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.
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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.
| | NEXT STEP:Still not sure how the auction IPO works?
Don't despair, because it took a Nobel Prize-winning economist
to design the system. For a quick, enlightening and enjoyable
tutorial on the auction IPO technique, visit www.wrhambrecht.com/wrhco. |
| |
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.
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