Opinion: Why you won't get any VMware stock

I don't trade stock because I find it illogical

Editor's Note: Last week, Steve wrote about how EMC's plan to take 10% of its VMware subsidiary and create an IPO for the company could have far-reaching financial implications, including additional money for EMC to retain and hire talent, and a massive 50% market cap boost (see: "EMC's cashing in on VMware IPO"). This week, a reader who is considering taking a job with VMware wrote in to find out what benefit the IPO might have for him.

Great article, but can you help me out? What do you think an employee of VMware will come out of this with?
I have been made an offer to join [VMware] and would appreciate your views on what could happen.
Would you need to be employed for a long time to see a windfall? My friend has been employed [there for] nine months -- what will happen with her? And, what do you mean when you say "you can't buy the stock" at the IPO? There won't be any stock
to buy?" -- Anonymous 

Good questions, and ones I can answer. First, when a company sells stock to the "public," it doesn't really. It makes its stock "liquid" by creating a market for it, which is called "going public." Until that event, the stock owned by folks and investors in the company is "private," meaning there is no market available for someone to sell their shares (which is their ownership interest) to.

When the company goes public, it is selling a certain percentage of the ownership of the entity -- in this case, 10% of VMware -- to noninsiders or the "public." A public market means the stock is listed on an exchange and you and I can buy it if someone who owns it is willing to sell it to us. The people who act as middlemen in this type of transaction are called "market makers." The trading companies where we have our stock accounts will execute a trade for us (buy or sell) with the market makers. It is the market makers who then need to go fill the order (i.e., if you want to buy they need to get someone to sell at the price you agreed to pay). The good news is there is always someone willing to sell for the right price as long as there is enough "float," which is the amount of shares that are out in the public domain.

What I meant by "you can't buy it" is simply that during the IPO process itself, all the stock that is becoming public is essentially prepurchased. If I am selling 100 million shares to the public markets, my underwriter (Goldman Sachs, JPMorgan, among others, also known as the "sell side" because they sell/broker your stock) runs me all over the planet on my "roadshow," where I pitch my company and stock to the "buy side" -- the institutions that get the chance to commit to buying my stock at the IPO. The buyers commit to a certain amount of shares at a certain price and when enough commit to the same price at the right amount, the pricing "range" is set. When the bell rings, those deals are consummated, and only if there is any leftover stock can it be purchased by John Q. Public. However, that never happens.

The buy side consists of the big mutual funds like Fidelity that are "long" buyers, meaning they hold stocks for longer periods than the "short" buyers or sellers (a.k.a. Hedge Funds) that are not restricted to holding stock for any length of time and can flip in and out all day long. Both Buy Side institutions have more money than you and I will ever possess, and as such, they are able to dictate the price of stocks. When you sell 87 shares of IBM, no one cares. When Fidelity sells 800,000 shares of IBM, the price goes down.

So at the IPO, the 10% (which may very well be 100,000,000 shares) of VMware that becomes public will first officially be purchased by the Buy Side guys. John Q. Public who likes the story will then place buy orders with his or her broker, typically at a higher price than the Buy Side guys paid two minutes earlier, and a market maker will accept or refuse the order. Once accepted, you own the shares you bought (even if they can't deliver, they are on the hook so whether you physically get them or not is irrelevant) at the price you bought them. Now you can do with them what you like: hold them or sell them.

Let's say the VMware stock is priced with a prepublic valuation of $10 billion (that's what the company is valued). Ten percent of the company is going public, so EMC will sell 10% of VMware for $1 billion to the Buy Side. If they sold 100 million shares, then the buy side paid $10 per share. By the time you place your order and get it filled, you might pay $20 per share. Depending on the insanity (hence the Krispy Kreme reference in the last article), the stock might zoom to absurd levels all based on supply and demand. If the demand for the shares exceeds the available supply, the price will go up. If no one wants to buy it, the price will come down to a level where it will sell. Simple economics.

Not that you asked, but sometimes stocks just sit at the same price for a long, long time. That happens in high-volume stocks when the price is what it is (i.e., the economics level out and until a positive or negative change or event occurs, the price stays pretty flat). EMC is a good example of that. The other reason is that there is very limited float and very low volume -- attributed to smaller companies, usually -- so it is hard to generate big interest in the stock. If no one is trading, the price is irrelevant. The caution on "small cap" stocks like this is that since there is such low volume and float, any trade can cause large percentage pricing swings. With a limited float stock, those 87 shares might actually move the price when you sell.

As to the other question, unfortunately, your friend most likely will not benefit financially from the IPO. Unless she was granted "options" by EMC that were specific to VMware, there isn't much at stake. If she does have options, they are most likely EMC options, so she may get some of the benefit and gain that EMC stock gets, as I discussed in the last article.

Options, by the way, are a way a company can provide employees stock incentives without actually giving them stock. In other words, let's say that your friend is considered super valuable, and the company really wants to make sure she stays at EMC/VMware for a long time. They might grant her options as an incentive. An option is a right to purchase stock at some time in the future for a price that is set today. If the stock goes up, the employee can "exercise" the option and buy the stock at the predetermined price. If you have an option to buy at $13 per share for EMC and the stock goes up to $18, you would exercise the option and buy the shares offered for $13 and either sell them for the profit or hold them hoping for a larger profit later.

Options normally have future dates associated with them (i.e., you might not be able to exercise your option for two years from the grant date). "Backdating" options is why so many public companies are in trouble these days; they got caught giving people options in arrears, setting the price based on two years ago so that the person who gets the options is already "in the money." That's illegal, if not immoral. The good news is no one appears immune to the rules these days, even Mr. Jobs is in trouble for this, and mark my words, we have not heard the last of that story yet. This could take him down, and he has been a stud of a CEO who didn't personally even profit by doing this. But rules are rules.

Now, since I know you were going to ask, I don't trade stocks. I'm not legally restricted since I'm not a "financial" analyst, nor do I ever get inside financial information since most of the tech CEOs I know aren't that interested in going to jail so that I can make a buck. I don't trade stock because I find it illogical.

First, I don't get it most of the time. There are no rules, per se. If emotion is allowed to play such a huge role in the price of a stock, that defies logic to me. Having my portfolio value wiped out because some CEO was found to be a cross-dressing tango dancer on the weekends who posted his latest video on MySpace -- even though he has delivered stupendous results for 15 years -- goes against my overly logical grain. Plus, I just can't get over the fact that billions of dollars of stock influence is controlled by 25-year-old MBAs, most of whom have never had a real job. They are super smart -- mostly -- and they know their world better than I know mine, but there is something unnerving to me about someone investing or selling a company without knowing anything about the company outside of a spreadsheet.

If I was going to invest, I'd be one of those boring, long guys, not one of the sexy, short guys with the huge income and the penthouse at age 28. They work too hard and fast.

I buy funds because that makes me feel insulated somehow. It's probably stupid, but no one said I was smart at such things.

So if I ever try to give you financial advice, you might not want to take it. Because I doubt my own abilities in such matters, I rely on the experts. I figure the guy at Fidelity has to be better at this than me, so I bet with him. That has worked out just fine for me. Of course, I'm also the first person to ever lose money investing as a limited partner in venture capital funds, which were the "thing" to get into because they always make piles of dough and are impossible to get into. Wrong.

Send me your questions -- about anything, really, to sinceuasked@computerworld.com.

Steve Duplessie founded Enterprise Strategy Group Inc. in 1999 and has become one of the most recognized voices in the IT world. He is a regularly featured speaker at shows such as Storage Networking World, where he takes on what's good, bad -- and more importantly -- what's next. For more of Steve's insights, read his blogs.

Copyright © 2007 IDG Communications, Inc.

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