Trends reported a 10x increase in search interest for Beyond Meat leading up to its 2019 IPO. Even now, Beyond Meat continues to generate search interest 2-3x higher than in the months prior to its IPO, clearly indicating a level of success.
Reputation. Beyond mere visibility, perhaps the most important indicator of a successful IPO is the degree to which it improves a company’s reputation. Beyond Meat also succeeded in this area by branding itself as a leading provider of plant-based meat substitutes, securing precious market share, and gaining customer loyalty before competitors could react. Although many plant-based alternatives have since tried to capture profits, Beyond Meat has cemented its place as a top competitor in the industry for years to come.
Credibility. Public companies must follow stringent regulatory requirements and listing standards, which enhance credibility and give investors and analysts better information to rely on. Part of a successful IPO is a company’s ability to meet these stringent requirements without losing credibility. WeWork’s attempt at an IPO clearly illustrates the harm that comes to both credibility and reputation when a company fails to meet the regulatory rigor of the public markets. While preparing for its IPO, not only was WeWork’s potential for profitability cast into doubt, but its corporate governance structure was also deemed unworkable. Reports emerged that WeWork’s CEO, Adam Neumann, owned many of the buildings leased by WeWork, received millions in loans directly from the company, and was guaranteed stock with twice the voting power of other CEOs. These facts, combined with reports that Neumann created a culture of partying and drug use, caused Neumann to step down as CEO and WeWork to withdraw from its IPO. WeWork’s credibility and reputation remain tarnished, negatively impacting not only the company, but also investors, employees, and underwriters who were associated with the IPO.
Measuring the degree to which a company’s IPO increases its visibility, reputation, and credibility could take on many forms. However, simply reading the news may be the simplest and most accurate indicator of a company’s success in this measure. The positivity and confidence with which major analysts and news outlets refer to a company will undoubtedly influence the opinion of many stakeholders and may ultimately determine whether an IPO is successful.
Which measure best reflects an IPO’s success or failure depends on the objectives of the stakeholder in question. Because IPOs rarely satisfy the objectives of all stakeholders, most IPOs will be judged a success by some and a failure by others. This article demonstrates the benefits and drawbacks of common measures of success while highlighting competing objectives and priorities. Certain measures will be more helpful for some stakeholders than for others. Often, a combination of several measures will provide the most holistic view of an IPO.
- According to B. Espen Eckbo of Dartmouth College, “Most of the underpricing is evident by the closing of the offering day.” See Eckbo’s article “Initial Underpricing of IPOs” for more information.
- A follow-on offering, also referred to as a seasoned offering, takes place when a company issues shares to the public following its IPO. Typically, these shares are newly issued and dilute existing shareholders.
- A secondary offering takes place when an existing shareholder, such as a company’s founder, sells a large block of shares to the market. These offerings do not dilute shareholders because the shares were previously issued, likely in an IPO. Secondary offerings must be filed with the SEC and commonly take place in the years following an IPO once the lock-up period has expired.
- Over the last decade, IPOs have averaged underpricing of 16 percent. See Jay Ritter’s IPO Statistics for historical IPO underpricing data.
- Trailing price-to-sales is a measure of the last 12 months of sales per share relative to the current stock price. Because many growth companies are unprofitable, the denominator includes sales rather than earnings.
- The Sharpe ratio is calculated as follows:
7. The Treynor ratio is calculated as follows: