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Why did the Funding Circle IPO flop so badly?

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Just over a week ago, my colleague Edward Sheldon asked “Should you participate in the Funding Circle IPO?

With hindsight, and into just its second day of conditional trading on the London Stock Exchange, the answer would seem to be a firm “No”.

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With an offer price that turned out to be 440p, Edward pointed out that “the valuation looks quite high.” And with an initial expected market cap of £1.5bn, it’s not hard to see what he meant.

From that initial flotation price, we’ve already seen a fall of 21% to 348p at the time of writing on Thursday. And that was even after the firm’s management went for the lower end of the earlier provisional range of 440p-460p, apparently pressured by institutional investors who saw the valuation as over-optimistic.

Criticism

The investment bankers behind recent high-profile IPOs have also come under pressure over the Aston Martin flotation, which has seen an offer price of 1,900p per share quickly pared back to 1,770p for a loss of nearly 7%. That slashes the hoped-for market cap of around £5bn to a little over £4.1bn, which suggests the company is unlikely to make it into the FTSE 100.

The real shame about the Funding Circle flop, I think, is that it’s a fundamentally sound company offering a very valuable peer-to-peer lending service. By enabling private savers to lend their cash directly to smaller companies seeking funding, the company cuts out the usual banking middlemen with their high charges and makes the deal sweeter for both parties.

Companies get funding at better rates, while savers get a higher return on their cash than if they left it in the bank. In fact, the 5%-6% that fellow Fool Edward has been enjoying is a decent investment return in its own right.

Anything that makes the allocation of capital more efficient and less costly has to be a good thing, and Funding Circle has got in as an early starter with an already solid reputation.

What went wrong with the IPO?

Actually, from the company’s point of view, absolutely nothing went wrong at all — at least not in the short term. The thing is, the purpose of an IPO is to get as much cash as possible for the company being floated — not to provide investors with a bargain purchase price. And the job of a company’s investment bankers is to make that happen.

And it’s no good fund managers and other institutional investors complaining a pricing was too high — if they don’t like an offer price, the obvious answer is to simply not buy at the IPO.

Longer term, a flotation flop like Funding Circle’s could damage confidence in the company if it’s thought to have been too greedy. And initial investors could have to wait some time to get back into the black.

As for me, I’m sticking with my general rule: “Never buy at an IPO.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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