IPOs: Going, Going...Not So Fast


By Beth Carney With Google (GOOG) shares nearly tripling over the past 12 months, it can be tough to remember the controversy around its unconventional initial public offering last August. A weak tech market and missteps following regulatory procedures set the stage. Wall Street was also highly skeptical of Google's Dutch-auction IPO, which limited bankers' influence by opening bidding to the public and setting a debut price through supply and demand.

Yet despite the success of the $1.7 billion Google sale, which saw a 17% price jump on the day of issue, a year later only a handful of other companies have chosen auction-style IPOs. Moreover, traditional investment banks aren't a lot closer to embracing the method.

But if Google's high-profile experiment didn't set off an immediate spate of imitators, the method's proponents say it raised awareness -- and acceptance -- of an approach that had previously been limited to much smaller companies. Advocates also note that Dutch-auction IPOs have notched some significant successes in the past year.

WATCHING GOOGLE. While the numbers remain small, interest in Dutch-auction IPOs is growing, according to W. R. Hambrecht + Co., the San Francisco firm that has pioneered the process. The group has taken 13 companies public through its patented OpenIPO process since 1999, including three this year. John Schneider, W.R. Hambrecht's assistant head of investment banking, said that he expects between four and eight outfits to follow suit before yearend. "That's a pretty significant step up from what you've seen in previous years," Schneider notes.

One victory for auction proponents: the Morningstar (MORN) IPO. The Chicago-based mutual fund and stock-research group's $140.8 million May 3 offering was the biggest Dutch-auction IPO since Google, and a direct result of the search giant's move.

Morningstar began by pursuing a traditional IPO with Morgan Stanley, but switched to an auction with W.R. Hambrecht after watching Google list. Google "showed that larger companies could successfully go public with an auction," says CEO Joe Mansueto. "I think it gave us greater confidence it could work for Morningstar."

"EXTREMELY HAPPY." According to Manseuto, the openness and transparency of the auction method made sense for Morningstar, since it's in the business of providing information to investors. While in traditional IPOs, investment banks distribute shares directly to preferred clients, in auction IPOs, even small investors can take part.

The auction method was also less expensive, at a fee of about 2% -- even lower than the 3% to 5% W.R. Hambrecht typically charges, because Morgan Stanley had already done some due diligence. Priced at $18.50, Morningstar gained about 8.5% on the first day, closing at $32.75 on Aug. 15). "We were extremely happy with the method," he said.

Another success, on a smaller scale, centered on New River Pharmaceuticals (NRPH), a Virginia biopharmaceutical company that debuted Aug. 5 at $8 a share, raising $33.6 million. Since then, its price has shot to $40, as of Aug. 15. This makes it, as it hits its first anniversary, the best-performing IPO of the past 12 months, on a percentage basis, eclipsing even Google's post-IPO run, according to London-based research firm Dealogic.

INSTITUTIONAL PLAYERS. For New River, a 28-person company specializing in developing safer versions of commonly used drugs, an auction IPO was not a first choice. The firm initially approached an investment bank to arrange a traditional IPO, but the bank wanted to wait until the market improved. "We began getting pushback from them about it perhaps not being the best time to go to market," said New River CEO R.J. Kirk. "Their rationale didn't relate to anything we could understand as a factor that spoke to the relative merits of our offering." The firm decided to seek an auction IPO through W.R. Hambrecht instead.

The gains in New River's stock in the past year aren't directly tied to the mechanics of its IPO or the company's financial performance, since it doesn't yet have revenues. Rather, investors are excited about a drug for attention deficit hyperactivity disorder (ADHD) it has in development.

Still, the fact that institutional investors signed up for the offering and have supported the stock is significant, according to those involved with the listing, because one of the criticisms of auctions is that institutional investors avoid the companies that conduct them. "We ended up with the same kinds of buyers that we would have had in a traditional process," said Kirk.

"BEAUTIFUL EXAMPLE." For proponents, one of the most persuasive recent advertisements for the auction method came in the traditional offering of Chinese Internet search engine Baidu (BIDU), Aug. 4 (see BW Online, 08/05/05, "Baidu: Strong IPO, Stronger Rivals"). Investors hoping to get in on a stock considered the equivalent of a Google in China pushed the price from its offering of $27 to $154 on the first day of trading (it closed at $123 and closed at $93 on Aug. 15). Though it was lauded by many as a successful IPO, Paul Klemperer, professor of economics at Oxford University, who has authored a book on auctions, said, "It's a beautiful example of how badly a traditional IPO can work."

If the company had run an auction that priced the stock at what investors were clearly willing to pay, the startup would have made another $400 million. Instead, that money went to investors to whom the underwriters distributed shares. Baidu "basically left a huge amount of money on the table," notes Klemperer. The other risk: the stock could plummet in coming weeks and months, leaving Baidu and many investors in the lurch.

Still, auction IPOs are unlikely to become the norm anytime soon, according to experts and academics. Old-line investment banks have avoided the process, with the exception of Google's listing, which was handled by Morgan Stanley and Credit Suisse First Boston.

SLOW TRANSITION? While banks have an incentive to discourage auctions, since they have more control over traditional IPOs, firms going public may also be justifiably reluctant to take that step without the backing of a bank and its clients, said Raffi Amit, professor of entrepreneurship at the University of Pennsylvania's Wharton School.

"The reason a lot of people are skeptical of using auctions is what happens the day after. Yes, the market price will be higher [initially], but you won't have analyst coverage and the price will go down," Amit says. Though he considers himself a strong supporter of auctions, Amit noted that he chose a traditional IPO in 1999, when he was chairman of Creo Products and the company went public. He would still be wary of the auction method today, he adds.

What's more likely to happen: a gradual opening up of the process until auction IPOs are a mainstream option, in much the same way that stock-buyback auctions have become more common since the 1980s, said Laurie Simon Hodrick, professor of finance and economics at Columbia Business School. Companies that are not well-known or have business models that are difficult to understand will likely continue to seek the help of investment bankers to build support among institutional investors, while higher-profile outfits may increasingly opt for auctions.

AVAILABLE OPTIONS For its part. Google, which clearly falls into the latter category, is satisfied with its unorthodox path. "We believe the process worked well for Google. It may work well for others, too, but that is ultimately up to each organization," says spokesman Steve Langdon.

Now, at least, companies have a choice. Carney is a BusinessWeek Online correspondent in the London bureau


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