Going Once, Going Twice
I should have known there would be trouble when the Gen X and Gen Y intelligentsia were proclaiming that the run-ups in the prices of technology IPOs were actually "branding events" for those companies. Where are those brands now?
The fact is, an IPO is no more than a capital markets event. The danger you'll run into thinking otherwise is aptly demonstrated by the case of Versata Inc., an e-commerce "provider of software and services that automate the development, deployment and change management of transaction-intensive, process-oriented e-business applications." Whatever.
Versata went public on March 13, 2000, raising $92.4 million before underwriting expenses at $24 per share, trading as high as $100.94 on the first day and closing it at $92.75, giving the company a market cap of $3.5 billion. With a pro forma net loss of more than $11 million for the latest calendar year, Versata shares now trade for about $3.
Assuming you believe in the future prospects of Versata, the problem with a traditional IPO that prices the company at $24 when the market is ready to pay $100 is that it can force a company to run out of cash faster than need be. If the company had sold shares at $50 instead of $24-and the market was willing to pay $50-then Versata could have raised almost twice as much cash. That would mean that today, while most e-business consultants struggle for survival, the company would be sitting on an even larger horde of cash to gird itself against the shakeout.
And, if the market was willing to pay $50 per share, and $92 million was exactly what the company's business plan said was needed, then Versata founders could have raised the same amount by giving up half the equity.
The Auction Option
"When stock prices jump 200 percent in a short period of time, nobody wins. Not the company, not the investors and not the employees," says Clay Corbus, senior managing director of San Francisco-based WR Hambrecht & Co.
The firm is pioneering a new kind of auction IPO that attempts to price new issues based on market demand rather than the best guess of investment bankers. In a Machiavellian twist, the company was founded by William Hambrecht, founder of Hambrecht & Quist, the Silicon Valley investment bank that introduced Apple Computer, Genentech and Netscape, among others. Hambrecht has endured numerous slings and arrows from his traditional investment banking brethren, who feel the financier has broken ranks and shaken up the status quo by starting the auction IPO.
According to Corbus, the auction mechanism is quite simple. Investors (individuals as well as institutions) place a bid describing the numbers of shares they want and the price they're willing to pay for a particular issue. Then, Corbus says, "we take all the bids, ranked from the highest to the lowest, and count backwards until we hit the price at which all the shares the company wants to sell will clear." Let's suppose you have bids for 2 million shares at $15 and 2 million shares at $14 and 2 million shares for $13. If you're attempting to place 4 million shares, the auction process tells you that all 4 million will sell at a price of $14 or less.
In truth, this mechanism is not all that different from a traditional IPO. Investment bankers get bids from potential buyers that are used to help them price the deal. But a critical difference is the ultimate execution. The auction process is completely democratic, while the traditional model is more like Tammany Hall politics.
For hot deals, specifically, most investment bankers place shares with their best customers instead of the investors who truly want the stock. "There's often substantial turnover the first day as investors who want the stock try to get in," says Corbus. This demand for the stock drives prices skyward.
But when a company uses the auction model, the shares get priced by, and placed with, the investors who want the stock the most. "For companies with a large affinity group," says Corbus, "the auction IPO is a great way to get stock into their hands."
For example, WR Hambrecht took Ravenswood Winery public, and presumably Ravenswood customers had the opportunity to play a role in the deal. And true to the auction-price credo, after three days of trading, Ravenswood common was $10.50, the same price at which the company went public. With accurate pricing, the winery didn't give up any more equity than it had to.
Yet Andover.net, which WR Hambrecht priced at $18, went up to $67 within several days. The system isn't perfect, but it does offer companies a better opportunity to do deals whether the market is good or bad. A traditional IPO can be priced at $12 and drop to $5, which is bad for the company and investors. An auction model would have priced it at $5 right away. Just as a rapid increase in price can do damage in the long run, a hurried decrease in price can take an equally devastating toll.
The past year has seen the best and worst of what the stock markets have to offer. And for entrepreneurs, Hambrecht's auction process addresses the challenges presented by both scenarios, which is why it may ultimately become the IPO process for all seasons.
David R. Evanson is a principal at Gregory FCA, an investor relations firm.
- WR Hambrecht & Co., (800) OPEN-IPO, www.wrhambrecht.com