NetSuite Inc., a business software company owned primarily by Oracle's Larry Ellison, went public on December 20, 2007 using the W.R. Hambrecht OpenIpo platform.  Besides being merely another datapoint in a very small group of completed U.S. IPO auctions, the NetSuite offering raises some interesting questions.

The offering was initially publicized with an expected price frange of $13 to $16.  On December 19, after having the registration statement declared effective and accepting bids for over a week, the offering was priced at $26.  On the first day of trading, NetSuite shares closed at $35.50.  What do these numbers tell us, if anything, about IPO auctions?  One could tell a story that market demand for the offering was $26 and that the auction format allowed the company to capture the full market demand.  However, the offering price then rose to $35.50, suggesting that $26 was not the full market demand after all.  Perhaps from the bids received on December 19, $26 did represent the full market demand, but demand rose on December 20 as the market responded positively to the higher-than-expected offering price.  The share price rose due to this herd effect and will eventually fall due to arbitrage.  (The current price is $29.62)  Let's call this story Alternative #1.

If one is cynical about auction IPOs, then one could construct a different story.  Perhaps the market demand was always higher than $26 -- somewhere between $26 and $35.50.  The folks running the auction IPO underpriced this offering just like underwriters in bookbuilding offerings.  This story has some support in the fact that the offering was overallotted and that NetSuite allowed its underwriters to purchase more shares to sell after the IPO closed.  Let's call this story Alternative #2.  However, the next question would be whether the auction underpriced the issue more or less than a bookbuilding offering would have.  Would a bookbuilding offering have resulted in an offering price closer to the $13 - $16 range, pocketing more of the underpricing for those receiving IPO shares and not the company?  Or would the bookbuilding offering price have been between $26 and $35.50?

An ancillary question, and one that I raise in my article Initial Public Offerings and the Failed Promise of Disintermediation is whether a bookbuilding offering would have raised market demand to higher than either $26 (under Alternate #1) or $26 + X (under Alternate #2) through the underwriter's marketing and reputational value.  In the NetSuite offering, the lead underwriter was CreditSuisse, so it may be that this offering had both the pros of a Hambrecht IPO and an offering led by a Wall Street underwriter.

In addition, this offering raises questions I haven't considered, but on which I would love more data.  First, Ellison sold about 10% of his own holding, but retained a majority of the shares.  Remember that in the Google offering, founders Sergey Brin and Larry Page also sold a small percentage of their shares.  Does the presence of a shareholder with a large stake who is selling shares in the offering create an incentive to go the Dutch Auction route?  Or would the retention of a large stake create an incentive to go the bookbuilding route and hope for a price "pop" that lasts long enough to sell inside shares?  Does the shareholder's stated intentions for programmed sales change this incentive.  (Also remember that both Brin and Page sold off large amounts of Google stock beginning shortly after the IPO.)  Does the savviness (is that a word?) of the founders affect the offering decision?  Ellison is obviously a seasoned player in the technology world.  Ellison, Brin and Page are currently the #4 and #5 (tie) wealthiest Americans.  Is it a coincidence that each chose an auction IPO?

Permalink | Initial Public Offerings | Comments (1) | TrackBack (0)

Last March, I had the privilege of speaking at the second annual symposium of the Ohio State Entrepreneurial Business Law Journal entitled "IPOs and the Internet Age:  A Case for Updated Regulations."  My esteemed co-blogger Vic Fleischer was also there, as well as other esteemed law colleagues.  I have recently fulfilled my promise to provide a paper for the journal (almost on time, too!), and I have posted this paper to SSRN.  The title is Initial Public Offerings and the Failed Promise of Disintermediation; the abstract is here:

At the beginning of this millennium, the future of initial public offerings conducted using an Internet-based auction method in the United States seemed very bright. The Internet, and web-based technologies, promised disintermediation in the IPO markets just as it had in other markets where producers could be linked with consumers without costly intermediaries. In a world in which a buyer would choose to pay a certain price (X) for a product, the producer of that product would prefer to capture as close to 100% of X as possible and not share unnecessarily with intermediaries. The market for initial public offerings is no different from other markets; a small number of investment banks and the underwriters and brokers they employ act as intermediaries that distribute and market offerings for a substantial fee, including a customary discount on the offering price that benefits the intermediaries. However, web-based auction IPOs have the potential of allowing issuers to avoid these investment banks and sell directly to the public at closer to the market price (100% of X), not the bookbuilding underprice (approximately 80% of X), minus the substantial underwriting fee.

However, the number of online auction IPOs each year is miniscule compared with the number of IPOs conducted in the U.S. using the traditional bookbuilding method. Although the market saw an increased number of auction IPOs in 2005, following Google's 2004 auction IPO, the market for online IPO auctions against stalled beginning in 2006. Proponents of these IPOs must explain why the auction IPO model has not challenged, much less replaced, bookbuilding as the dominant offering method in the U.S. This Article argues that although the Internet works well to eliminate intermediaries formerly necessary for distribution, the Internet cannot reliably eliminate intermediaries used by the public for creating demand networks and establishing third-party certification. Because of the power of investment banks and their demand networks, the base market price (X) of any product will be increased (X + Y). Therefore, an issuer must determine whether more profit is to be made by sharing revenues with Wall Street intermediaries and receiving 80% of (X + Y) than by capturing 100% of merely X. In addition, to attempt to ignore these powerful Wall Street intermediaries comes with great risk. In certain cases, those who attempt to sidestep these intermediaries may find themselves capturing not 100%(X) but 100% of a depressed market price (X-Z). Given this choice, rational issuers will choose the bookbuilding method, which promises .80(X + Y).

Permalink | Initial Public Offerings | Comments (1) | TrackBack (0)

Well the wait is over.  The Blackstone Group LP is set for its IPO today, raising $4.13 billion dollars, the largest US IPO in some five years.  It is also the 6th largest US IPO in history, which puts it behind AT&T, Kraft, UPS, CIT Group and Conoco.  Interestingly, four of the top five largest US IPOs (excluding UPS) were all the result of spin-offs, showing that there is much money to be made in break-ups.  And of course, none of these IPOs managed to top the largest IPO in history--that honor goes to the Industrial & Commercial Bank of China, which raised $19 billion in its IPO last year.

Permalink | Initial Public Offerings | Comments (1) | TrackBack (0)

SPACs, "special purpose acquisition corporations," are shell corporations that use the proceeds of public offerings for acquisitions. I was shocked to read this from the NYT: "According to the market research firm Dealogic, SPACs represented 26 percent of the 73 initial public offerings so far this year, and 15 percent of the money raised on public markets."

SPAC offerings have some interesting features. The investments typically are structured as units consisting of common stock and warrant(s). Of course, the main risk is that the company has no operating history, so the success of the venture depends wholly on the ability of the principals to pick investments. Wikipedia has a nice entry on SPACs. For a recent offering, try 2020 ChinaCap Acquirco Inc.

By the way, according to a Westlaw search, the number of law review articles discussing SPACs = 0.

Permalink | Initial Public Offerings | Comments (0) | TrackBack (0)

I like Canada.  Growing up in Buffalo I watched a lot of "Hockey Night in Canada," and like Don Cherry, I appreciate the value of a good enforcer.  But as much as I love Canada, I'm not sure I'd bet $1.4 Billion on it as the ideal global branding location if there wasn't some other motivation.

Let me explain.  When MasterCard went public, it donated a pile of stock to a newly-formed charitable foundation.  A couple of Canadian readers drew my attention to this story from the Globe and Mail (the Canadian "Paper of Record"), which describes MasterCard's decision to locate its charitable foundation in Canada.

From the Globe and Mail story:

"Toronto is a diverse, dynamic city; it's the centre of finance in Canada and it's got a reputation as an international player," said Deanna Rosenswig, president and chief executive of the $1.4-billion (U.S.) foundation that will invest in charitable causes around the world, largely in developing countries.

"If you're MasterCard, and you're sitting in New York and saying to yourself, 'I represent MasterCard worldwide, I want this to be an international player' -- why not Toronto?"

I'm not sure this passes the smell test.  Last time I checked, New York wasn't exactly provincial.  Especially for finance.  Toronto is a great city, to be sure, but still.  A MasterCard spokeswoman explained further:

A MasterCard spokeswoman confirmed the company wanted to put the foundation "in a place that reflected our global nature." She added that Toronto "reflects both North American and European roots."

That's sort of odd too.  I know they speak French in Quebec, but does that make Canada "European"? 

There's two other possible explanations; both are rooted in the fact that the MasterCard foundation is more of a corporate governance device than a philanthropic endeavor.

Neutral Territory.  The US and European banks who once owned all of MasterCard continue to own a substantial economic stake in the company, although they no longer control it directly.  The foundation will instead be the controlling shareholder for the next 20 years or so.  One possible explanation for locating the foundation in Canada is that the European banks didn't want to see the foundation dominated by the interests of the US banks.  So in that sense, organizing the foundation in Canada -- and away from New York -- may have reflected a compromise between North American and European interests.

Tax.  The second possible explanation is tax.  (What else?)  Under US law, the foundation would have to spend down 5% of its endowment every year to retain its nonprofit status; under Canadian law, the limit is 3.5%.  Since the foundation is barred from selling its stock for four years, and MasterCard's dividend yield isn't quite that high, locating the foundation in Canada limits the amount of additional cash that MasterCard has to contribute to the foundation.  (I've got more detail on this in my MasterCard paper.)

The MasterCard foundation will do some great things, I'm sure, and its location in Toronto will be a great platform for accomplishing its goals, whatever those may turn out to be.  But it's also clear that philanthropy isn't the only goal MasterCard has in mind.

Permalink | Initial Public Offerings | Comments (0) | TrackBack (0)

The antitrust IPO case, Credit Suisse First Boston Ltd. v. Billing, was argued in front of the Supreme Court this morning.  The transcript is here.  According to the Houston Chronicle, the justices seemed skeptical that securities laws should not preempt antitrust laws in this arena.  (The district court had held that the securities laws did preempt antitrust laws, but the Second Circuit had reversed.)  I guess we'll have to read and decide for ourselves.

C

Permalink | Initial Public Offerings | Comments (0) | TrackBack (0)

Related post:  The Blackstone IPO: Regulatory Arbitrage

Blackstone's S-1 describes an intriguing tax structure, and it promises a tax opinion from Simpson Thacher.  It looks like it probably "works."  Given the current DC political climate and hunger for revenue offsets, however, and the likelihood that Congress will take a hard look at the taxation of private equity funds, the tax risk is significant.  Analysis follows after the jump.

As I discussed last week, Blackstone's IPO structure takes an aggressive tax stance. 

Background.  By operating in partnership form, private equity funds take advantage of a quirk in the tax law that allows fund managers to receive compensation in the form of equity taxed at long term capital gains rates (15%) instead of ordinary income rates (35%).   The partnership form also allows the asset management aspect of the operation to take place without incurring an entity-level corporate tax.  Private equity funds also want to avoid operating as RICs (regulated investment companies), which get pass-through taxation but subject the firm to the restrictive regulation of the Investment Company Act of 1940.  Publicly-traded entities are normally taxed as corporations; accessing the liquidity of the public equity markets usually requires paying a steep toll charge in the form of an entity-level tax.

The tax issue.  Blackstone elegantly finesses this tax problem by trying to qualify to an exception to the publicly-traded partnership rules (section 7704) for entities that earn "passive-type income."  Normally, publicly-traded partnerships are taxed as corporations, regardless of how they are organized under state law.  Section 7704 carves out exceptions for partnerships with "passive-type income," which include interest, dividends, real property rents, certain oil and gas activities, and gain from the sale or disposition of most capital assets.  The exception thus distinguishes passive investment activities, for which pass-through treatment is appropriate, from the operation of an active trade or business, for which it's not appropriate.

What's at stake.  Failing to qualify for pass-through treatment wouldn't be fatal to Blackstone's future.  But it would hurt.  A lot.  It would lose two key tax advantages:  (1) the capital gains preference on carried interest distributions, which I address in Two and Twenty, and (2) the ability to pass income through to investors without incurring an entity-level tax.  Blackstone's impressive IRRs depend, in part, on the availability of these tax preferences. 

Suppose a Blackstone fund buys a portfolio company for $100 million and sells it five years later for $200 million.  It's 20% carry is worth $20 million.  If it's a partnership, then investors pay tax on a pro rata share on that $20 million at 15% capital gain rate, and collectively take home $17 million.  If it's a corporation, the corporation first pays tax on that $20 million at 35%, leaving $13 million; shareholders then pay another 15% tax on the dividend distribution, leaving about $11 million.  $6 million goes to the government instead of investors ... that's a huge difference.

Does it look like a duck?  Drawing the line between corporations and partnerships has always been a challenge.  In the old days, entity classification depended on a four-factor test of limited liability, continuity of life, centralized management, and free transferability.  (Under the old test, then, it's obvious that a publicly-traded Blackstone would be treated as a corporation.)  Under the check-the-box regs, however, unincorporated entities may elect whether to be taxed as a corporation or a partnership.   Section 7704, however, serves as a backstop to the check-the-box regs, ensuring that  publicly-traded active businesses can't elect out of corporate taxation.  The normative justification for taxing some entities like corporations but not others is pretty fuzzy.  All we have as a guiding principle is the "corporate resemblance" test derived from an old 1935 Supreme Court case, Morrissey vs. Commissioner.  In colloquial terms, if it walks like a duck and quacks like a duck, it should be taxed like a duck.  (Although Minnesota tax prof Gregg Polsky has raised concerns about the validity of the check-the-box regs for failing to faithfully apply the resemblance test, my own view is that the regs are valid as a matter of institutional deference to a reasonable agency interpretation of the Code.)  In any event, a publicly traded Blackstone sure quacks like a duck, so a careful reading of 7704 is in order.

Passive-type income.  To retain its partnership tax status, Blackstone will have to avoid classification as a publicly-traded partnership under section 7704.  Section 7704(c) makes an exception for publicly-traded partnerships with at least 90% passive-type income, which includes interest, dividends, and gain from the sale or disposition of a capital asset.  Most of Blackstone's income comes from carried interest distributions.  These distributions, in turn, are generated by the sale of portfolio companies held by the underlying Blackstone funds.  Do these distributions qualify as passive income?  It appears so.  Section 7704(d)(1) lists the different types of qualifying income, including 7704(d)(1)(B), dividends.  Portfolio companies generate dividends.  Under the plain language of 7704(d)(1)(F), then, carried interest distributions would appear to be "gain from the sale or disposition of a capital asset ... held for the production of income described in any of the foregoing subparagraphs or this paragraph ...."

Still, Blackstone may not be home free.  First of all, the tax status depends on not being treated as a regulated investment company, which in turn relies on a delicate 40 Act interpretation.  Second, there's a pretty strong argument that it's violating the spirit of the rules, and non-textual arguments have special force in the tax context. 

Legislative History.  The House explanation in the legislative history explains that the purpose is to distinguish "those partnerships that are engaged in activities commonly considered as essentially no more than investments" and "those activities more typically conducted in corporate form that are in the nature of active business activities."  Passthrough treatment is appropriate if the partners could "independently acquire such investments."  Public investors, of course, can't normally independently acquire an investment in Blackstone. 

The House report goes on to explain, in the context of interest and rents, that amounts contingent on profits are not intended to be included as passive income.  Interest that's contingent on profits "involves a greater degree of risk, and also a greater potential for economic gain," than fixed or market-indexed interest rates, "and thus is properly regarded as from an underlying business activity."  Carried interest distributions are obviously contingent on profits -- the profits of the underlying fund.  But they are a step removed from the underlying business activity of the portfolio companies, so it's not clear that this is improper. 

More to the point, perhaps, the House report then explains that interest isn't passive if it's derived in the conduct of a financial or insurance business, such as an active banking business.  The key question, then, is whether the management of the underlying funds is an active business. 

What about those management fees?  Fund managers derive income not just from carry, but also from management fees, advisory fees, break-up fees, and other streams of income that would be difficult to characterize as passive.  Regulation 1.7704-3(a)(2) explains that qualifying income does not include income derived in the ordinary course of a trade or business.  "For purposes of the preceding sentence, income derived from an asset with respect to which the partnership is a broker, market maker, or dealer is income derived in the ordinary course of a trade or business; income derived from an asset with respect to which the taxpayer is a trader or investor is not income derived in the ordinary course of a trade or business."

A private equity fund manager isn't a broker or a dealer ... but neither is it a trader or investor, at least in the usual sense.  What is it?  It's an active financial intermediary, for which we have no established tax classification.  The receipt of management fees and other fees that don't depend on the profitability of the underlying portfolio companies is pretty clearly active income.  The receipt of carry is something closer to investment income.

To solve this problem and slip into the 90% qualifying income exception, Blackstone will siphon off its "bad" income (management fees, etc.) into a separate entity that elects to be taxed as a corporation.  The blocker entity pays tax on the ordinary income.  That entity will then pay dividends to the master partnership.  The master partnership then has two primary sources of income:  (1) dividends from the blocker entities, and (2) capital gains from carried interest distributions from the underlying funds.  Since dividends are qualifying income, and since carry is income derived from the sale of a capital asset, all is well. 

Or is it?  Blackstone, like many businesses, derives income from a mix of ordinary income and capital gains.  In the aggregate, it's difficult to characterize what Blackstone does as pure passive investing.  Blackstone finesses the tax treatment by paying corporate tax only on the ordinary income, and passing through the rest of the income without paying an entity-level tax.  This creates a significant competitive advantage compared to investment banks like Goldman Sachs and Morgan Stanley, which are structured as corporations and pay an entity-level tax on all of their income.

I'm not sure, as a matter of tax policy, that we should allow complex tax structuring to provide this sort of competitive advantage.  As I explain in Two and Twenty, most funds are pretty aggressive about converting management fees into special allocations of carry.  Moreover, even if some "bad" income is siphoned off, that doesn't change the essential character of what fund managers do.  And that's pretty difficult to characterize as passive investing. 

Think about it this way.  Pass-through treatment is appropriate for passive investment vehicles where fund managers are just sourcing and screening investments.  Most mutual fund managers don't try to take an active role in the governance of the underlying company that their investors put money in.  At most, they apply indirect pressure on management.  But private equity fund managers do much more than that - they create alpha.  They sit on boards, restructure portfolio companies, fire managers, spin-off divisions, streamline operations, create new jobs --- this is not passive investing.  Investors would be crazy to pay the kind of fees that fund managers earn if all they were doing was picking stocks.

And Blackstone doesn't help its case by arguing, in the context of the 40 Act, that it is indeed an active business.  As I noted in my last post,  Blackstone argues in the context of the 40 Act that the "primary source of income from each of our businesses is properly characterized as income earned in exchange for the performance of services."  Service income, not investment income.  Active income, not passive income.  Now, it's certainly plausible that Congress intended active financial intermediaries to be treated as active for purposes of the 40 Act and passive for purposes of the tax code.  The tax code tolerates a fairly high degree of planning, such as when REITs siphon off "bad" income into a blocker entity.  But when this sort of regulatory arbitrage promises to significantly diminish corporate tax revenues, Congress is likely to revisit how the rules are written. 

At the end of the day, I think Blackstone is violating the spirit of the rules.  I'd be surprised if Congress didn't agree.  Still, since carried interest distributions are income derived from the gain derived from the sale of a capital asset, the language of the existing statute may be enough to carry the day, for now.   It's certainly appears to be enough to justify the S-1 filing and the tax opinion from Simpson that will accompany it. 

In sum, under current law there's some tax risk that the IRS will challenge Blackstone's claim to the "passive-type income" exception to the publicly-traded partnership rules.  The greater risk, I think, is that Congress may change the rules.  Tomorrow:  The politics of taxing Blackstone. 

Previous post:  The Blackstone IPO: Regulatory Arbitrage

Permalink | Initial Public Offerings | Comments (5) | TrackBack (1)

Hat tip to Blackstone's lawyers for a fascinating deal structure.  Here's a link to the S-1. 

I'd been wondering if Blackstone was really going give up the tax advantage of the Two and Twenty structure in order to get some liquidity and acquisition currency.  Publicly-traded entities, of course, are usually taxed as corporations, and pay tax at the entity level. 

Blackstone's plan is to retain the partnership form and take advantage of an exception to section 7704, which generally dictates that publicly-treated entities be taxed as corporations.  Brilliant.  And aggressive.

The basic structure is as follows:  Blackstone is the GP in various investment funds.  The GP, itself a limited partnership, is the entity that's going public.  Investors will receive common units with economic rights (but limited voting rights) in Blackstone.

40 Act.  Before turning to the tax issues, though, it's worth a word about the 40 Act.  To avoid being regulated as an Investment Company, Blackstone is relying on a couple of delicate arguments.  First, they have to establish that they're not in the business of investing in securities.  Of course, if you ask most people what Blackstone does, that's exactly what people would say they do: buy and sell securities in portfolio companies.  Because Blackstone the GP is going public, however, and not the Blackstone funds, they can make the argument that they are an asset management firm.  From the S-1:

We believe that we are engaged primarily in the business of providing asset management and financial advisory services and not in the business of investing, reinvesting or trading in securities. We also believe that the primary source of income from each of our businesses is properly characterized as income earned in exchange for the provision of services. We hold ourselves out as an asset management and financial advisory firm and do not propose to engage primarily in the business of investing, reinvesting or trading in securities.

See S-1 at page 49.  If this works, they avoid section 3(a)(1)(A) of the 40 Act.  They then face the additional hurdle of arguing that the GP interests in underlying funds aren't "investment securities."  I'm not sure how they get there on this one -- I'll have to dig into the 40 Act regs and rulings to understand the argument.  Partnership interests sure seem like securities, but presumably there's some case law or regs distinguishing partnership interests from common stock for purposes of this section. 

Corporate Governance.  Retaining the partnership structure allows Blackstone to avoid the NYSE corporate governance restrictions, like having a majority of independent directors.  Blackstone clearly doesn't fetishize independence.  It will, however, have to become SOX-compliant. 

Tax.  Now to the key bit of regulatory engineering:  tax.  To review:  the Blackstone partners currently get capital gain treatment on the income that results from holding carried interests in the underlying funds.  This means that they usually pay tax at the long term capital gains rate of 15% instead of the top ordinary income rate of 35%.  Because going public usually means getting taxed as a corporation, you'd think Blackstone would have to give up the tax break and incur an entity-level tax at the corporate tax rate. 

But instead, Blackstone will remain structured as a partnership and will try to qualify to an exception to the publicly-traded partnership rules (section 7704).  Specifically, Blackstone will try to qualify as a partnership with "passive-type income" (7704(c)).  To do so, it'll have to establish that 90% of its income comes from interest, dividends, and most relevant here, gain from the sale or disposition of a capital asset.  I'll focus in more closely on this tax issue tomorrow, but I have to wonder if this tax treatment relies on the successful conversion of management fees into carry.

The beauty of the structure is in the arbitrage between the 40 Act and the tax code.  The key tax advantage here is the treatment of carry as investment capital that gives rise to long-term capital gain.  As I explain in Two and Twenty, however, the income to GPs is probably better characterized as a return on human capital, not investment capital.  GPs get this income in exchange for services provided.  Blackstone, of course, says this explicitly in the S-1 section on the 40 Act:  "We also believe that the primary source of income from each of our businesses is properly characterized as income earned in exchange for the provision of services."

If you believe that Blackstone's income is properly characterized as service income, then how do you justify capital gains treatment? 

For the structure to work, then, what Blackstone does has to be active services for 40 Act purposes (we're an asset management/advisory firm, not a pass-through who lets you invest in a pool of securities) but passive for tax purposes.  I'm not saying the structure doesn't work - quirks in the rules often allow this sort of regulatory arbitrage -- just that it seems a little aggressive.  I don't think I've ever seen an entity go public with such uncertain tax treatment. 

More on the publicly traded partnership rules to come.  I'll also address how this relates to the Senate Finance Committee's interest in changing the tax treatment of carry, and a word about the "Wall Street Rule" and the enormous pressure this deal may put on the Treasury and the IRS. 

Update:  By way of comparison, here's the Fortress S-1.  It appears that Fortress uses a blocker entity to siphon off management fees; Blackstone will follow a similar structure.  The idea is that the blocker entity checks the box to qualify as a corporation, pays corporate tax on the fees, and then the payouts to the holding partnership are dividends, which count as "qualifying income" under 7704. 

It strikes me as somewhat easier for Fortress, a hedge fund, to make the 7704 argument; 1.7704-3(a)(2) notes that income from trading or investing assets isn't income derived in the ordinary course of a trade or business (as opposed to being a broler, market maker, or dealer).   Private equity is none of those things, of course:  it makes its money from changing the management and/or financial structure of portfolio companies.  In my mind that creates some uncertainty (although the strength of the plain language of 7704(d)(1)(F) ("any gain from the sale or disposition of a capital asset ... held for the production of income ...") probably helps).  I'm being a little cryptic, but I'll try to elaborate and clarify later today, schedule permitting ....

Permalink | Initial Public Offerings | Comments (5) | TrackBack (2)

The Glom is well represented here in Columbus today, as Christine and I are presenting at a conference on "IPOs in the Internet Age" hosted by Ohio State's Entrepreneurial Business Law Journal.  The symposium topic sounds a little 1999 bubblesque, doesn't it?  As it's shaping up, though, the conference will be forward-looking.  With a keynote by Peter Oh, I suspect we will spend a lot of time debating exactly what lessons to draw from the Google IPO and the Dutch Auction mechanism in general. 

My presentation is entitled "IPO Intelligence."  I'll argue that while the Internet has spurred the disintermediation of many transactions by driving down the costs of acquiring information, we're not likely to see similar efficiency gains for IPO transactions.  In Gladwellian terms, IPOs are a mystery, not a puzzle.  It looks like you can watch the webcast here. 

The speakers include Richard Booth, James Fanto, Christine Hurt,  Don Langevoort, Dale Oesterle,  Peter Oh, and TOTM's Bill Sjostrom.

Permalink | Initial Public Offerings | Comments (1) | TrackBack (0)

Last Friday Fortress Investment Group hosted its IPO, the first hedge fund to go public in the US. Apparently appetite for the offering was tremendous. Indeed, it opened at $35 a share, nearly double its offering price of $18.50. And the offering raised $634 million for Fortress. Obviously the public viewed the offering as an opportunity to participate in the tremendous profits hedge funds have been able to generate. But I wonder how going public will impact the ability of the hedge fund to continue producing such profits in the long term.

Based on the (albeit limited) scholarship I have read about hedge funds, I was under the impression that lack of significant regulation was part of the reason such funds were able to produce such robust returns and outperform other firms. Indeed, in a recent article on hedge fund activism, Frank Partnoy and Randall Thomas attribute the success of hedge funds to their ability to utilize financial strategies unavailable to more heavily regulated entities. And there has been some suggestion that, because of the greater risk associated with them, hedge funds should be limited to highly sophisticated and wealthy investors.

To be sure, there have been a lot of calls to better regulate hedge funds, and it could be that Fortress just sees the writing on the wall. But while there may be benefits associated with increased regulation of hedge funds, I am not sure that we can obtain those benefits while retaining the huge profits that public investors are surely hoping to receive. Interestingly, several experts have indicated that if hedge fund managers are selling, then it is probably not a good idea to be buying.

Permalink | Initial Public Offerings | Comments (2) | TrackBack (1)

As I've blogged about before, Industrial and Commercial Bank of China went public last October in the largest IPO in history, selling $22 billion in stock.  And despite the mammoth size of the offering, it was oversubscribed by well over $300 billion.  How are these IPO shares doing?

Pretty well, it seems.  Trading in ICBC, as well as the stock of two other major Chinese banks that went public in the last year or so (Bank of China and China Construction Bank) has been going great guns on the Hang Seng, Hong Kong's stock market.  ICBC stock has returned 26.8% in US dollar terms since last October, and China Construction Bank has produced a total return of 72.2% since its $9 billion IPO in October 2005.

These majority state-owned institutions are hardly models of good governance or accounting transparency.  Why are investors going gaga?  A recent Fortune article explains that  the big US and European banks are buying stakes in Chinese banks as part of a larger strategy to gain access to China's retail market for financial services.  Foreign banks aren't allowed to sell retail banking services in China, and foreign ownership of local banks is generally limited to 25%.  As a result, state-controlled banks dominate the retail market.  That market is a worthy prize for Western banks--1.3 billion people, $2 trillion in household savings, and only 20 million credit card holders so far.

Will Chinese bank stock prices continue to climb?  (This is not investment advice, BTW; I just know what I read).  Their P/Es are pretty high now, about twice those of Western banks.  OTOH, China's banks are modernizing, and they're backed by the government, which wants a strong retail banking sector anchored by local banks.

Permalink | Globalization & Trade| Initial Public Offerings | Comments (3) | TrackBack (0)

Yesterday, I posted on Tuesday's Second Circuit opinion that vacated class certification in the litigation that can only be described as "the IPO cases."  However, those cases have a companion litigation, which I guess can only be described as "the IPO antitrust cases."  In both these cases, plaintiffs allege a vast conspiracy in the IPO market by Wall Street investment banks.  (I analyze this conspiracy in Moral Hazard and the Initial Public Offering.)  One action claims these practices violate securities laws; another action claims the same practices violate antitrust laws.  The Second Circuit slapped down the securities law case Tuesday.  However, a different panel of the Second Circuit revived the antitrust case in September 2005 after that action was dismissed by Judge William H. Pauley III in district court. 

Today, the Supreme Court of the United States granted cert to hear the antitrust case, on appeal from the Second Circuit.  At issue is whether the securities laws that govern these practices preempt antitrust laws from getting in the picture.  (The antitrust claims are grounded in Section 1 of the Sherman Act and Section 2(c) of the Robinson-Patman Act.)  Although the district court ruled that the cause of action was preempted, the Second Circuit disagreed:  "The district court's decision goes too far. The heart of the alleged anticompetitive behavior finds no shelter in the securities laws."  The panel must have known there circuit fairly well!  WSJ story here.

See, people complained today about how the Supreme Court has taken less cases this term than usual, and then the court takes the case I'd prefer it just let alone!

Permalink | Initial Public Offerings | Comments (0) | TrackBack (0)

A few more boulders have been thrown on the plaintiffs' rocky road to recovery in the consolidated (former) class action case, In re Initial Public Offering Securities Litigation.  This case involves more than 300 issuers and 55 underwriters in more than 1100 original actions filed as early as January 2001 alleging IPO abuses (spinning, laddering, excessive compensation, and analyst conflicts) that were all consolidated in the Southern District of New York in Judge Shira Scheindlin's court.  First, the claims had to survive a motion to dismiss, and Judge Scheindlin denied in part that motion, keeping alive most IPO claims but dismissing claims relating to secondary offerings and mergers and acquisitions.  Judge Scheindlin also dismissed some claims under Section 11 brought by plaintiffs who sold stock above the offering price.  Judge Scheindlin revisited the question of dismissal after the Supreme Court opinion in Dura Pharmaceuticals and dismissed claims involving the "Pop and Performance" scheme of issuing knowingly low earnings estimate in order to give investors a pleasant surprise later. (Interestingly, the Supreme Court of the United States denied certiorari on that dismissal on Monday.)

Along the way, Judge Scheindlin approved two settlements:  (1) the issuers and individual officer defendants guaranteed recovery of one billion dollars by agreeing to pay plaintiffs the difference between underwriter recovery and $1B, if any; and (2) J.P. Morgan Chase settled claims in April 20006 for $425 million, pending court approval.  These settlements are a little more unsettled today!  Much more below the fold (maybe too much):

In October 2004, Judge Scheindlin certified the class by analyzing six "focus cases": Corris Corp., Engage Technologies, Inc., Firepond, Inc., IXL Enterprises, Inc., Sycamore Networks, Inc., and VA Linux Corp.  This determination was vacated yesterday by the Second Circuit, denying class certification.  The court stated that Judge Scheindlin erred in applying a "some showing" standard of proof for Rule 23's four requirements of numerosity, commonality, typicality and adequacy of representation.  The court acknowledged that it was fashioning a new standard as "our Court has been less than clear as to the applicable standards for class certification and. . . we have used language that understandably led Judge Scheindlin astray."  In addition, applying the court's new standard, commonality is not proven as to reliance because as a matter of law "the market for IPO shares is not efficient."  The Second Circuit remanded for further proceedings, but not further inquiries into certification, which it resolved.

So, lots of questions now as to the future of these lawsuits.  Without the class action mechanism, individual investors may bring lawsuits (if not bound by arbitration agreements), but finding representation for smaller claims will be difficult.  In talking to a reporter today, I heard that word on the street is that an individual plaintiff would find it hard to find an attorney if the plaintiff's claims were under $1 million.  So, tack that up to a $1 million deductible before any compensation for losses due to fraud.  And remember the fate of Donald Sturm, who chose to individually arbitrate his analyst conflict case and was provided no remedy for losing $900 million on Jack Grubman's tainted advice.

Is there compensable fraud?  Although the Second Circuit never expresses an opinion as to the ultimate question, the opinion seems to be fairly disparaging of Judge Scheindlin's denial of motions to dismiss.  In describing the December 2003 order, the court states that Judge Scheindlin "held that it was fair to infer dissipation of the inflated price over time in a manipulation case, notwithstanding the Second Circuit's intervening decision in Emergent Capital (citation omitted)."  The very question presented asked whether the class certification question can be answered without delving into the merits of the underlying case, and the Second Circuit seems to answer that a court must delve into those merits, and then does.

Finally, remember that many of the allegations in the Master Allegations were the subject of the record-breaking April 2003 Global Settlement of Analyst Conflict of Interest engineered by Eliot Spitzer, the DOJ and the SEC.  In the settlement, ten major Wall Street investment banks and analysts Jack Grubman and Henry Blodget settled allegations of improper IPO allocation practices.  The allegations focused on analyst conflicts, but two of those banks, Credit Suisse First Boston and Salomon Smith Barney (now Citigroup) were also charged with IPO spinning.  At the same time as the Global Settlement was finalized, these banks entered into the Voluntary Initiative Regarding Allocations of Securities in "Hot" Initial Public Offerings to Corporate Executives and Directors.  Recall also the prolonged prosecution of Frank Quattrone for obstructing justice in relation to spinning charges of allocating hot IPO shares to hedge fund managers in return for excessive fees on unrelated trades.  So, we have another example of regulators and prosecutors seeing a widespread industry practice they view as abusive and criminal, investigating and strong-arming targets into a settlement, but the victims of those abuses can find no relief in civil litigation either because of structural hurdles, procedural or substantive.  Is this an area of "overcriminalization" or "undercivilization"?

UPDATE:  Some links:  NYT, WSJ, Law.com, and the opinion (via Law Blog).

Permalink | Initial Public Offerings | Comments (0) | TrackBack (0)

Shutterfly, an online site for storing, editing, disseminating and printing digital photos, went public at the end of September, seven years after launching in 1999.  Coming to the party a little late in the game, the VC-backed startup had to weather the early 2000s as the economy was dragging and competition was fierce.  I've blogged before about this market and how the acquisition of competitors Ofoto and Snapfish by big players forced Shutterfly to compete on price here and here.  Now, as this NYT article describes, other online photo sites aimed at dissemination have popped up, such as Flickr.  In addition, big retail outlets such as Sam's Club, Wal-Mart, Target and Walgreens offer photo editing and printing and have even started to offer other photo products, such as mugs, calendars, mousepads, etc.

The lifecycle of Shutterfly would make an interesting study.  It could have folded either by going to IPO too early in 1999-2000 and then going bust or by not having enough cash flow to survive the aftermath of the technology bust.  However, because of the huge competition in this area, success is still not assured.  Since its IPO, the stock price has declined below Shutterfly's opening price.

One way that online photo companies could really shake up the market is by creating a way to transfer albums from one service to another.  An admitted archiver and scrapbooker, I have 102 albums on Shutterfly, probably representing about 8000 pictures.  Even when other sites were cheaper, I didn't switch because I didn't want to orphan those pictures or pay for archival CDs, which I think would cost me about $350.  If photo sites were like cell phone companies and could make it easy to take your stuff with you when switching, the market would really be different.

Permalink | Initial Public Offerings | Comments (1) | TrackBack (0)

Echoing our discussions here regarding the connection between public and private markets, Hertz announced on Friday its intention to host a public offering that could raise about $1.8 billion. The amount nearly doubles the value for equity firms who acquired the company about 10 months ago, confirming Gordon's belief that private equity firms look to the IPO as an exit strategy. In this case, the exit was fairly quick. An interesting feature of the Hertz IPO is that investors are set to receive a special dividend of about $426 million depending on the deal pricing, and that amount could increase if the green shoe is exercised. Hence, the IPO will represent a huge payout for private investors.

However, the IPO is not the only method private investors used to recoup their investment. In fact, Hertz will use its IPO proceeds to pay off a $1 billion loan taken out by Hertz to pay dividends to private investors. According to some experts, these special dividend payments reflect one way that private investors are able to get their money back even before the IPO.

Permalink | Initial Public Offerings | Comments (0) | TrackBack (0)

Yesterday, China's biggest bank, Industrial and Commercial Bank of China, or ICBC, began trading its shares simultaneously in Hong Kong and Shanghai in the world's biggest IPO, raising $19 billion. The offering was the first ever to list in both Hong Kong and Shanghai--raising $13.9 in Hong Kong and the remaining $5.1 in Shanghai. More than 1 million people placed orders. In case you were wondering, the all time biggest US offering was the AT&T offering at $10.6 billion, with the most recent largest offering being the Master Card offering that Vic has discussed, which raised close to $2.5 billion. The offering surpassed the last biggest offering ever by the Bank of China. Can't resist the pun, that's a lot of investors banking on the strength of China's economy!!!

Permalink | Initial Public Offerings | Comments (0) | TrackBack (0)

Visa is going public.  (Details here.) 

The IPO is necessary to create a single-entity defense to antitrust claims.  This will primarily limit its liability going forward and will not extinguish past claims.  (See generally my MasterCard IPO paper here and Josh Wright's paper on MasterCard here.)

Visa Europe will not be included in the new corporate entity that will eventually go public.  Instead, it will license the necessary IP and networking assets from Visa Inc.  The website explains the Europe presents some "unique opportunities and challenges" related to the EU's desire to create a single payment systems market. 

The implication is that the European banks have unique expertise that will allow them to create better value in Europe.  Or it may be that the European banks think that they have better expertise, they don't trust the US banks to run the show, and they weren't able to agree on a price for giving up control over the market.

Another possible explanation (or contributing factor) is that the European banks feel that the US banks are responsible for the antitrust problems in the US, and they don't want to share in the liability attributable to the time period before they joined Visa.  And they may also want to build in some distance from the US banks going forward. 

MasterCard, by contrast, was able to negotiate a payment to the European banks to account for past liabilities in the form of a holdback from the US banks of a large amount of the IPO proceeds.  MasterCard also included a board-within-a-board structure to give wider authority to the European banks over development of the European market. 

It will be interesting to see what the market thinks of Visa's new structure.  The market loves MA these days.  But until we learn more about the licensing deal with Visa Europe, it's hard to fully evaluate Visa.

Permalink | Initial Public Offerings | Comments (2) | TrackBack (0)

Dale Oesterle has a nice update on the Alternative Investment Market (AIM), and he explains why the U.S. needs to pay attention:

The AIM market is booming. In 2005 AIM had 335 IPOs compared to NASDAQ’s 35. The deal size comparisons are also telling. The average technology IPO deal size on the NASDAQ was $117.5 million, on the AIM it was $18.7 million. The AIM supported the smaller deals. Interestingly, the enterprise value as a multiple of revenue was lower on the NASDAQ 4.7x than on the AIM, at 6.3x. AIM investors were willing to accept more risk. The London market has successfully created a public offering market for small and micro cap companies. To remain competitive, the United States trading markets need to mount a successful competitor to this market.

Permalink | Europe| Initial Public Offerings| Securities Trading & Regulation | Comments (0) | TrackBack (0)

Dr. Seuss is currently the most widely read author in my house, so please forgive the literary allusion. . . .

SOX is conventionally blamed for driving IPOs overseas.  Apparently, higher underwriting fees and greater underpricing may also be to blame.  Daniel Gross at Slate cites a study by Oxera--a European economics consulting firm--which suggests that these IPO costs are generally higher in the US than in London.  Alan Murray also comments in WSJ.  The report was commissioned by the London Stock Exchange and so must be taken with a big grain of salt. 

In any event, as the world gets smaller and capital markets integrate, Gross reminds that IPOs are becoming a commodity, where even small pricing differences may matter.  Higher fees and more regulation.  Is the US becoming (as Gross suggests) the Europe of capital formation?

Points for anyone without preschool children who can identify the literary allusion in the title. . . .

Permalink | Globalization & Trade| Initial Public Offerings | Comments (0) | TrackBack (0)

In her presentation at SEALs, Joan Heminway spoke about the differences in how men and women trust as well as the extent to which both groups are viewed as trustworthy, and then pinpointed some implications for these differences in the corporate context. In doing so, she spoke about a study conducted by Professors Lyda Bigelow and Judi McLean Parks of Olin School of Business, Washington University in St. Louis, which found that investors overwhelmingly favored companies run by men over those run by women. The professors created two different prospectuses for a company they claimed was going public and distributed them, along with the bio of the company’s CEO, to people with a business and finance background to assess their willingness to invest in the company. The two prospectuses were identical except that half of the investors received prospectuses indicating that the company’s CEO was a woman and the other half received prospectuses indicating that the CEO was a man. The bios of both CEOs were virtually the same. However, the professors found that the CEO’s gender had a huge impact on how both men and women investors viewed the company and its potential for success.

Thus, investors were not only willing to invest more money in men-led firms, but also were willing to pay the male CEO more money than the female CEO—saying they would pay the woman only 86% of the salary they would pay the man. In addition, investors had a less favorable view of the female CEO’s ability to manage the company, despite the fact that the resumes of both CEOs were identical. For example, investors indicated that the female CEO would be less able to handle a crisis and resolve conflicts on the board. They also suggested that the female CEO was less competent and had less leadership experience. Ultimately, investors—both male and female—agreed that the female-led company represented a riskier investment. In the professors’ opinion, the study revealed the difficulties women CEOs face raising money in the IPO market. The professors expressed surprise with the bias they found particularly given that 40% of companies in the US are run by women. However, the 2006 Fortune survey revealed that only 10 Fortune 500 companies are run by women, while only 20 Fortune 1000 companies are run by women. Certainly there are many reasons for this phenomenon, but the study suggests that gender bias among all investors continues to play a role in how we perceive the strength of a company.

Permalink | Entrepreneurs| Initial Public Offerings | Comments (6) | TrackBack (0)

As each day’s headlines attest, the world’s stock exchange business is consolidating. The NYSE has bid for Euronext, the company that owns and operates the Paris, Amsterdam, Brussels, and Lisbon stock exchanges and the London International Financial Futures and Options Exchange. The Deutsche Borse had also made a bid, but its offer appears to be floundering, as Euronext shareholders voted recently expressing their preference for the NYSE's bid.  Predator and prey, Deutsche Bourse and Euronext are also each pursuing a deal with Borsa Italiana.  NASDAQ has bid for the London Stock Exchange, as have the Deutsche Bourse and Macquarie Bank of Australia.  NASDAQ already owns over a quarter of LSE's shares, making rival bidding difficult.  Whew!

The conventional story for this consolidation seems to be the inexorable scale economies that come from pushing more trading volume through expensive computerized trading systems with unlimited capacity.  Given the technological advances, the world’s securities trading may be a winner-take-all market, and once the large start-up costs of the trading infrastructure are sunk, it behooves each exchange to gobble up as much volume as possible. For consumers, the story goes, benefits will come in the form of cheaper trades at better prices. 

This conventional story comes with a number of interesting complications, though—economic, regulatory, and political. On the economics, while competition among exchanges to capture scale economies is surely an important impetus to consolidation, as the Economist points out, the exchanges are also coming under increasing pressure from alternative trading venues.  First off, the big Wall Street firms are increasingly internalizing their crossing trades--matching buy and sell orders internally instead of sending them to the exchanges for execution.  In addition, brokerage firms are registering their internal crossing networks as alternative trading systems with the SEC, thereby bringing in regulatory oversight, which allows for connections with external networks and increased liquidity.  Second, over-the-counter trading via brokers is becoming more and more popular.  Third, block trading by institutions is more and more being conducted over private electronic trading systems like Liquidnet and Pipeline, where anonymity is more readily available.  So exchanges as a group are losing market share.  Up to two-thirds of British share trading and 75% of German trading now occur off-exchange.  The consolidation of exchanges turns out to be as much survival strategy as innovative cost cutting strategy.

On the regulatory side, Sarbanes-Oxley is the big gorilla everyone is trying to keep behind the closet door. The UK’s Financial Services Authority has received comfort from the SEC that a NASDAQ-LSE merger would not by itself trigger an attempt by the SEC to apply SOX or other US regulation to LSE-listed firms.  SEC commissioner Anne Nazareth has been publicly commenting to similar effect, and last week, the SEC issued a blunt fact sheet stating that:

– Joint ownership of a U.S. exchange and a non-US exchange would not result in automatic application of U.S. securities regulation to the listing or trading activities of the non-U.S. exchange.

– Whether a non-U.S. exchange, and thereby its listed companies, would be subject to U.S. registration depends upon a careful analysis of the activities of the non-U.S. exchange in the United States.

– The non-U.S. exchange would only become subject to U.S. securities laws if that exchange is operating within the U.S., not merely because it is affiliated with a U.S. exchange.

This is of course no small concern. In 2000, ninety percent of the world’s IPO dollars were raised in the US; in 2005, ninety percent of the world’s IPO dollars were raised outside the US. SOX has largely been blamed for this IPO flight from the US. FSA chair Callum McCarthy did note, however, the possibility that the merged NASDAQ-LSE entity itself might seek to rationalize its regulatory structure by consolidating its operations within one jurisdiction in order to subject itself to only one regulatory regime. He went so far as to suggest the possibility that some day the LSE might not be subject to UK regulation.

On the political end, it’s not difficult to imagine the nationalistic pressures being brought to bear on these various deals.  The French are keen to preserve a strong French exchange overseen by French regulators, and the NYSE promoted itself as Euronext's best merger partner for augmenting Paris as the premier European financial center.  OTOH, the NYSE has also made noises about starting an new exchange in London to compete with LSE, thereby undermining its professed commitment to promoting Paris.  Deutsche Borse has also found itself in political hot water over the conduct of its Euronext bid.  Just the other day, DB sweetened its offer for Euronext, attempting to appease the French by promising that the office of the chairman of the supervisory board of the merged company would be in Paris, and that the merged company would use French technology for trading shares.  Not only was Euronext not impressed, but German politicians and DB employees on its supervisory board moved to block attempts to shift businesses elsewhere.  A politician from the German state of Hesse, DB's home state, professed that DB "has definitely gone too far," and threatened to revoke DB's license if concessions cost too many jobs in Frankfurt.  Germany's minister for trade and industry noted that any deal would have to preserve "the central role of Frankfurt."

It's complicated!  Stay tooned.

Permalink | Europe| Globalization & Trade| Initial Public Offerings| Securities Trading & Regulation| Takeovers | Comments (0) | TrackBack (0)

Using IPOs as branding is Vic's arena, but I wanted to add on to Lisa's Vonage IPO post with some commentary on Vonage's attempt to use its IPO to build customer loyalty.  Directed share programs that pre-allocate IPO shares to known investors are obviously not new and grew in the 1990s beyond "friends and family" plans to plans to include vendors, business partners, employees, and other groups.  Although these programs were historically small, the size of these programs grew as the range of persons grew also. 

One of the more interesting (and administratively difficult) uses of a directed share program prior to the Vonage IPO was the mp3.com IPO.  In that start-up firm's IPO, it pre-allocated a large percentage of tis shares to the musicians who posted their music on its site.  The mp3.com shares, however, more than doubled during its first day of trading in May 1999.  The Vonage shares, as we now, fell dramatically in price the first day.  Vonage seemed to attempt the same kind of hip IPO:  pre-allocate shares to its customer base (historically, a telephone company's "friends and family").  This gesture would build customer loyalty and brand Vonage as the cool, co-op style telephone company.  But, it only works if the customers get value; if the shares rise in price.  When the Vonage shares did not rise in price, for various reasons, Vonage only got angry customers, in addition to customers who were frustrated with the adminstrative process.  And, when customers get angry, they like to call customer service and complain.  Unfortunately, investors don't get to call the issuer, complain and be placated with a credit to their account.  As this article describes, Vonage has ended up looking as hip as someone's Dad trying to do the Macarena.

Permalink | Initial Public Offerings | Comments (0) | TrackBack (0)

After the Vonage IPO train wreck as Gordon described it, apparently at least one law firm is looking to put together a class action suit against Vonage. Vonage stock, which was priced at $17 a share is now trading at a little under $12. Vonage encouraged many customers to purchase the stock. Those customers are not just disgruntled by the stock's fall, but apparently can cite some potential Securities Act violations. Hence, Vonage apparently sent an email to customers encouraging them to invest without providing a link to the prospectus. Vonage also appears to have left voice mail messages with customers that did not include information about how to get a prospectus. While these acts may not pose a problem in an IPO that does well, they could leave the door open for suits when the IPO takes a nose dive as this one did. We will just have to wait and see how things shake out.

Permalink | Initial Public Offerings | Comments (0) | TrackBack (0)

In addition to Vonage, the Bank of China went public in Hong Kong today, raising $9.7 billion before the overallotment option. That's BILLION!

And MasterCard is slated to hit the NYSE tomorrow. If you want to know more about that, take a look at Vic's case study.

Permalink | Initial Public Offerings | Comments (0) | TrackBack (0)

We have been talking down the Vonage IPO from the moment we heard about it. Today, the IPO is happening, and this is ugly: "Internet phone service provider Vonage Holdings Corp.'s initial public offering encountered shareholder static Wednesday morning, and appeared headed for the worst IPO debut in two years."

I am happy to report that I refrained from using the George Costanza Method of Investing and stayed on the sidelines.

Permalink | Initial Public Offerings | Comments (2) | TrackBack (0)

Fortune Magazine has a nice piece on the battle for China among the big Western investment banks.  It opens by describing the beauty contest to lead the upcoming $12 billion IPO by the Industrial & Commercial Bank of China, a contest for which Goldman Sachs seemed to have the inside track.  (See here and here for other recent coverage of Goldman).

Goldman Sachs was the hands-down favorite. Its executives had courted ICBC for years. On his many trips to China, CEO Hank Paulson had called regularly on chairman Jiang Jianqing. Jiang's daughter had worked as a summer intern at Goldman in New York City. Earlier this year Paulson had underscored the firm's commitment by pledging to buy a 7% stake in the bank for $2.6 billion.

ICBC hadn't even invited Goldman's archrival, Morgan Stanley, to submit a proposal, allowing Fred Hu, a polished, Harvard-trained economist, to make Goldman's pitch with confidence.

Of course, Goldman got aced out of the offering, which went to a group including Merrill, Credit Suisse, and Deutsche Bank.  The story goes on to describe the increasing sophistication of Chinese leaders in playing I-banks off against one another, and the cutthroat competition among the I-banks not only for deals, but for experienced China hands and strategic partnerships with local firms.

Citigroup has apparently had some tough sledding in China, earning ignominy by having led the only China IPO to date that had to be pulled--the CNOOC IPO in '99 (the same CNOOC--China National Offshore Oil Corp.--that bid for Unocal last year).  So like a good strategic player in China, Citigroup beefed up its guanxi by hiring former Premier Zhao Ziyang's daughter-in-law for a salary in excess of $8MM.  Things didn't work out so well . . . but I'll let you read the rest.

Permalink | China| Initial Public Offerings | Comments (0) | TrackBack (0)

Last week Bill Sjostrom and I were commenting on the weakness of the Vonage IPO as evidenced by the company's eagerness to promote the Customer Directed Share Program.

Now, Andy Kessler argues that Skype's "free calls" promotion is likely to be the knockout punch for Vonage:

At Skypeout = zero, its infinite minutes. The value of what Vonage provides has just gone from $25 per month to somewhere close to $0, goose egg, nada. Tough to get a return on equity with those kind of numbers....

Capitalism is not without its Department of Dirty Tricks. Not much different than your beloved Yankees overpaying for Johnny Damon - because they could!

Even the timing gives a clue - now through the end of 2006 - just long enough to sink the good ship Vonage. The effect on Ebay? Noise. They already took the 3% or so dilution when they overpaid for Skype, they might as well have some fun with it. Lose some cash flow? So what, you’ll barely be able to find it in their income statement.

Is this a plausible story? As I have noted before, I am a satisfied Vonage customer, and I am not ready to switch to Skype, even though I downloaded Skype a couple of months ago. Check out the comments to Andy's piece if you want to see the pushback.

Permalink | Initial Public Offerings | Comments (1) | TrackBack (0)

The W$J has an interesting article about IPO companies with lots of debt:

So far this year, one-third of the 64 initial public offerings issued warnings in their prospectuses about the risks associated with their debt levels.... Twenty percent carried net tangible book-value deficits even after raising money through their IPOs, meaning that, if those companies were liquidated the day they came public, stockholders would receive nothing.

Is debt a bad thing? We are still having the same debate about debt that was raging in the late 1980s: debt-as-burden v. debt-as-discipline. This is a silly debate in the abstract because getting the right amount of debt is the trick. Easier said than done.

One argument that is -- hmm, how to say this diplomatically? -- not helpful comes from John Coyle, head of J.P. Morgan's financial-sponsors group: "As a company deleverages, it adds to its earnings capacity. So in a way, investors in these IPOs know there is some future earnings growth that is already in the bag -- as the leverage comes down, earnings will go up."

This might be an interesting insight in Accounting 101, but it doesn't tell us anything useful about the highly leveraged companies that are hitting the public markets. The notion that "future earnings growth ... is already in the bag" brushes aside the main concern about high levels of indebtedness: uncertainty over future earnings. A slight downturn, either for the highly leveraged company or its industry, can place substantial constraints on the highly leveraged company's ability to operate.

Permalink | Initial Public Offerings | Comments (1) | TrackBack (0)

Earlier this week, Bill Sjostrom mentioned the letter from Vonage to its customers about the Directed Share Program, which I discuss here. This morning, I received an automated voicemail from Vonage, pitching their shares. Same text as the letter, but if you are interested in hearing, click.

Permalink | Initial Public Offerings | Comments (2) | TrackBack (0)

One year ago, I signed up for Vonage, and I have been very happy with the service. But is this a good business model?

In February of this year, I noted that Vonage was going public, and I expressed concern about the role played by Vonage's Founder, Chairman and Chief Strategist, Jeffrey A. Citron, who has a long history of shading dealing. Even if Citron behaved himself, this is a company that is incurring "increasing net losses" as a result of marketing expenses, and faces daunting competition from telecoms, cable companies, and wireless providers, as well as Skype, Google, etc.

Despite this seemingly bleak appearance, Vonage recently doubled the projected size of its offering on the strength of a recent spurt in subscriptions. Pretty rich for a company that may never reach profitability.

Today, I received an invitation to participate in the Vonage Customer Directed Share Program. I am not a great investor, so my inclination is to make a decision in my normal way, then do the opposite. I call this the George Costanza Method.

Permalink | Initial Public Offerings | Comments (4) | TrackBack (1)

Here's a story on Bank of America's announcement that it may elbow its way into the credit card business.  (Thanks to Chad Rolston for the heads up.) 

The MasterCard IPO structure has several features that seem puzzling.  I'd been focusing my attention on one end of the network and how MasterCard is getting squeezed by merchants (esp WalMart) and regulators.  The announcement by B of A suggests that MasterCard and Visa will face competition from the other end of the network -- first B of A, tomorrow Citi?  What happens if, say, Citi and Walmart team up to form a competing payment system network?  What will happen to interchange fees?  The next decade will be very interesting for payment systems.

The most puzzling feature in the MasterCard deal is the charitable foundation -- why would MC give away $600 million in value?  What makes it especially interesting is that the foundation can't sell its stock for a long time (none for 4 years, and only in small amounts for 21 years).  It can't be *just* an embedded takeover defense, as other features of the deal would make a takeover difficult.  The foundation instead will provide some stability to the brand and the market -- not only does the structure of the deal prevent B of A from taking over MasterCard, it makes it impossible for any of the member banks to use voting power to influence MasterCard to benefit themselves to the detriment of other member banks.   Pretty clever.

Permalink | Initial Public Offerings | Comments (2) | TrackBack (0)

Peter Oh (William Mitchell, moving to Pittsburgh) has posted his latest paper on SSRN:  The Dutch Auction Myth.  I saw Peter present this paper at the Midwest Law & Economics Association conference last Fall, and I look forward to reading the paper.  Here is the (heart-wrenching) abstract:

The initial public offering process is under assault. Critics of this process have woven a complex set of interconnected objections to the orthodox method for conducting IPOs, pricing of shares, and allocating them to preferred investors. These critics instead point to online auctions as an alternative IPO method that can provide more equitable access, efficient prices, and egalitarian allocations. These claims rest on Google's IPO and W.R. Hambrecht & Co.'s OpenIPO mechanism, which are impure variants of the descending-bid or Dutch auction (Dutch IPO). This article assesses the empirical and theoretical case for Dutch IPOs. The first data set is from Google's IPO, which featured peculiarities that delimit its utility as a case study. The remaining data sets are from OpenIPOs and the Mise en Vente, an auction-based mechanism prevalent in France. The results fail to vindicate Dutch IPO supporters' primary claims, which perilously rely upon interpretative data from the anomalous two-year internet bubble period. Moreover, economic and financial analyses of Dutch IPOs reveal ways in which they may be susceptible to fraud and manipulation that bookbuilding is not. Ultimately, claims of the Dutch IPO's superiority over bookbuilding at best are unproven and at worst fail to appreciate certain risks.

Permalink | Initial Public Offerings | Comments (0) | <