Blackstone went up! Right?

Posted by Marc Hodak on June 24, 2007 under Invisible trade-offs | Read the First Comment

You’d think that the financial press would understand, you know, finance…until you read stories with headlines like “Blackstone IPO Rallies 13% On a Down Day.”

First, what happened: Blackstone’s investment bankers priced their shares at $31 to those subscribers lucky enough to be let in on the IPO, pre-trading price. At Friday’s open, those shares immediately began trading at $37. They jumped up to $38, before quickly settling down to about $36, finally easing down to $35 by the end of the day. The rest of the market also started with an upward blip shortly after the opening, only to meander down over the course of the day, finishing down about 1 percent.

Next, the story around what happened: Most of the press counted the IPO subscription price as the starting point, and the final price after the first day of trading as the end point in their calculation, yielding the aforementioned 13 percent gain. They noted this gain in contrast to the decline in the overall market.

Here’s my version of the story: The investment banks under-priced Blackstone’s IPO, distributed to their favored clients, by about 15 percent. The floated shares subsequently lost about 5 percent of their actual market value on the first day of trading. This loss was greater than the overall market decline, suggesting either a high beta or significant disappointment.

The details behind my version are no mystery to those somewhat familiar with the workings of our financial markets. The investment banks invented a non-market price of $31 per share in the initial distribution of shares. That invented price was deliberately below the fair market value of those shares. Why would the banks deliberately underprice the shares of their IPO clients? To create above-market demand, or “interest,” in those shares among their trading clients, the institutional investors to whom those shares got distributed. Wouldn’t Blackstone, a sophisticated and powerful financial firm, feel short-changed by having their IPO shares discounted? Apparently not. Blackstone’s principals believed in the need to insure that their shares would float without sinking below the subscription price, no matter what happened to the rest of the market on the first day. That’s why IPO clients like Blackstone provide only a fraction of their shares for initial sale–so only that fraction suffers the discount, and the remainder of their holdings realize their full market value as the shares float to their correct price. The investment banks naturally get the added benefit of being able to reward their favored clients, those who create beaucoup trading profits, with discounted shares.

None of this is a mystery to any of the participants in the IPO process, or to the business press. So, why would anyone compare the final price of a trading day–a market price–to the price set for the IPO at the time the shares were distributed–an invented, below-market price? Because the writers don’t know this version of the story? Because they don’t want to embarrass the big IBs or their clients? Because they need to insult the intelligence of their readers so as not to confuse them with a back story to accompany the “story” they’re hearing from their media competitors? I’m sure there is a set of facts behind the media side of this story of which I am as ignorant as the media reps appear to be about the workings of financial markets.