Square jumps after lackluster IPO pricing

Shares of upstart credit card processor Square (SQ) jumped nearly 50% on Thursday, after lackluster interest from investors in the company's initial public offering depressed its value.

On Wednesday evening, underwriters for Square sold 27 million shares to big investors at $9 each, well below the $11 to $13 range it had sought and valuing the company at half of what private investors had assumed a year ago.

But the stock price leapt as high as $14.78 once ordinary investors could buy the shares on the open market Thursday. In frenzied trading of over 47 million shares, the stock finally ended the day at $13.07, still a 45% gain.

IPO investors were concerned that Square's primary business, processing credit-card transactions for millions of small- and medium-sized businesses, might not be appealing in the long term. Numerous other companies, including much larger players such as JPMorgan Chase (JPM) and First Data (FDC), dominate the generally low-margin, commodity processing business. In almost seven years in business, Square hasn't ever shown a profit. Another concern: CEO Jack Dorsey is splitting his time since taking on the top role at Twitter (TWTR) in October.

Square built its business with a tiny, plastic device that could turn any smartphone into a credit card reader. The simple card reader attracted millions of small merchants, like coffee shops and food trucks, that previously couldn't accept credit cards. Now the company's growth strategy depends on selling those customers other services, like payroll processing and working capital loans.

"Long-term margins are dependent on achieving much greater scale and driving a lot more business from some of its non-payments activities," says Jan Dawson, chief analyst at Jackdaw Research. "It's no guarantee that it'll achieve those things, but that's the only way it's going to happen."

Square's low initial pricing followed by a strong, positive reception in the stock market was extremely unusual for companies going public, according to University of Florida professor Jay Ritter, who has tracked IPOs for decades. Of all 2,236 deals priced below their expected IPO range since 1980, only 36 had increased by 40% or more on the first day of trading, Ritter said.

And that odd reception probably won't be enough to entice many more technology companies to go public. "While the first day euphoria looks good, public investors are still wary of the many one-day wonders that have gone on to break their IPO prices," says Kathleen Smith, principal at Renaissance Capital, which manages several IPO-related funds. "We will have to see positive performance over the months ahead from Square and all the other recent IPOs to get to a more friendly IPO environment for issuers."

Square's weak initial share pricing came as Match Group (MTCH), the owner of several dating web sites and the popular app Tinder, priced its shares at $12, the low end of its expected range. The shares experienced a more modest 23% jump to close at $14.74 on Thursday.

Match, majority owned by IAC/Interactive (IACI), is profitable, but also faces questions about its long-term prospects. And some investors were put off by the large amount of money IAC drained from the unit's coffers ahead of the IPO.

Square's volatile trading could not obscure the fact that the public market placed a much lower value on the company than private investors had last year. Even after the Thursday jump, Square's value of $3.5 billion was only slightly more half the $6 billion value established in 2014.

Private investors have pushed the value of some 143 startups over $1 billion in recent years, according to data from CB Insights. But none of the so-called unicorns have been able to validate the heady valuations when they have gone public, with Square being just the latest example.

Still, unlike the disastrous ending of the Internet bubble over a decade ago, the current wave of overhyped companies appears to be going through a slower, healthier cycle of reassessment.

"In terms of implications on other unicorns, those with large valuations and mediocre performance are most at risk," says Anand Sanwal, CEO of CB Insights. "But again, the market should punish mediocre companies. That's the rational and right thing to do. Great companies with solid growth and fundamentals aren't wasting time thinking about Square."

Even some of the still-private startups have taken recent hits to their valuations. Mutual fund companies that own small stakes in companies including Snapchat, Dropbox and Pinterest have written down the value of their holdings over the past three months.