As 2014 – which many are dubbing the ‘year of the IPO’ – rolls on, more and more technical terminology surrounding major market floats is appearing in news articles, blogs and reports. One such term is ‘grey market’, which many outlets tend to use to produce a prediction for the value of the year’s bigger IPOs. But how do grey markets work and how accurately can we use them to predict the value of a company as it arrives on the stock market?
What are they?
A grey market allows traders to speculate on the value of a company by the end of its first day of trading in the build up to its IPO. As with post-IPO trading, the price changes according to demand and sentiment, so taking a look at the grey market value of a company can offer insight into what traders believe it might end up being worth.
How accurate have they been?
Overall, as an indicator grey markets can be pretty reliable: for example, over two-thirds of online trading company IG’s grey marketshave ended up within 10% of their predicted price on day one. Last year, traders were on average 16% away from the correct figure.
Just two IPOs were more than 25% away from their predicted values. Weibo, which surprised the market by massively down pricing its shares before launch (and devaluing the business), and Just Eat, which went 26% higher than anticipated, were the major outliers.
After all, IPOs are inherently unpredictable, and not always indicative of a company’s true value. This was exactly the case with Just Eat, whose IPO was unexpectedly popular but faded after. The market cap for the business has moved far closer to the grey market estimation of £1.23 billion over the past few months and is currently sitting at £1.19 billion.
Interestingly, any sign of ‘IPO fever’ or ‘IPO fatigue’ – where traders are either overhyped or exhausted with the new businesses hitting markets – appears to be non-existent. The number of predictions that either overvalued or undervalued their business was split exactly down the middle.
The most accurate prediction was for the downbeat performance of King Digital Entertainment, which lost $1 billion in a dismal first day on the market to end up at £6.03 billion. IG’s grey market foretold a value of £6 billion.
Next came Zoopla, the rental and sales property website that had a far easier debut in June. It managed to attain a value of £960 million value at the end of its first day, just £15 million (or 1.4%) below its predicted £975 million.
It may be that the lack of clear precedent to Weibo and Just Eat impaired traders’ ability to assess their value. Companies similar to King and Zoopla have arrived on the markets in similar ways: with Zynga’s infamous fall and Rightmove’s solid performance are both well known to traders.
No such companies exist for Just Eat or Weibo. Just Eat’s main rival, Hungry House, is owned privately and Weibo has only Twitter as a comparison: not a like-for-like company and, anyway, not Chinese.
The upcoming Alibaba IPO is currently subject to the most speculation from traders, brokers and analysts. That is because it is set to possibly become the biggest IPO ever, beating Facebook (the largest online IPO) and Visa (the largest IPO full stop) along the way.
The likelihood of Alibaba attaining that status is not yet known, largely because no one at the company has yet revealed what portion of the company will be floated. We can, however, take a look at where its current estimated value might land it on the markets.
Value estimations for the business range somewhere between $115-245 billion, a fairly large range. IG’s grey market has been fairly steady around the $200 billion level for a few months (but is currently sitting higher at $210-220 billion). At that worth, the business would have to float 10.5% of its shares to beat Visa and 8.5% to beat Facebook.
Despite competing with both companies in terms of IPO value, it would comfortably beat both on market cap. Facebook is currently worth $189 billion and Visa is worth $131 billion.
Grey markets offer dual opportunities for traders. Those who believe that they can correctly assess the market value of a business can attempt to profit from their perceptiveness; those who wish for an indicator of market sentiment on a company can turn to its grey market. But gleaning a correct assessment from a grey market is a skill in itself and new traders should treat them with caution.
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