October 14, 2013
Twitter and Underwriter Gross Spreads
Posted by Usha Rodrigues

Ever had that experience of presenting a paper at a conference and coming home to a front-page WSJ article on your topic?  Me neither.  Until now!  The paper I presented at the Kentucky symposium (which was amazing-- I felt honored to be in such company) was very much a work in progress.  It asks a simple question: did the JOBS Act affect underwriter IPO fees?  The question I'm still mulling over is whether we would expect it to.  And behold, this morning I awoke to an article on Twitter's underwriting fees! 

Telis Demos' WSJ article focuses on Twitter's "squeezing" its underwriting banks in two ways: first, by securing a $1 billion credit line from its bankers, and second, by negotiating a discount on the underwriting fee itself.  Taking the second point first, in a firm-commitment IPO the underwriter buys the shares from the company at a discount, and then turns around and sells them to the public at full price. That discount, also called the gross spread, is the underwriter's overt compensation, and there's been a lot of literature about how it clusters at 7% for small and mid-sized IPOs. 

The Journal reports that the banks' spread is 3.25%--not as low as Facebook's 1.1%, but pretty low.  Suprisingly low?  That's the question.  Everyone agrees that as IPOs get bigger, the spreads should decline.  It's just not that much more expensive to market a big deal versus a small deal, so economies of scale kick in.  So is Twitter's low spread the function of its size, or has it really put the squeeze on the banks?   

I examined U.S. IPOs from the passage of the JOBS Act through July 27, 2013.  My sample excludes banks, S&Ls, REITs, ADRs, unit issuers, and closed-end funds.  One problem is that Twitter is a really big IPO, with few comparables out there.  During that period no emerging growth companies launched a Twitter-sized IPO (remember, Twitter is an EGC).  The very biggest EGCs ranged from $430-630 million, and that spread averaged 5.67%. So 3.25% is obviously a much cheaper IPO price tag, but that could just be economies of scale kicking in.

Besides Facebook, there is one big non-EGC IPO, Zoetis, that raised north of $2.2 billion.  Its spread was 3.7%. Which could suggest that perhaps Twitter did snag a deal--half the offering size, and yet a smaller discount rate.  But that's just one data point, and a non-EGC company to boot.  Hardly apples to apples.

Moreover, there's a lot going on with underwriting fees.  As the WSJ article points out, Twitter also got what might be a sweetheart deal on its loan terms.  And it might be that issuers are willing to pay more for sector expertise, or analyst coverage, marketing prowess, or plain old reputation.  There's also the presence of underpricing, which may act as sub rosa compensation.  And the fact that you may not want to pay rock bottom for underwriting--I don't remember anyone particularly highlighting the 1.1% spread during the fallout from Facebook's IPO debacle.  But one wonders if you can cut the spread too low.

Watch for more from me on this topic once I can revise my draft.  And let me know if you have any thoughts.



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