A Kinder, Gentler IPO?

Some see both longer-term investors and higher proceeds for the issuer with one Internet-based approach.

Two pioneering initial public offerings– priced Dutch-auction style through Internet bidding — have ushered in a whole new way to go public. Called OpenIPO, the system has the dual advantages of maximizing the issuer’s net proceeds, while making the IPO market fairer for smaller investors. The question now: How open is the market to the new technique?

OpenIPO is the brainchild of Hambrecht & Quist co-founder William Hambrecht, who left his West Coast venture-capital and investment- banking firm to start W.R. Hambrecht + Co. “Open” means just that: all would-be investors have an equal opportunity to invest in the deals, in contrast to traditional IPOs, in which a handful of institutions tend to get favored allocations of stock. The highest bidder–whether it’s Joe Investor or T. Rowe Price — gets the shares. Low bidders usually get nothing.

While there’s some skepticism about the long- term future of OpenIPO, its first two experimenters, Salon.com and Ravenswood Wineries Inc., are enthusiastic. “We did a full bake-off with nationally known investment banks and compared them with W.R. Hambrecht,” says Todd Hagen, CFO of Salon.com, the San Francisco­based online magazine. It raised $26.2 million using OpenIPO last June, even though “we had options to handle the underwriting from some top-tier firms.” Why? “We thought this would maximize the amount of cash that would come into the company, [and wanted to] place our stock directly in the hands of long-term investors that believe in the company.”

Neither goal is satisfied by most IPOs, notes Jay Ritter, a University of Florida finance professor, who calculates that $11 billion of potential capital was left on the table in the first half of this year, even as $25 billion was being raised in IPOs (see chart, page 42). His figures are derived from the difference between the issue price and the price at the end of the first day’s trading run-up. Consequently, “most investors aren’t buying IPOs because they are interested in the company, but because they are hoping to make a quick profit,” he argues. “If auctions had been used, the companies would have raised more money, or sold fewer shares, which would allow the founding shareholders to retain a larger percentage of the total value.” Moreover, OpenIPO transaction costs are lower. W.R. Hambrecht’s commissions are 5 percent of the amount raised, compared with the typical 7 percent for standard IPOs.

Who Wants a Level Field?

The greatest drawback to the OpenIPO, for now at least, may be that it is poorly understood. “It is revolutionary,” says Steven Lacey, managing editor of IPO Reporter, a New York­based newsletter. “So it is difficult for the market to digest”–especially a market accustomed to underwriters that take major under-allocations in an attempt to spur frantic buying after the opening bell. “You won’t see tremendous aftermarket performance from the auction process versus the book- building process,” Lacey says. And this, in turn, could put the stock under a cloud for a while–even if the downward plunges that are often part of such volatility are also missing.

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