The IPO Buzz: Into the Tank

Rackspace Hosting (NYSE: RAX) (Quote, chart, news) a San Antonio-based Web hosting service provider, priced its IPO Thursday evening through a Dutch auction bidding system. The company offered 15 million shares at $12.50 each, on the low end of a $12- to $16-per-share price range. The IPO opened Friday morning at $10, DOWN 20 percent from its offering price.
That’s bear market territory.
And it was the worst opening-day performance by an IPO since the Nov. 6, 2007, offering of Agria (NYSE: GRO) (Quote, chart, news), a Chinese agri-solutions provider. That one got socked with a loss of 26.9 percent. Agria offered 17.2 million shares at $16.50 each and the IPO closed its opening day at $12.06 per share.
Now back to Rackspace and what happened. A couple of things went wrong with Rackspace’s Dutch auction. It ran into a fog of hype and false hope.
The Hype
The hype was fanned by the financial media quoting sources claiming the Rackspace deal was hot, hot, hot and even going so far as to say it would jump-start a faltering IPO market. The sources claimed the deal would be priced at $16 to $17 per share, UP from a filing range of $12 to $16 per share. After all, it was the summer’s only high-profile deal, it was a great company and it would be priced “to sell” — or so the claims went.
(Editor’s note: There is no historical evidence that a single initial public offering has ever “jump-started” a faltering IPO market.)
False Hope
The false hope — fanned by the misinformed — spread to the hedge fund managers as many reportedly placed huge bids for the Rackspace offering at $20 per share.
That looked like a safe bet.
After all, the Rackspace deal was to be “modified” like some of the other U.S. Dutch auctions. The ones that came to mind immediately were Google (GMS: GOOG) (Quote, chart, news) and Interactive Brokers’ Group (GMS: IBKR) (Quote, chart, news). In each case, the allocations to the winning bids were pro-rated (leaving orders on the table) and, in each case, the deals popped on their respective openings.  
The first hint of confusion surfaced when underwriters announced a $12.50-per-share offering price on a $12- to $16-a-share filing range. Many thought it should have been higher. But their nerves were soothed when the allocations were handed out to winning bids on a reportedly 67 percent pro-rated basis.
The first pre-opening bid was reportedly $8 per share. Then the IPO opened at $10 per share -– DOWN 20 percent.
Supply versus Demand
Econ 101 played its hand. Judging from the stock’s opening, the “sell” orders far exceeded those “left on the table.” And the rest was written in red ink.
A bad summer for many suddenly became a disaster.
The Dutch Auction
On Wall Street, you are only as good as your last trade. The Rackspace Dutch auction will be etched in many minds for a long time, possibly forever. The professionals on Wall Street have memories like the proverbial elephant. And they tend to be an unforgiving crowd, to boot.
Only time will tell what will happen with this type of offering in the future.
In the meantime, there is only one Dutch auction in the IPO Pipeline, according to U.S. Securities and Exchange Commission filings. It is Pogo Jet (GMS: POGO proposed) (Quote, chart, news), a start-up regional airline based in Chicopee, Massachusetts. The deal was postponed in mid-March 2008.