Search Salon

- - - - - - - - - - - -

Recently in Salon Technology Log

Condomania enjoys online growth spurt
[12/10/99]

Click on charity
[12/09/99]

Viva Net glam!
[12/08/99]

Y2Kiss
[12/06/99]

The free PC is dead! Long live the free PC!
[12/03/99]

Complete archives for Technology

- - - - - - - - - - - -

- - - - - - - - - - - -

- - - - - - - - - - - -

In this case, I don't think that happened, either. After TheGlobe.com went public, many brokerages instituted tighter control to make sure this didn't happen again. Most will now not let investors ask to buy a new issue without putting in a limiting price.

So who was it who bought VA Linux at these astonishing pricing?

There's one theory that has gotten a lot less notice than it should. Earlier this year, TheStreet.com's Cory Johnson reported that investment banks were asking institutional investors who got shares in hot IPOs to buy additional shares after trading opened. In other words, a large mutual fund might get 30,000 shares of a hot stock at the low offering price –- but only if fund managers indicated they would buy 60,000 more shares after the stock opened for trading.

"It might not be stated explicitly," says Johnson, "But investment banks will give shares to funds that will buy more shares in the after-market and support the stock."

Why would investment bankers want institutional investors to do this?

Simple. It assures that when trading opens there will be significant demand for the shares. That keeps the price up, gives company insiders a healthy profit, and makes the investment bank that underwrote the offering look good. (It's the investment bank's job to generate investor interest, and there's no better proof of investor interest than a blockbuster first-day opening price.)

Now look at it from the point of view of the mutual fund or other large institutional investor that might have purchased these shares. Let's say Bigshot Internet Fund got 10,000 shares of VA Linux at $30 a share. Then let's say it bought 20,000 shares more at $280 a share. The stock ended the day $239 -– let's say $240 to keep the math simple.

Here's the final result. On paper, Bigshot Internet Fund made $210 on each of the shares it got at the offering price. It lost $40 on each share it bought at $280. That's a $2.1 million paper gain, and an $800,000 paper loss -– a total profit of $1.3 million. So it works out well for everyone involved. The company has a great opening day, the investment bankers look good, and Bigshot Internet Fund still makes plenty of money.

The funny thing is that there's a very good chance that Bigshot Internet Fund sold its low priced initial allocation. In other words, Bigshot Internet Fund could be both buying and selling stock in VA Linux.

I can't prove that's what happened. But right now it sounds like a better explanation than the idea that there are tens of thousands of small investors putting lots of money into a stock that has jumped above $200 –- if only because I can't find those naive investors.

I like this theory, also, on epistemological grounds. The market is a lot more sophisticated than it is given credit for being. It is generally a bad idea to assume that investors who buy a stock do so because they are simply silly or inexperienced. Sometimes, of course, that is the case, but more often it turns out that the market behaves quite rationally, and it is only the observers who are naive.
salon.com | Dec. 10, 1999

- - - - - - - - - - - -

- - - - - - - - - - - -

  Get a printer-friendly version

  E-mail a friend about this article

  Backflip this article to find it again

- - - - - - - - - - - -

Search Salon