I've been thinking about IPOs, and the potential lack thereof, quite a bit in connection with my next project. Today's WSJ decribes the current IPO market as hot:
U.S.-listed companies and their financial backers have sold $19.6 billion in stock this year, putting the IPO market on track for one of its biggest years since the financial crisis, according to Dealogic. Just 25% of this year's deals have priced below companies' expectations, the lowest since 2009.
How much of the new action is due to the JOBS Act? Not much, says DealProf Steven Davidoff. He recounts the Act's failure to do increase small IPOs:
The act was intended to help spur a moribund market in small I.P.O.’s. But for offerings that raised less than $100 million, there were actually fewer after the JOBS Act. According to Dealogic, there were an average of 15 such I.P.O.’s per quarter in the year before the new law versus an average of 13 per quarter the year after.
Which begs the question: how many IPOs (small or large) should there be, anyway? And what, if anything can or should the government do about it?
The titular questions have been swirling in the back of my head for the past month or so. Spoiler alert: I don't have the answer. But Jeff Schwartz' post in the CLS Blue Sky blog on the SEC Advisory Committee on Small and Emerging Companies' proposal to create a separate market for small and emerging companies, open only to accredited investors--more or less a public SecondMarket/SharesPost--has me asking it again.
This strikes me, unlike Jeff, at first blush as a bad idea, but let's ignore the merits of the proposal and focus on one of its premises. One of the arguments the Committee makes in favor of it is that "providing a satisfactory trading venue" for these companies might encourage IPOs of their securities.
First question: Really? Isn't it just as likely that, if a robust market exists for these companies, they're less likely to go public? Isn't obtaining liquidity one big reason for going public in the first place?
Second question: How many is the right number of IPOs, anyway? The WSJ told me yesterday IPOs are set to raise the most cash since 2007. Jay Ritter argued in a recent paper that IPOs have dried up not because of heavy-handed government regulation but because times have changed. Now getting big fast is the way to go, and going public and being a small independent company isn't as attractive to a young firm being acquired by a bigger player.
As Ritter writes, "If the reason that many small companies are not going public is because they will be more profitable as part of a larger organization, then policies designed to encourage companies to remain small and independent have the potential to harm the economy, rather than boost it." Ritter's prescriptions to help IPOs are to encourage auctions over bookbuilding (here's yet more evidence that the underwriter spread is too big), discourage class action lawsuits, and reform the copyright and patent system.
Ritter closes with: "I do not know what the optimal level of IPO activity is in the United States or any other country, nor do I think that it should necessarily be the same now as it one was."
Right now I'm with him.
VentureBeat has created a list of leading IPO Candidates for 2013, and there are some exciting prospects. Box, Dropbox, Eventbrite, LivingSocial, Square, Survey Monkey, and Twitter are some of the familiar names on the list. Still, in a recent survey by the National Venture Capital Association, VCs and CEOs were rather restrained in their outlook. The outlook for VC investment is also muted, and I am wondering: will Fred Wilson make an investment in 2013?
P.S. If you are interested in whether the JOBS Act will have any effect on startup financing, you might be interested in the Hot Topics Program at AALS entitled "Jobs," the JOBS Act, and the Future of Small Business Finance and the U.S. Equity Markets. It is scheduled for this Sunday at 10:30 am, and speakers include Glom friends Steve Davidoff, Joan Heminway, Kristin Johnson, Jeff Schwartz, and Bob Thompson.
Who's ultimately to blame for the fact that the Facebook IPO was colossally overpriced? So much so that it's lost $50 billion of market cap in 3 months? Andrew Ross Sorkin made a compelling case earlier this week for Facebook's CFO, leading with a killer two-sentence paragraph:
It is David Ebersman’s fault. There is just no way around it.
Sorkin's DealBook piece is well worth a read, but left me ultimately unconvinced. Here's why. In general, our securities laws view firms wanting to sell stock to the public with suspicion. What's to keep fly by night companies from lying about their assets, inflating their worth, and then getting while the gettin's good? 1929 and all that.
The bankers, that's who. The rather elegant mechanism of the Securities Act of 1933 is to put a deep-pocketed repeat player, with reputational capital as well as cold hard cash at stake, on the hook. Cue the investment banks. Sorkin may be exactly right to blame Ebersman because
[h]e signed off on the ever-increasing offer price, which ended up at $38 after the company had originally planned a price range of $28 to $35.He — almost alone — pushed to flood the market with 25 percent more shares than originally planned in the final days before the offering.
But there's at least an argument that he was acting in the company's best interests by pushing for a high stock price, not leaving money on the table, etc. The fact that the 25% of extra shares came not from the company but from Facebook's investors weakens this argument, but a high price range still benefited the company. Morgan Stanley was supposed to be the grown-up here, stepping in and saying, "Not so fast, the market might not bear this price, let's look at demand, let's look at the fact that Facebook shares have been trading on the secondary market for a while."
But Morgan Stanley appeared so delirious over having hooked the IPO of the decade that it forgot its role in the IPO: it was supposed to be the grownup.
Last week I posted the first of a three-part series on my new article with Mike Stegemoller on SPACs. In this post I'll discuss our second finding, which relates to underwriter discounts, or the gross spread. In a normal IPO, the nominal way an underwriting bank makes money is by buying stock from the company at a discount, and then turning around and selling it to the public at full price. The difference, or "spread" between the purchase price and the sale price, is the investment bank's official compensation for bringing the fledgling firm to market. Some scholars would point to underpricing--and the banks' corresponding ability to curry favor with client--as the true compensation for underwriting, but we covered underpricing last week.
What do underwriters do to earn their discount? Well, they expend a lot of effort trying to value the firm correctly (I'm looking at you, Morgan Stanley), because in a firm-commitment offering they take on the "risk" that they won't be able to unload the shares they buy from the company and offer to the public. "Risk" is in quotation marks because the underwriters build a "book" of pre-sale offers of interest, and generally won't agree to take the firm public without being sure all of its shares will sell. The underwriter does face a real risk of liability for false statements in the offering documents, however, and the spread may also compensate the bankers for this risk.
A curious fact about traditional U.S. IPOs is that the gross spread is sticky--underwriters almost always buy company shares at a 7% discount, as documented in this fabulously named Chen Ritter paper, shouting out to Sherlock Holmes, no less. As Chen & Ritter, describe, the clustering of spreads around 7% is 1) a relatively recent phenomenon, 2) specific to the U.S., and 3) roughly twice as high as in other countries.1
Suspicious. After all, shouldn't some firms be riskier to underwrite than others, and thus command a higher spread? And others by the same token be surer bets, with a correspondingly smaller spread? Chen and Ritter conclude that most spreads for firms over $30 million are above competitive levels and discuss explanations ranging from implicit or explicit collusion to reducing underpricing.
SPACs, essentially piles of cash, should be easier to value than the typical company. The information asymmetries that characterize the average company just aren't there. Moreover, bookbuilding should be an easier process because there isn't much of a "story" needed to persuade potential customers to buy. By the same token, SPACs should be less risky to underwrite, since the trust fund creates a floor price below which the stock should not drop. As a shell company, disclosures are boilerplate and close to risk-free for the underwriter. So we hypothesize that the spread should be lower than 7%.
Yet the mean and median underwriting discount for our sample is 7%. We argue this offers further evidence that spreads are above competitive levels. Moreover, as the SPAC form evolved, investment banks began to accept a portion of the spread as deferred compensation. Meaning that the nominal discount remained 7%, but some of that cash was tied up in escrow, and only released to the bank if and when a subsequent acquisition occurred. The fact that the SPAC underwriting discount initially clustered around 7%, but all of the banks quickly proved willing to sacrifice nearly half of their compensation, without demanding any increase in overall spread as compensation for the delay in payment, is further evidence that a 7% spread is not the product of a competitive market. In other words, if competition is fierce enough, underwriters can apparently operate at spread levels much lower than 7%.
That sticky 7% is looking curiouser and curiouser...
1 The Chen Ritter study is from 2000, but Abrahamson, Jenkinson, and Jones (2011) confirm their findings.
Faithful Glommers know that I've been thinking and writing about SPACs for a while now. For those who don't remember, SPACs (short for special purpose acquisition corporations) are essentially one-shot private equity funds, where the managers raise a pile of money via IPO and then park it in a trust account. They then have 3ish years to search for a target, at which point shareholders get some sort of say on whether they want the acquisition to occur. If no deal occurs or if they veto it, they get back their share of the trust account (an average of 96.4 cents on the dollar in our sample). Mike Stegemoller and I studied a sample of SPACs from 2003-11. Our first piece, Special Purpose Acquisition Corporations: A Public View of Private Equity, forthcoming in the Delaware Journal of Corporate Law, traced the evolution of the form from a contract design perspective.
We recently posted our second piece, What All-Cash Companies Tell Us About IPOs and Acquisitions, on SSRN. It's a more finance piece, intended for a peer-reviewed journal, so I thought I'd use a few posts to translate our findings for the law crowd. Plus you can draw more conclusions and make bigger claims in a blog post than in a finance article, and that's always fun.
So SPACs are interesting in and of themselves, but that's our first paper. This one is about using SPACS as a tool to see how two major events of a firm's life--the IPO and making an acquisition--work. The cool thing about SPACs is that they're essentially a pile of cash, with all the extraneous "noise" (capital structure, industry-specific characteristics, heterogeneous goals, etc.) that typically plague empirical studies stripped away. Because of SPACs' cookie-cutter nature, we can make more definitive conclusions about the mechanics of these events. As a preview, we have 3 main findings, regarding IPO underpricing, underwriter gross spreads, and acquisition announcement returns. I'll devote a post to each, beginning today with underpricing.
I've already blogged about underpricing in the context of the Carlyle IPO. For those not familiar with this phenomenon, Facebook and Carlyle notwithstanding, most IPOs are underpriced by the investment banks that sell them to the general public. In other words, those wizards at Goldman or Citigroup or Morgan Stanley (ahem!) spend months evaluating what price the public market for the company's stock will bear, price it accordingly, and yet by the close of the first day of trading the stock price generally rises, sometimes substantially.
So what gives? The company is leaving money on the table by offering the shares to IPO buyers at a bargain, and letting those buyers enjoy the runup in stock price. As I wrote in May:
There are 2 dominant stories for IPO underpricing, one sinister and one innocent. Both hinge on the fact that in an IPO investment banks act as intermediaries, buying the company's shares at a discount and then turning around and selling them to the public. The sinister story blames greedy investment bankers that strong-arm companies into asking too little for their shares so that the bankers can curry favor with their clients. The innocent one chalks underpricing up to information asymmetry: it's hard to gauge the true price of a stock that hasn't been traded, and uninformed investors will shy away from the market entirely unless they can be enticed in with the prospect of a sure thing. (Steven Davidoff has a characteristically incisive review of all the underpricing theories here).
A variant of the first explanation is that managers may willingly underprice in order to get favorable analyst coverage from the banks down the road. With SPACs we have a case where the information asymmetries should be almost precisely zero. Meaning I don't have a degree in finance, but even I can probably value an offering of 100,000 shares that will raise $50,000,000 for a shell company. And SPAC managers generally exit after the acquisition, so they don't have the incentive to retain investment banker goodwill that the operating company managers do. So we predict that SPAC IPOs will not be underpriced. And (drum roll, please)...
They're not. Well, they are a little bit (0.9%), as compared with 11.8% from 2001-09 for conventional firms (Gao, Ritter, and Zhu (2011). What little underpricing we find relates to the rank of the lead underwriter. Lower ranked underwriters underprice their SPAC offerings more than do higher rank underwriters. It may be that higher risk SPACs select lower-reputed underwriters. Or it may be that, regardless of the underlying quality of the SPAC, lower ranked underwriters have to price their product to sell to convince investors to buy, in a way that the Goldmans of the world do not.
Either way, the small amount of underpricing might lead one to conclude that our findings support the innocent story (information asymmetry), rather than the sinister one (greedy banks). However, sinister proponents could argue that the greedy banks underprice IPOs for the average firm, they just can't get away with it in the transparent world of SPAC valuation. That's a limitation of using a sui generis beast like the SPAC to study underpricing.
Luckily, SPACs' idiosyncratic nature actually makes our findings on the underwriter spread and acquisitions more compelling. Tune in soon for more on those topics...or if you simply can't wait, read about them here.
Update: Post 2 is here.
One of today's WSJ headlines reads "Nasdaq CEO Lost Touch Amid Facebook Chaos," referring to Robert Greifeld's being on a flight from California to New York from 12:14-5:07 without phone or internet service on the afternoon of the Facebook IPO. What follows is a tick-tock description of that day, culminating in SEC Chairman Mary's Schapiro's call to Greifeld to ask for explanations on the offering. She was "surprised" at not being able to get ahold of him. (She called at 4:03, and he called her back at about 6.)
Am I the only one who thinks the fuss over Nasdaq's trading glitches is overblown? I mean, don't get me wrong, mistakes were made. Nasdaq tested its system with 53 million shares trading, and apparently 70 million shares traded in the opening, "about a third more than the exchange had run in its test." Order confirmations were delayed, and released problematically:
At 1:50 p.m., Nasdaq released long-delayed confirmations of earlier trades into the market. Some brokerage firms would later complain that a wave of sell orders on Nasdaq made it look as if investors suddenly were turning against Facebook. About 12 million Facebook shares changed hands around 1:50 p.m., and the stock price fell about $2 in minutes.
It's bad that people couldn't complete trades when they wanted to, especially as it became clear the anticipated IPO pop was not going to happen. I know that people lost money on these sales, and Nasdaq will spend $40 million compensating them, as it should. Still, it seems like Nasdaq is getting a bum rap on this one.
To me the deeper problem with the IPO was that it was fundamentally mispriced, and that Morgan Stanley let Facebook investors flood the market by upping the IPO size at the last minute. It was "the wave of sell orders" that made it seem like the market was turning against Facebook--the problem was that the price was too high to start with. Sure, Nasdaq's technology snafus didn't help matters, but Facebook is trading down more than $10 from its IPO price. The company sold too much at at too high a price.
So what if Nasdaq's CEO was up in the clouds when the sale went down? He can't repeal the law of supply and demand. And if your trading strategy is based on being able to trade into and out of stocks fast--well, live by the sword...
Faithful Glom readers know that Special Purpose Acquisition Corporations (SPACs) have been on my mind for some time. SPACs are a type of "blank-check" company that goes public in order to raise money, and then begins a hunt for a target. The beauty of the SPAC model is that going public is easy--the SPAC is basically a shell, so disclosures are minimal and cheap. If and when the SPAC acquires a target, (usually a private company) that target immediately becomes public without the hassle of an IPO. Some call it a "back-door" IPO--but please don't associate SPACs with the more seedy reverse mergers that led to so many Chinese companies with questionable accounting practices going public. They're different, trust me.
I wondered what effect the JOBS Act would have on the SPAC market. Because JOBS' "on ramp"/emerging growth company option makes it easier and cheaper from young corporations to go public, I figured JOBS would make SPACs relatively less attractive. Why use a SPAC when you can just go public on your own?
I have to admit, I never considered that SPACs themselves would opt to go public as emerging growth companies. But according to the WSJ,
Just eight weeks after [JOBS']passage, however, more than a dozen of the companies seeking to use its looser rules for going public aren't the type of high-tech growth companies lawmakers had in mind.
"Special-purpose acquisition companies" and "blank check" companies, basically empty shells with almost no employees that are used in mergers or as a backdoor route to U.S. stock listings, have been quick to identify themselves in regulatory filings as "emerging growth companies."
The article quotes Meredith Cross, director of the SEC's Division of Corporation Finance, as having examined whether "trusts that collect music and movie-royalty payments, or structures used to create tax-free corporate spinoffs" could qualify as emerging growth companies. "These are not companies that are job creators," she observes.
JOBS Act, meet the Law of Unintended Consequences. Nothing in JOBS requires that EGCs be job creators--they just have to "total annual gross revenues of less than $1 billion." Ms. Cross is apparently reluctant to label SPACs and blank-check companies as non-job-creators--she points out that SPACs can lead to private job-providing companies to become public, thus qualifying as job creators. But the statute doesn't require jobs creation, so I don't see why we care. Is the scandal that some companies that don't create jobs are benefiting from the law? I am shocked, shocked.
As to SPACs using the on-ramp, at first I didn't get it. SPACs' disclosures are largely boilerplate, along the lines of "we have this much money, it earned this much interest"--at least until they acquire a target. In other words, it's pretty easy for them to go public already. Why bother with the on-ramp?
But Stuart Neuhauser of Ellenoff Grossman & Schole LLP explains that if his client Infinity Cross Border Acquisition Corp. does acquire a target, "[w]hen we become an operating company the savings could be enormous." Ah, this makes sense--EGC status lasts up to 5 years, as long as your revenues, market cap, and debt issuances stay low, and with that status comes "scaled-back disclosures, certain exemptions to executive-compensation disclosures and attestation requirements for the auditors." So a private company looking to go public on the cheap (even cheaper than by way of the JOBS Act's on-ramp) might well favor an EGC acquiror that promises lower disclosure burdens over a traditional public company that would require more in-depth disclosure when the target eventually goes public.
According to the article, Neuhauser thinks "most SPACs will bill themselves as emerging-growth companies." Very interesting...
Google went public on August 18, 2004, at a price ($85) that was literally underpriced from its auction clearing price. (We know this because "winning" bids were allotted 75% of what they asked for at a particular price. The clearing price would have been the price at which 100% of the bids at that price were filled.) What happened then? There was a pop, an 18% pop that is almost exactly average for first-day pops, and the shares closed at a little over $100. Then what happened? They sort of went down. By September 3, Google shares were at $100.01, lower than the closing price on opening day. Then what happened? You know what happened. Google is at $600/share now, and hit $700/share in December 2007 (those were the days).
Why do I bring this up? Because I have been fascinated with IPOs for a long time, and I have written three articles about underpricing here, here and here. Reading about the Facebook IPO, all the questions, criticisms and insights seem very familiar. So, once and for all, I think we need to come to terms with two things, teach journalists about these two things, and then calm down about IPOs for the rest of the history of capital markets.
1. First-day pops are meaningless. Say my house is worth $300k. If I list it for $290k, and someone buys it and then immediately resells it for $300k, then this doesn't mean my house is worth any more than if I had originally listed it for $300k and it sold. Or, if I listed it for $310k, and the buyer resold it for $300k. These are all $300k houses. In the first instance, I left some money on the table, which makes the second instance more attractive to me. But none of these scenarios changes whether my house is worth $300k or not.
Now, some people would argue that pop creates value. That if onlookers see someone resell my house immediately for more than she paid, they will be attracted to my house and may purchase it from the second buyer for more than $300k. This may in fact be true, given the amount of uninformed trading associated wtih IPOs. But, eventually the price will return to $300k. If the pop creates value, it is created for someone other than the seller. The argument that the seller benefits is tenuous -- the seller may reap the benefits in a follow-on offering or via "good feelings" for its retail brand.
Could the absence of a pop destroy value, even if temporarily? Maybe. The confusion and criticism over the Google IPO may have caused its price to struggle the first few weeks. But then fundamental value caught up.
2. First-day pops are meaningless. It bears to be repeated. Studies have shown that firms with the biggest pops (60% or more) have the worst one-year returns of all issuers in that same year. Anecdotally, we know that some firms with the largest pops (Webvan, mp3.com, VA Linux) don't even exist in the same form any more. First-day pops are not correlated with long-term value.
So, was Facebook's IPO successful? This all depends on what the definition of success is. If "successful" means "had an initial offering price that rose on the first day," then no. If "successful" means reaped the optimal amount of capital for its shares, then maybe so. I think it's interesting to think about the Facebook IPO with the Google IPO in mind. That IPO was considered unsuccessful by many. There were technological glitches. There were last-minute disclosure snafus. It was August. It was a slow time for technology IPOs. At the last minute, a bunch of insiders sold their shares, too. Rumors suggested that Google paid a very low commission to its lead underwriter. None of these things had anything to do with the fundamental value of Google, and time bore that out. I say let's see.
The post-mortem on Facebook's IPO is well underway. Who's to blame? There's an argument for the answer "no one"--after all, if the IPO's goal is to raise money for the company, Facebook accomplished the mission by not leaving a penny on the table. Indeed, it reached into investors' pockets and grabbed a few dollars, to boot.
From investors' perspective, however, the IPO was a bust. The SEC and Congress are investigating. Without further ado, in no particular order, I present the Facebook IPO theories I've run across.
1. CFO David Ebersman. Ebersman is faulted for boosting the number of shares by 25% right before kickoff (money that, incidentally, went to investors rather than the company). According to the WSJ Ebersman did not defer to the bankers as companies typically do. And by letting outside investors get more than half of the IPO proceeds (57% according to WaPo), Ebersman arguably did leave money--Facebook's money--on the table.
2. Morgan Stanley: Lead underwriter, its job was to price at least accurately. Instead, it kowtowed to a heavyweight client and let itself (and its reputation) get used.The WSJ also makes it sounds like Ebersman, rather than the bankers, set the final price of $38. Normally I tell my students the company plays the role of "concerned spectator" in the final pricing decision. Facebook was doing a whole lot more. By the way, did you know that the underwriter discount was only 1.1%? The underwriter's discount is the cheaper price at which the banks buy the shares from the company. They then turn around and sell them to the general public at the IPO price. The spread is their automatic profit, and the compensation they get for the risk of the deal and for providing price support. Typically the spread is more like 5-7%. Wow. Morgan Stanley may have bungled this offering, but am I the only one that feels a little sorry for them?
3. Goldman Sachs. Always a popular villain, Goldman's sin was telling clients earlier this month that they were revising downwards their projections for Facebook's earnings. Morgan Stanley did the same thing, but Goldman is the perennial favorite if you're going to launch an I-bank conspiracy theory. Lawsuits have already been filed alleging selective disclosure.
4. The secondary markets. Rich Karlgaard of Forbes: "Facebook‘s shares have been dead in the water for the last 12 months. Private investors had already bid up Facebook to a $100 billion value a year ago."
5. Zuckerberg: Christine observed months ago that Zuckerberg has almost secured paranoiac control of the company. And he couldn't be bothered to lose the hoodie.
6. Nasdaq: Technical glitches, delays in trading, FINRA investigations. Oh my!
7. Timing: Rich Karlgaard again:
From Facebook’s shares debuted in a cloudy market. Beyond Europe in 2012, May is a bad time to go public. For the past several decades, nearly all of the stock market’s gains have occurred between October and May. The canard “Sell in May and go away” turns out to be true.
If you see/have more theories, let us know in the comments.
After some hiccups, Facebook shares hit the market late this morning priced at $38, the high end of their target range. According to the WSJ's Deal Journal, "given the hype and demand the question has largely been “How big a pop is coming?” not “Will there be a pop?” For the record, two weeks ago I asked if there'd be a pop, and I'm still wondering.
Facebook shares opened at $42.05 and "then instantaneously hit $42.99, up 13% from its IPO pricing." But when I left for lunch shares were trading at a meager $39 and some change--more a bump than a pop. Now (1:30 EST) they're around $40, and they may well end up by close of business. Still, early reports characterize the IPO as "more whimper than bang", "fizzling", and "cool." Underwriters have reportedly been buying to prop up the price.
I observed regarding the Carlyle IPO "No first day pop means you didn't leave any money on the table. And that's a good thing, right? But that's not how it's playing in the press." A similar story seems to be unfolding with Facebook. Which leaves me with these unconnected thoughts:
1. Facebook's shares traded heavily on the private secondary markets, about which I've had much to say. Given those trades, there's more information about what Facebook shares are actually worth. Ergo, more accurate pricing. Ergo, less pop.
2. To the extent that the conventional wisdom is that the first-day pop is about branding, name recognition, and reputation building--um, Facebook doesn't need that. This IPO has dominated the business news. Facebook is the highest valued U.S. company ever at IPO, its $104 billion valuation dwarfing UPS's $60 billion in 1999. Pop, schmop.
3. There were some investors that were too late to the SharesPost/SecondMarket party. The last private auction sold Facebook at $44/share. Those buyers would have been better off waiting for the public sale with the rest of us. How unhappy are they? And...will they sue?
4. Zuckerberg, Goldman Sachs, and the other early investors who are cashing out don't really give a damn about a first day pop. So what if the IPO investors don't see an immediate return? Zuckerberg & Co. maximized their first-day take by pricing the shares accurately, and they're laughing all the way to the bank.
Update: FB closed up 23 cents. So no pop to speak of.
Yesterday private equity giant Carlyle priced its IPO at $22, below its initial range of $23-25, looking for a first day pop (according to the WSJ). It couldn't find it, and closed yesterday up just $0.2%. Also in the IPO news, Facebook set a range of $28-35, valuing the company at $96 billion, lower than some valuations had suggested--and,notably, lower than the most recent price on SharePost, $44. It looks like Facebook is looking for the first-day pop, as well.
Why? There are 2 dominant stories for IPO underpricing, one sinister and one innocent. Both hinge on the fact that in an IPO investment banks act as intermediaries, buying the company's shares at a discount and then turning around and selling them to the public. The sinister story blames greedy investment bankers that strong-arm companies into asking too little for their shares so that the bankers can curry favor with their clients. The innocent one chalks underpricing up to information asymmetry: it's hard to gauge the true price of a stock that hasn't been traded, and uninformed investors will shy away from the market entirely unless they can be enticed in with the prospect of a sure thing. (Steven Davidoff has a characteristically incisive review of all the underpricing theories here).
Here's what I think is weird about the recent IPO news. First, Carlyle is a sophisticated player, not your average Groupon or LinkedIn to be victimized by investment banks. I could see Carlyle's management saying: "You know, we want to raise as much money as possible, first day pop be damned." No first day pop means you didn't leave any money on the table. And that's a good thing, right? But that's not how it's playing in the press. Carlyle's IPO is "unimpressive," "lackluster." Uh, how about "shrewd" or "accurately priced"?
Facebook's IPO is interesting because it lacks the information asymmetries that plague the typical IPO. We know Facebook's market valuation as measured by sophisticated, er, accredited, investors. As Davidoff writes, "Underpricing has also been found to be lower when information about the issuer is more freely available so that uninformed investors are at less of a disadvantage." Yet Facebook is pricing quite a bit lower than the last SharesPost sale of shares. Which suggests either 1) that the information asymmetry story is wrong, and that management and/or the banks purposefully leave money on the table for their own sinister purposes. Or 2) that the secondary market isn't particularly good at valuation.
Last month I predicted that SharesPost would be in trouble if there's no first day pop. Today's WSJ quoted an investor that was pretty sanguine about it: John Landis bought at $31-32/share, and he's still hopeful that he'll make money, speculating that the low end of the range might be a "tactic to build excitement for the IPO." The WSJ didn't quote any investors who bought Facebook at $44/share. I know what they're hoping now. We'll have to wait until May 18th to find out.
Glom readers know I've been thinking about Special Purpose Acquisition Corporations (SPACs) for a while now. Yesterday Justice Holdings Ltd. (listed on the London Stock Exchange), announced that it would take a 29% stake in Burger King, buying from private equity firm 3G Capital, Inc., which took the company private only 18 months ago. After the acquisition the company will trade as Burger King Worldwide Inc. on the NYSE.
According to Bloomberg Businessweek, Justice Holdings, a SPAC started by Nicolas Berggruen, Martin Franklin and Ackman, raised 900 million pounds ($1.4 billion) in a February 2011 initial public offering in London.
From the WSJ:
The decision to go public again was driven by building momentum at the restaurant chain, with the deal providing Burger King a chance to list itself without going through the time-consuming process of a traditional initial public offering, Burger King Chief Financial Officer Daniel Schwartz said Tuesday.
"This route allows management to focus on running the business," Mr. Schwartz said.
This probably the most high-profile SPAC acquisition ever, and certainly in the past few years. While our work focuses on domestic SPACs, it's definitely an international phenomenon.
The Facebook registration statement was filed today. If you were Facebook, how would you grab the attention of investors?
Think big: "Our mission is to make the world more open and connected."
The sales pitch is pretty simple: growth, growth, growth!
The first Risk Factor? "If we fail to retain existing users or add new users, or if our users decrease their level of engagement with Facebook, our revenue, financial results, and business may be significantly harmed."
The purpose of the IPO? "The principal purposes of our initial public offering are to create a public market for our Class A common stock and thereby enable future access to the public equity markets by us and our employees, obtain additional capital, and facilitate an orderly distribution of shares for the selling stockholders."
Their strategy in a nutshell: expand and monetize.
Carlyle Group is the next in a line of private equity firms to want to go public in an initial public offering. Our old pal Victor Fleischer has written extensively about one of the first of these publicly traded partnerships from the buyout firm industry and the tax manueverings of these PTP IPOs. Well, Carlyle's IPO rings with a different controversy.
Having first filed for an IPO in September, Carlyle filed its second amendment this month, which contained an interesting new item in its "Risk Factors" section. The following appears under the heading "Risks Related to Our Organizational Structure":
Our partnership agreement will contain provisions that require individual arbitration of any disputes arising out of or relating in any way to our partnership agreement or the common units, including those under the federal securities laws of the United States. Accordingly, you will not be permitted to bring any such claim in court or as part of any representative or class proceeding and your cost of seeking and obtaining recoveries may be higher than otherwise would be the case.
And, to be specific, this means claims relating to:
the provisions of our partnership agreement (including without limitation the validity, scope or enforceability of the arbitration provisions of our partnership agreement or the arbitrability of any such claim, suit, action or proceeding);
• the duties, obligations or liabilities of us to our common unitholders or our general partner, or of our common unitholders or our general partner to us, or among partners;
• the rights or powers of, or restrictions on, us, our common unitholders or our general partner; • any provision of the Delaware Limited Partnership Act or other similar applicable statutes;
• any other instrument, document, agreement or certificate contemplated either by any provision of the Delaware Limited Partnership Act relating to us or by our partnership agreement; and
• the federal securities laws of the United States or the securities or antifraud laws of any international, national, state, provincial, territorial, local or other governmental or regulatory authority, including, in each case, the applicable rules and regulations promulgated thereunder.
And, just in case you were wondering, readers are told in bold that claims may only be brought to the artbitrator in the investor's individual capacity and arbitrators may not consolidate claims. copies of the LP agreement have not been filed with the SEC yet, but reports say that arbitration would be held in Wilmington, DE.
This report quotes a lot of folks, including law prof Don Langevoort, on whether this provision would fly with the SEC, which has to approve its registration for IPO. This provision actually modifies the affect of the securities acts, which might peeve the SEC. Apparently, the SEC has said no to this kid of thing before, but not with a PTP and not since 1990, which seems like an entirely different era as far as investor rights go.
As an observer, this kind of provision makes me nervous for investors. However, as a law professor, I think it would be fascinating if the SEC okayed the provision and the IPO went forward. Think of the interesting questions that might be answered if one or more (hopefully a lot more) public companies had these kind of waivers: Would shareholders demand to pay less for no recourse to class-action securities claims? Would different kinds of shareholders care? Ironically, small shareholders might not care at all because they rarely follow class actions for their shares anyway, but large shareholders might care a lot. Would companies with these types of waivers disclose more or less? More accurately or less accurately? Could this be similar to dual class common, an evil that shareholders really didn't care about?