Monthly Archives: May 2011

two stages in a US prospectus: preliminary and final

May 25, 2011 By in preliminary and final prospectuses Tags: , , , , , , , , Leave a comment

As long as I’m writing about IPOs, I thought I should make a comment about prospectuses.

hire an investment bank; prepare a prospectus

In the US, the first step on the road to offering securities to the investing public (“going public”) is to hire an investment bank to act as lead underwriter.  The underwriter will, among many other things, help the firm create the prospectus, an offering document that discloses to potential investors all material and relevant company information.

There are two stages in the life of a prospectus:  the preliminary and the final.

file the preliminary prospectus with the SEC

Once the prospectus is completed, it’s marked as preliminary and submitted to the SEC for approval, in a form S-1, or registration statement. 

Here’s the one LNKD filed. If you scroll down past the cover page of the S-1 to the prospectus itself, you’ll see that the first page has a lot of blanks, where the offering price and number of shares will eventually be filled in.  As well, there’s a narrow band of bright red print at the top.  It’s the following notice:

“The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

PROSPECTUS (Subject to Completion)

Issued January 27, 2011”

becoming “effective”

The SEC staff reviews the preliminary prospectus for compliance with the disclosure requirements of US securities laws.  It may ask the filing company for further detail or clarification.  Once the agency is satisfied, it declares the prospectus as “effective,” or in legal compliance.  When this happens, the prospectus may be distributed to potential investors.  But it’s still preliminary and contains the red warning notice.

the sales campaign

The preliminary prospectus is the main sales tool for the IPO.  One or more teams of top company management members may tour the country meeting investors, either one-on-one or in large groups.  There may be “virtual” meetings through audio or video conference, as well.  But these events tend to be heavily rehearsed and scripted.  The issue?  The prospectus is supposed to contain all material information about the offering.  So the last thing the firm’s legal advisers want is for some company representative to make an off-the-cuff remark that’s not in the prospectus, that someone later on tries to construe as relevant.

the IPO date; the final prospectus

Investors give their indications of interest.  The underwriter buys the issue from the company and resells it to clients (this is a more convoluted process than it seems, but that’s a topic for another day).

Only then does the final prospectus appear.  It’s distributed to investors after they’ve already bought stock.

Here’s the final prospectus for LNKD.   Note that the blanks have been filled in and that the red warning label, which includes the key statement:”is not complete and may be changed” has been removed.

the significance of “final”

In my experience, everyone does analysis of an offering using the preliminary prospectus.  When the final comes, it’s just stuck in a file–unread.  Legally, however, the final prospectus is important.  It is the official, complete disclosure of all facts relating to the offering.  Technically, investors have a short period of time in which to read the final.  They can return the stock to the underwriter if they don’t like what they see.

I’ve never heard of a case of an investor exercising this right.  My impression is most investors are unaware they can do so.

preliminary and final aren’t always the same

Nor do they know that last-minute changes to the prospectus can be inserted into the final that aren’t in the preliminary.  I’ve only seen this happen once.

Armand Hammer, the corporate buccaneer who was CEO of Occidental Petroleum years ago, decided to spin off IBP, a meatpacking subsidiary, in 1987.  The final prospectus revealed that Occidental had allocated to IBP an extra $1 billion in corporate debt above what was stated in the preliminary.  The move made the deal worth about 10% less, by my reckoning, than the preliminary prospectus made it seem.

Not a nice thing to do.  Not something calculated to make you ever trust anyone associated with the deal again, ever.  But, however ethically suspect, legally permitted.  This would have been a famous incident, and might have spurred regulatory changes, had the IPO not come in mid-October, the week before the crash on Black Monday.


“LinkedIn Scammed”–what were you thinking, Joe?

May 24, 2011 By in Current Market Thoughts, hedge funds, Industry Analysis, internet, Investment firms Tags: , , , , , Leave a comment

“Was LinkedIn Scammed?”

A friend who’s a regular reader asked for my comments on the LinkedIn article that reporter Joe Nocera wrote for the op-ed page of the New York Times last Friday. (See my post describing the offering.)

Nocera’s comments about LinkedIn

The article makes two assertions:

–underwriters Merrill Lynch and Morgan Stanley (I don’t know why JP Morgan, listed as a first-rank underwriter on the prospectus, isn’t included)  “scammed” LKND–which is an NYSE stock, by the way, despite the four-letter ticker symbol.  They deliberately priced the IPO too low, he says, in order to shift tens, maybe hundreds, of millions of dollars out of the pockets of LKND and into those of favored clients.

–this damaged LKND, for whom the money left on the table may one day be the difference between success and Chapter 11.

Wow!!  Strong stuff.  What’s the evidence?  I can’t see much.

my thoughts

general

Of course, anything’s possible.  And I think it’s clear that the sell side’s primary loyalty is to its largest brokerage customers, not to one-time investment banking clients.  But the acknowledgement of status involved in dispensing and receiving a large allocation of a “hot” IPO is, to my mind, far more important to the broker-client relationship than whether the price is $45 a share or $65.  For large clients, the money difference is a rounding error in their performance calculations.

In addition, I don’t see why an industry so deeply distrusted by most Americans and under continuing scrutiny from Washington would take the chance of deliberately mispricing an offering–especially when campaigning for the next election has already begun.  Also, why jeopardize your chances of being in the running to manage the really big social networking IPOs, like Facebook or Groupon?

the example of Renren (RENN, also a NYSE stock)

LKND followed close on the heels of RENN, a Chinese social networking stock that came public on May 4th.  RENN was priced at $14.  It opened at $19.50, quickly reached a high of $24 and closed that day at $18.01.  But by the time LKND was being priced, RENN had fallen below its IPO price–the last thing any party to a public offering wants to see.

RENN had to be an argument for more cautious pricing of LNKD.   It suggests, as well, the jury is still out on whether LNKD should have been priced more aggressively than it was.

the LNKD valuation

LKND earned $.17 a share last year.  At the initial suggestion of a $32 offering price, that would have been a PE of 188x.  At $45, the actual IPO price, the multiple is 265x.  Is Mr. Nocera actually saying the stock should have been priced at 350x earnings?

is LNKD hurt financially by an IPO price of $45, instead of, say, $60?

an opportunity loss of $90 million?

In one sense, yes, because at $60 a share, LNKD would have taken in $340 million or so instead of $250 million.  But at $60 the risk of a failed IPO would have been higher.  Remember, too, that LNKD wasn’t exactly a babe in the woods.  It had a list of professional investors who were already shareholders that it could call on for advice.  Goldman was the only one to take the money and run, but still…

Use of Proceeds

There’s a section of any prospectus called “Use of Proceeds.”  When I looked at this section of the LNKD document, I almost started to laugh.  I’ve never seen a company struggle so much to explain what they’re going to do with the money.  Here’s a sample:

“The principal purposes of this offering are to increase our capitalization and financial flexibility, increase our visibility in the marketplace and create a public market for our Class A common stock. As of the date of this prospectus, we cannot specify with certainty all of the particular uses for the net proceeds to us of this offering. However, we currently intend to use the net proceeds to us from this offering primarily for general corporate purposes…”

In other words, LNKD can’t imagine how it will spend the money.  By the way, the company already had over $100 million on the balance sheet on March 31st and had just started to generate enough cash flow to cover all its expenses.

employee stock options gain $1 billion+ in value

What LNKD really needed was a way for its 990 employees to cash in the tons of stock options LNKD has issued to them (page F-24 of the prospectus tells us that there are 16+ million of them, with a weighted-average exercise price of $5.86).  That works out to over $1 million apiece–a billion dollars in compensation that LNKD doesn’t have to come up with itself.

lapses in logic

Mr. Nocera asserts that the investment bankers “with their fingers on the pulse of the market, absolutely must have known” that LNKD would double on the first day.  He forgets to mention that the only investment bank among the insiders, Goldman, cashed out completely at $45.

He starts out the article by saying that during the past decade investment banks routinely tricked their institutional clients into buying dud securities at wildly high prices.  He then uses this as support for the assertion that Morgan Stanley and Merrill are now doing the opposite.  Huh?

Mr. Nocera cites two “authorities” in support of his contentions.  Both are web postings.

One is by an employee of social games maker Zynga.

The other is by Henry Blodget, the former Merrill internet analyst who is barred from the investment industry for having lied, in glowingly positive reports, about his negative investment opinion for companies under his coverage.     Maybe Bernie Madoff was unavailable.

All in all, not your best day, Joe.




the big three Las Vegas casino companies

May 23, 2011 By in Asian economic development, Casinos, China, economics, Entertainment, Hong Kong, Industry Analysis, Lodging, Recent Market Action, Stock ideas Tags: , , , , , , , , , , , , Leave a comment

My post last Friday outlined the upcoming IPO for MGM China, which will show us the Hong Kong market’s view of the value of MGM’s Macau exposure.  At the top of the price range for the IPO (already specified by the HKSE), and based on last Friday’s closing prices, a 51% stake in MGM China would be worth about $4 billion (all amounts are in US$) and would represent just over half of MGM’s market capitalization.

A reader asked what the rest of MGM–its Las Vegas interests–might be worth.  That’s not an easy question to answer.  So I thought I’d write about what I think are the significant issues for all three of the big casino operators in the Las Vegas market.

the basics of the big three Las Vegas gambling companies

All three have subsidiaries in the booming Macau market.

All three are situated on the Las Vegas Strip, where about half the city’s 149,000-odd hotel rooms are located.

In addition to their expansions into Macau, all three have made major hotel/casino capacity additions in Las Vegas over the past few years–just as the economy was peaking.  These were all multi-billion dollar projects, funded primarily with debt.

three points about Macau

1.  This market is already many times the size of Las Vegas, measured by the amount of money bet in the casinos.  So far this year, Macau gambling is expanding at a 40%+ rate.  I think the market will get to at least double the current size before it gives any sign of maturing.

2.  The obvious source of profits to each of the Las Vegas parents is its share of the Macau subsidiary’s profits.  But that money isn’t readily available for use in the US.  For one thing, it will likely remain in Macau to fund expansion there.  For another, the way shareholders receive income from their stocks is through dividends, which have to be declared by the management (only Wynn Macau has done so) and would be subject to US corporate tax if repatriated.

3.  WYNN, LVS and MGM all receive management fees from their Macau operations, in return for their operating expertise and for the use of their brand names.  This is the partents’ major source of cash from the subsidiaries.  In 1Q11 these fees amounted to $34.5 million for WYNN, $23.8 million for LVS and $38.0 million for MGM.  (The LVS number seems too low to me, but that’s what’s in the company release.)

the Las Vegas problem

It’s hotel room overcapacity, specifically in the high-end rooms on the Strip where the big three are.

In 2006, the Las Vegas market had 132,600 hotel rooms and served 38.2 million visitors.  By last year, visitor numbers had shrunk to 37.3 million, but expansion projects had increased the number of hotel rooms to 140,429.  Together, the need to repay construction debt and the fact that the out-of-pocket costs to a hotel from having a room occupied for a night are less than $20, mean price competition to sign up guests has been wicked. The Strip accounts for about half the room base, but virtually all the expansion—so the trouble has been most acute there.

Although the situation for the big three is gradually improving, I think it could be several years before the market grows into the existing capacity.

valuing the big three (all capitalization figures are as of the close on 5/20/2011)

  • WYNN:  The company’s market cap is $18.1 billion.  Its Macau holdings have a market value of $12.6 billion, leaving a $5.5 billion value assigned by the markets to the Las Vegas operations.  In 1Q11, WYNN was right around breakeven in the US, with $60 million in cash flow.  IN the US, WYNN has $87 million in cash on the books and $2.6 billion in long-term debt.
  • MGM:  The company’s market cap is $7.5 billion.  Its Macau holdings are likely worth $4 billion, leaving $3.5 billion in value assigned by the markets to the US operations–which are all over the place, but mostly in Las Vegas.  In 1Q11, MGM operated at a loss but had positive cash flow from operations of about $24 million.  The balance sheet showed $431 million in cash and $12.1 billion in long-term debt.  Until the IPO documents are available in the US, we won’t know how much of either of the last two figures is attributable directly to MGM China.
  • LVS:  The company’s market cap is $30.4 billion.  Its Macau holdings have a market value of $15.1 billion, leaving $15.3 billion in value assigned by the markets to Singapore + the US.  In 1Q11, US operations appear to me to have made a loss but hovered around breakeven on a cash flow basis.  The balance sheet shows $3.1 billion in long-term debt against US operations and just under $800 million in preferred stock.  The biggest issue with LVS is how to value the Singapore operations, which are in their infancy and which are wholly-owned by LVS–so there’s no separate market quote.  A very simple approach would be to say that Singapore is earning about 20% less than Macau, and apply a Macau multiple to Singapore operations.  Since LVS owns 100% of Singapore vs. about 70% of Macau, this would imply all the $15.3 billion is being allocated to Singapore and the US is in effect worth zero.

my thoughts

Take WYNN first.  It’s the strongest company of the three, with its finances under much better control than the other two.  Still, are the Las Vegas operations, generating $250 million in cash flow at an annual rate, but servicing $2.6 billion in debt, worth paying 22x cash flow for?  I’d prefer 10x.

I see two possible justifications for the current WYNN valuation:  the consensus expects a faster recovery in Las Vegas than I’m thinking, or (more likely, in my view) US investors regard WYNN as a more liquid and easier to buy version of Wynn Macau, and are willing to pay a premium to the Hong Kong price, simply to get exposure.

MGM.  If you’ve read any of my previous posts about gambling in Macau, you know I find having to be a business partner with the Ho family to be a deal-breaker.

The hedge fund Paulson & Co has recently become a large shareholder in MGM, apparently betting on the large upside leverage MGM will have as/when Las Vegas turns for the better.  After all, the company owns a ton of Strip real estate.  Over the years, it bought the former Mandalay Bay as well as Mirage Resorts, and has built the gigantic CityCenter complex.  Still, $12 billion in debt and cash flow of $110 million a year are a very risky cocktail to be involved in.  Too risky for me.

LVS.  This company’s financials are almost as complex as MGM’s, but I find it much more intriguing.  Depending on how you value the Marina Sands in Singapore, you could think–as I suggest above–that the present stock price gives you the US operations for free.  …less than that, if you buy the argument that LVS should trade at a premium to the value of its Asian holdings because its the only liquid and convenient way for Americans to buy them.

Yes, there’s $3.1 billion in debt linked to the US casinos + construction obligations that were suspended during the darkest days of 2008.  But management fees from Macau and Singapore seem to me to be potentially large enough to service the debt, even without an uptick in the US business.  Not for widows and orphans, however.

By the way, I own WYNN, Wynn Macau and a little bit of LVS.





LinkedIn IPO: sign of a second internet bubble? three reasons I don’t think so

May 22, 2011 By in Current Market Thoughts, Industry Analysis, internet, Private equity, Recent Market Action Tags: , , , , , , , 2 Comments

the LinkedIn IPO

Class A shares offered

Social networking company LinkedIn (LNKD) went public last Thursday, offering 7.8 million Class A shares.  According to the preliminary prospectus, 4.8 million of them were new shares sold by the company;  the rest were secondary shares sold by existing stockholders.

LinkedIn also has Class B shares, which differ from Class A mostly in that each has 10 votes while Class As have one apiece. This is a standard device used by family-owned or other closely held firms to raise public money and have a listed stock, while retaining complete control over operations.  News Corp., Hershey and Google are other US examples.  In the case of LNKD, the insiders who own Class Bs still muster 99.1% of the corporate votes, making the class As, in my mind, more like preferred shares than common.  For Thursday and Friday, though, no one cared.

pricing and initial trading

Underwriters initially talked of an offering price in the low thirty-dollar range–maybe $32.  But as they saw the strength of investor demand for the issue, the number gradually rose to $45.

The opening trade for LNKD was $83.  The day’s low was $80, the high $122.70.  The stock closed at $94.25, on volume of 30+ million shares–meaning each share changed hands 4x on average during the day.

I was in PA

I was driving to Pennsylvania while this was going on, listening to the Bloomberg Surveillance program on satellite radio.  The reporters on the broadcast commented a number of times that this felt to them like Internet-Bubble activity of late 1999-early 2000.  When I got home, I read similar comments in the Wall Street Journal and the Financial Times.

How quickly they forget!

Yes, there are some similarities.  Both then and now are periods of very easy money policy, and extra money sloshing around the system invariably gets into speculative mischief.

But the late-1999 Fed had the money taps wide open in spite of economic strength, not like today when the central bank is fighting to reduce sky-high unemployment (how effective today’s Fed policy can be is another question).

Y2K

If you recall, the Fed’s big worry back in 1999 was Y2K–the possibility that every computer in the world would shut down at midnight on 12/31/99, stopping commerce everywhere dead in its tracks (kind of like the Lehman failure did in 2008, only worse).  That would supposedly have left us with blue screens, warm refrigerators, stuck elevators, dead machine tools and ATMs that refused to give out cash.  All our financial information might be wiped out.

In 1999, Amish farmers couldn’t replace worn out horse-drawn plows, because survivalists preparing for this potential Armadeggon bought them all up.  Silver coins were trading at 10x face value, on the idea that paper money would be worthless as developed economies fought to avoid sinking back into pre-industrial chaos.

The Fed injected a lot of extra money into the system to help ease any Y2K damage–none of which occurred.

three big stock market differences:

1.  cult of the internet back then

In late 1999-early 2000, the US stock market was flooded with internet-related IPOs.  Many of these firms had no actual businesses and little more than business plans (sometimes, not even that).  In normal circumstances, they would be looking for venture capital financing.  At investor meetings, which had a cult-like quality to them, company executives focused on concept, not near-term business prospects.

Even a survivor of the subsequent dot.com meltdown like Amazon didn’t make money back then.  The company wouldn’t turn profitable until 2003, and had negative net worth until two years later.  In my opinion, Amazon only made it because it had large follow-on offerings of stock and bonds.  But very many more, like eToys or Boo.com, went out of business as soon as they burned through their IPO proceeds.

It wasn’t just crazy IPOs, either.  At the peak of the frenzy, media conglomerate Time Warner traded half its assets for a near-worthless AOL.

In contrast to the hundreds and hundreds of highly speculative transactions in 1999-2000, in 2011 there have only been two questionable ones that I see:  the first-day price of the LinkedIn IPO, and Microsoft’s purchase of Skype.

2.  wild overvaluation in 2000…

…in the TMT sector…  internet-related stocks as a group were known as Technology-Media-Telecom (TMT) stocks.  They made up a significant chunk of the overall US stock market, even before the buying frenzy began.

As I mentioned above, many e-commerce stocks had no earnings at al–and therefore no meaningful PEs.  More mature companies did have earnings, though.  And they were priced through the roof.  At the peak, Qualcomm was trading at 177x its 2000 profits; smaller chipmakers traded at even higher multiples.  Staid, slow-growing, highly cyclical communications equipment providers, like Ericsson and Alcatel traded at 137x and 110x respectively.  Similar “hot” names like Nortel no longer exist.

Brokerage house analysts like Henry Blodget (since barred from the securities industry and now a blogger) and Mary Meeker (now in vc) whose horribly inaccurate forecasts helped justify the mania, acted like–and were treated like–rock stars.

…and in the stock market as a whole

In March 2000, the S&P 500 peaked at about 28x earnings for 2000.  This compares with a ten-year Treasury yield at that time of about 6%, which would justify a stock market PE of 17.  Relative to bonds, then, stocks were 65% overvalued.

In contrast, the S&P is trading today at under 14x the consensus estimate of 2011 profits.  The ten-year Treasury is trading at a 3% yield, implying a stock market multiple of 33x.  So stocks are 60% below the level implied by bond yields.  Put another way, if stocks are fairly valued, bonds are trading at well more than twice the price history would say they should be.

3.  real rocketship IPOs back then

Yes, LNKD did double from the IPO price on its first day.  So what.  Renren (social networking in China), a first-day star a couple of weeks ago, is now trading $1 below its initial offering price of $14.

If you want to see real IPO action, take a look at UTStarcom (which still exists today).  It debuted in March 2000 at an IPO price of $18.  It closed that day at $68, up 277%, after having reached an intra-day high of $73.  It then proceeded to run up to its all-time high of $93.50–5x the IPO price–before the end of that month.  (It closed last Friday at $2.09–but, hey, it survived, which is more than you can say about most of the dot-com names.)

my thoughts

Yes, there may be overvaluation in today’s financial markets, but I don’t think it’s in publicly traded stocks.  Maybe  privately-traded equities are too expensive.  But that’s a relatively small market whose failure wouldn’t have severe negative consequences for the US economy.  For my money, if you want to see expensive, look at bonds and commodities.


MGM China’s IPO in Hong Kong

May 20, 2011 By in Asian economic development, Casinos, China, Current Market Thoughts, Entertainment, Hong Kong, Industry Analysis, Stock ideas Tags: , , , , , , , , , , , , , 2 Comments

the IPO details

According to Bloomberg, details, including pricing, for the IPO of MGM China, have been set.  MGM China is currently a 50/50 joint venture between MGM Resorts International and Pansy Ho, daughter of Stanley Ho.   The stock is going to debut on the Hong Kong Stock Exchange–presumably next week–through a secondary offering of 760 million shares by Ms. Ho.  The IPO price will be set by underwriters at between HK$12.36 and HK$15.34.

If we assume that the high end of the range represents a 20x multiple on expected 2011 earnings per share, which is where I view Wynn Macau as trading today, that would mean MGM China could earn HK$.75-HK$.80 this year.

timing of the offer is very favorable

The Macau gaming market is booming.  The publicly traded stocks have been exceptionally strong performers, year to date.

the IPO means cash for Pansy Ho, not MGM

In this respect, the offering is different from the listings of WYNN’s and LVS’s Macau gambling subsidiaries, where the shares sold in the offering came from the US-based parent.

a bit of history

Stanley Ho, Pansy’s father, controlled the monopoly casino company in Macau when it was a Portuguese colony.  After the handover to China in late 1999, the government of the new Macau SAR decided to end the monopoly.  It issued a new gaming concession to Mr. Ho, but also awarded one to Wynn Resorts and to Galaxy Entertainment.  Subsequently, each of the three was allowed to sell a sub-concession to another party.  Mr. Ho chose MGM.  He originally proposed a 50/50 joint venture between himself and MGM.  The Nevada gaming authorities apparently told MGM this was unacceptable because of Mr. Ho’s alleged underworld connections, and Pansy Ho replaced her father as the Ho family partner.

structure of the sale

Pansy Ho will provide all the stock being sold.  1% will go to MGM, giving it a 51% stake and making it the majority owner of MGM China.  Another 20% will go to the investing public (Paulson & Co. and Kirk Kerkorian, the largest shareholders of MGM, are together putting in for about 8% of the issue).  It also appears that Ms. Ho has agreed to a 3% overallotment, meaning that the underwriters can increase the size of the issue by that amount, if demand is strong.

So, rather than having a large cash inflow from selling stock, MGM will pay Ms. Ho about US$75 million to gain legal control of the venture.

The news isn’t really so bad for MGM, however.

Not content with keeping the transaction simple, Ms. Ho has apparently agreed to invest several hundred million dollars of her IPO proceeds in securities of MGM Resorts.

Also, pricing at the top end of the range (which is where I would guess the IPO will end up) implies that MGM’s stake in MGM China is worth just under US$4 billion, or about half of the parent’s market cap.  From now on, we’ll probably see the same sort of “tail wagging the dog” effect on MGM shares as we’ve witnessed over the past year with WYNN and LVS.  Given the still parlous state of the Las Vegas market, this is perfectly understandable.  I interpret the recent strength in MGM shares as the start of this behavior.

Pansy Ho’s role in MGM China?

The IPO will confirm Ms. Ho’s status as a multi-billionaire.  Other than that, your guess is as good as mine–maybe better.

As I wrote in more detail a little while ago, in a bizarre sequence of events earlier this year, control of the Ho family gambling concession–by far the largest in Macau, accounting for about a third of the market–appears to have been taken away from Stanley Ho by, among others, Pansy.  Press reports suggest Pansy has resigned from the board of MGM China–though I understand the IPO documents say otherwise.  As I indicated in my earlier post, my reading of the situation is that Ms. Ho wants to present herself as a passive investor in MGM China while she fights for control of the family company.

It’s ironic if the IPO is the vehicle Ms. Ho is using to distance herself from MGM China.  That’s because the IPO seems to me to undermine the argument of the New Jersey gaming authorities that Ms. Ho is completely financially dependent on her father–and therefore unsuitable to hold a casino license.

My guess is that a smaller role in MGM China by Ms. Ho will make little operational difference, and may make both MGM and MGM China more palatable to US investors.