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Some see both longer-term investors and higher proceeds for the issuer with one Internet-based approach.
John Thackray, CFO Magazine
October 1, 1999
Two pioneering initial public offerings-- priced Dutch-auction style through Internet bidding -- have ushered in a whole new way to go public. Called OpenIPO, the system has the dual advantages of maximizing the issuer's net proceeds, while making the IPO market fairer for smaller investors. The question now: How open is the market to the new technique?
OpenIPO is the brainchild of Hambrecht & Quist co-founder William Hambrecht, who left his West Coast venture-capital and investment- banking firm to start W.R. Hambrecht + Co. "Open" means just that: all would-be investors have an equal opportunity to invest in the deals, in contrast to traditional IPOs, in which a handful of institutions tend to get favored allocations of stock. The highest bidder--whether it's Joe Investor or T. Rowe Price -- gets the shares. Low bidders usually get nothing.
While there's some skepticism about the long- term future of OpenIPO, its first two experimenters, Salon.com and Ravenswood Wineries Inc., are enthusiastic. "We did a full bake-off with nationally known investment banks and compared them with W.R. Hambrecht," says Todd Hagen, CFO of Salon.com, the San Franciscobased online magazine. It raised $26.2 million using OpenIPO last June, even though "we had options to handle the underwriting from some top-tier firms." Why? "We thought this would maximize the amount of cash that would come into the company, [and wanted to] place our stock directly in the hands of long-term investors that believe in the company."
Neither goal is satisfied by most IPOs, notes Jay Ritter, a University of Florida finance professor, who calculates that $11 billion of potential capital was left on the table in the first half of this year, even as $25 billion was being raised in IPOs (see chart, page 42). His figures are derived from the difference between the issue price and the price at the end of the first day's trading run-up. Consequently, "most investors aren't buying IPOs because they are interested in the company, but because they are hoping to make a quick profit," he argues. "If auctions had been used, the companies would have raised more money, or sold fewer shares, which would allow the founding shareholders to retain a larger percentage of the total value." Moreover, OpenIPO transaction costs are lower. W.R. Hambrecht's commissions are 5 percent of the amount raised, compared with the typical 7 percent for standard IPOs.
Who Wants a Level Field?
The greatest drawback to the OpenIPO, for now at least, may be that it is poorly understood. "It is revolutionary," says Steven Lacey, managing editor of IPO Reporter, a New Yorkbased newsletter. "So it is difficult for the market to digest"--especially a market accustomed to underwriters that take major under-allocations in an attempt to spur frantic buying after the opening bell. "You won't see tremendous aftermarket performance from the auction process versus the book- building process," Lacey says. And this, in turn, could put the stock under a cloud for a while--even if the downward plunges that are often part of such volatility are also missing.
On its second day of trading, when Salon.com closed 50 cents below its $10.50 offering price, the New York Times declared that it "went public with a whimper." A Cyberinvest.com writer compared the Salon.com debut with previous huge aftermarket advances by Globe.com and TheStreet.com and said: "The OpenIPO is supposed to level the playing field for individual investors, but with returns like this, do we really want a level field?"
The CFOs of issuing companies do, of course. "After the stock went public," says Salon.com's Hagen, "it closed--give or take 50 cents--exactly where we came out. That validates the fact that the auction fully priced the shares." W.R. Hambrecht president Ian Zwicker observes that aftermarket run-ups put the stock into weak hands. "When there is a big aftermarket premium built into the deal, there is usually a tremendous volume of trading, and those who qualified for shares then sell them. So the company is stuck with a new class of investors at a much higher basis, and a lot of the original investors are gone," Zwicker says. "Sure, the company gets a few days of fame. But sometime down the road, if the market isn't so wonderful, they might like to have had the money they left on the table. You can't count on the ability to refinance when you want to. And small companies do burn cash at a prodigious rate."
Many have noted that Salon.com and Sonoma, California-based Ravenswood, W.R. Hambrecht's earlier OpenIPO, at best were relatively ho- hum issues. Ravenswood rose to $11 after issuing at $10.50 in April, then flattenedeven though financial results were impressive. "In actual fact, our third- and fourth-quarter earnings were fabulous," says Reed Foster, Ravenswood's chairman and CEO, but "if you transposed our stock chart to a hospital, they'd say the patient was dead, that there are no vital signs." And Salon.com has been trading at less than half its July weekly peak.
Zwicker, though, cautions against drawing generalizations from the two IPOs. He suggests that healthy upsurges may well take place after future Dutch-auction-priced IPOs, modeled after the U.S. government's sale of 10- year notes and 30-year bonds, in which underwriters set a price range and determine the number of shares to be issued. In the process, sealed bids are submitted -- W. R. Hambrecht takes them over the Internet -- and orders are then filled, with higher bids getting their full allocation, down to the last share's bid price. That sets the price terms every successful bidder pays.
In the psychology of investing, Zwicker suggests, investors may feel motivated to buy more, cheaper stock if they find themselves having a bid much above the eventual price derived from the auction. "If you have a 15-20 range for bidding, and the offering comes in at 16, someone who bid 20 might say, 'If I knew it was going to be so cheap, I might have bought more,'" Zwicker notes. Such a smoothed- out pricing approach, of course, doesn't allow the "doubling or tripling of an IPO," as can happen on the wilder rides of new issues.
The "Wine Geeks" Defer
The much-desired level playing field does, of course, have a few bumps --installed by the Securities and Exchange Commission, whose rules govern the sale of IPO shares to affinity groups. In one bid for affinity sales, Ravenswood released a "dangler" investment notice, printed as a mini-tombstone on bottles of its high-quality reds. But Foster blames the low $10.50 issue price on the nature of the company's affinity group. "We came close to having a considerably higher issue price," he says, "but a lot of our affinity group couldn't, or wouldn't, play the game." Most are "not financial people; they're wine geeks. So we were dependent on institutions to carry the ball over the goal line for us."
For its part, Salon.com conducted a 21/2-week road show to tell its story to some 90 institutions, some of them customers of co- manager Daiwa Securities. In addition, institutions and qualifying individuals accessed a W.R. Hambrecht Internet presentation called Net Roadshow. But making the institutional dependence a problem -- in both the Ravenswood and Salon.com cases --were the relative obscurity of the young W.R. Hambrecht organization, and the limited budget for drumbeating.
The OpenIPO will likely be getting a big boost soon, though. This fall, Fidelity Investments plans to offer OpenIPO access to its large body of discount brokerage customers, according to Zwicker. Fidelity is an equity investor in W.R. Hambrecht. Four new stock issues are close, Zwicker says, and two mainstream firms are contemplating a co- managership on some big future transactions.
Some experts think that OpenIPO -- even if it doesn't break into the mainstream of offerings -- could earn a niche as an alternative capital path for firms lacking the promise of spectacular aftermarket price surges. Demand also could grow among the small investors that haunt the Internet, where complaints are rampant about the "little guy" being shut out of initial offerings.
And "one of these days, the mass hysteria of day trading and investors buying three years of huge losses in Internet start-ups is going to stop," says Ravenswood's Foster. "Then people will turn to thinking of real values of young companies. Then OpenIPO could be a tool many companies might use."