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Pandora's Morning After, and the Associated Management Headache

In the run-up to its IPO yesterday morning, Pandora (P) seemed like another case of tech investor exuberance. The offering price kept growing, even jumping from $12 last Friday to $16 by Wednesday. Then the opening bell rang, the price spiked to $26... and the shares started a hard slide down to close at $17.42.

That may have been 8.8 percent over the initial price, but it certainly cast a pall over the party. Turns out the LinkedIn (LNKD) experience didn't mean that the good times were back for all. Pandora showed that greater-fool investment theory has its limitations and that investors aren't so quick to forgive a lack of solid financial success.

That could prove uncomfortable news for a company like Groupon, which hasn't mastered the art of profitable operations and needs an IPO to cash out some of those investors and VCs who put up $1.14 billion, much of which came at high valuations. What if they have to tell employees that stock options might be worthless -- or next to it -- by the time they vest?

Sliding down the razor blade of life
LinkedIn may have set some overly high expectations. Even though the opening price of $45 quickly doubled and then slid, the stock is still trading in the mid-70s a month later, as you can see from this Yahoo Finance graph (click to enlarge):

Shares have sustained a jump of 67 percent. Although LinkedIn was losing money for years (even though it claimed otherwise), it did become profitable.

Compare that to Pandora's experience in its first day of trading, as this graph from Yahoo Finance shows (click to enlarge):

Quite the downhill run. And that was in just six-and-a-half hours.

What we're seeing is what happens when the greater fool theory runs out of greater fools. Major investors want to cash out, institutions take shares early on, and then the little guys are left to buy high and sell low. Only, the selling low part starts quickly.

It's not a loss; it's a negative gain
Groupon has significantly higher revenues than Pandora, but its losses are larger by two orders of magnitude. Sure, there will be a bounce at the IPO, particularly if Groupon chooses to float a small number of shares the way LinkedIn did and Zygna is rumored to be planning. The way Pandora did, for that matter, as it had planned on selling just under 10 percent of its total shares. But how long can the boost last? As we just saw, as little as a few hours.

Forget the investor view for a moment and consider what all this means for managing a tech company. Top employees get stock because it's a low-cash way of compensating them, with vesting periods enforcing some degree of loyalty. The hotter the company valuation, the fewer shares people get.

If stock prices don't hold up, employees can find that their options prices are more expensive than street value -- i.e., underwater -- by the time they can exercise them. Without some care, a company could alienate many of the people that in theory it wanted to reward.


Image: Flickr user ilovememphis, CC 2.0.
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