NEW YORK (CNNfn) - As far as initial public offering pioneers go, Bill Hambrecht may be Superman. But whether you think his W.R. Hambrecht and Co. investment bank is out saving the world or collapsing under Wall Street-fueled Kryptonite depends on how you look at it.|
W.R. Hambrecht’s Dutch-auction method of IPOs treats institutions and individuals equally, selling the stock to the highest bidders. And of the three deals Hambrecht has lead managed to date, it sold a full 50 percent of the stock in the companies it took public to retail investors.
The average first-day "pop” of an IPO, or initial public offering, was 68 percent last year. No wonder individual investors clamor for access to IPOs -- and W.R. Hambrecht may present individual investors’ best shot at getting their hands on them.
But W.R. Hambrecht is an interesting contradiction. At the same time the auction method delivers stock, it reduces that first day pop substantially, even eliminating it. In other words, it gives access to IPOs, but it takes away many IPO investors’ main motivation for buying in the first place -- "free” money.
Getting individuals in on IPOs is a selling point for Wit Capital, FBR.com and E*Trade’s E*Offering, as well as online brokerages with traditional investment banks behind them, such as Morgan Stanley Dean Witter Online and Donaldson Lufkin & Jenrette’s DLJ Direct. But Main Street investors are frequently frustrated by how few shares end up in their hands.
The idea is to restore some sanity to an IPO market that has become increasingly out of control, according to W.R. Hambrecht Chief Operating Officer J.D. Delafield. Big institutions and big banks have served each other and profited greatly from IPOs. Along the way they ended up excluding a lot of investors and giving away issuing companies’ money. He wants to redress that.
"We’re not anti-institutional. We’re not pro-retail. We’re agnostic,” he said. "This is financial innovation. This is not about the peasants at the gates trying to barge into the city and take over the palace.”
1999 a record for money left on the table, too
After the astounding first-day returns for initial public offerings last year, it’s a perfect time for W.R. Hambrecht to prove its mettle. The IPO market ran rampant last year, setting records in virtually every field. U.S. IPOs raised around $70 billion, though the exact amount varies by source and likely won’t be finalized for another few weeks.
Those companies set another less propitious record. They left a record $36 billion on the table, according to Jay Ritter, a finance professor and IPO expert at the University of Florida. That’s the difference between the price at which they sold their shares and what they fetched in the aftermarket. That’s money they could have raised if they had matched demand perfectly, money that could have gone to the issuing company.
Instead it went to the institutions and other favorite clients of the investment banks. The investment banks, which typically take a 7 percent fee of the amount raised in the IPO as their cut, have to sell the stock at its offering price rather than profit from the pop themselves.
But they pick who can buy the stock, a vital marketing tool. In normal public offerings, investment banks build a "book” of interest in the stock, then pick how many shares get allocated and to whom. When a stock prices at $20 and closes the first day at $40, "essentially they’re handing out $20 bills to their clients,” Ritter said.
Not surprisingly, everyone wants to line up for the handout. Institutions as well as retail investors complain that they get a minute fraction of the number of shares they really want, if they get any at all.
Hambrecht hopes it has come up with the most sensible, democratic way for investors to buy into companies they may want to hold long-term.
"There are a lot of people at traditional investment banks who agree that something is not working when stocks trade up 600 percent in the aftermarket,” Delafield said. "They don’t know if we have the answer. But they know that what they’re doing is not working.”
How does it work?
Hambrecht’s Dutch auction process, which it calls OpenIPO, lets investors bid for the number of shares they want and stipulate a price. A computer sorts out the electronic indications of interest with an algorithm.
The final price is decided by a "lowest common denominator” method. If 1 million shares are for sale, the computer works down from the highest bid until the 1 million shares are allocated to the highest bidders. The sale price is that of the lowest successful bid.
The point isn’t access for all. It’s equal instead of preferential access, without the discounts for special customers. W.R. Hambrecht limits the minimum bid to 100 shares and caps the maximum bids to make sure shares are distributed widely. But otherwise, Fidelity and an individual investor are one and the same.
One benefit to issuing companies is that Hambrecht also undercuts traditional investment banks for their fees. It takes between 5 percent and 6 percent of the offerings it lead underwrites instead of 7 percent.
The IPO auction process in theory measures the total demand for a public offering very well. The shares should price at the level of demand, meaning they don’t leap after the public offering. Even the retail investors who wanted to buy at the offer price got in, and everyone else wasn’t willing to pay that much. The company gets full value for its shares and then stands on its own merits in the aftermarket.
"I personally am very sympathetic to auctions for selling IPOs, both in terms of allowing the issuing companies to get full value and in terms of democratizing things,” Ritter, the University of Florida professor, said.
It’s clear investment bankers like book building, not auctions, Ritter continued. Their take is bigger and they allocate hot IPOs to their favorite clients. "But if auctions work well, there will be neither hot nor cold IPOs.”
By cutting fees and changing how shares are allocated, W.R. Hambrecht presents "a big potential threat” to U.S. investment banking, Ritter thinks. On the other hand, online brokerages such as Wit Capital, which recently said it would not lead manage IPOs, and DLJ Direct, "represent very little threat to regular investment banking,” he said. They just change the distribution channel.
What’s in the auction method for investors? The pop many expect from an IPO has gone. But investors have a more reasonable chance of buying into companies they want to hold long-term. Companies that use the auction process often cite getting shares into the hands of a broader range of investors as one motive.
"The retail guy can get in,” said Irv DeGraw, research director with IPO tracker WorldFinanceNet.com. "He won’t be the only guy, but he can get in, at the same level as the institution. It sure beats hoping that E*Trade or Wit or somebody is going to give you a shot.”
The auction process should also remove the "winner’s curse” for retail investors, the thinking that if individual investors get shares in an IPO, it’s because it’s a dog and the institutions passed it up.
Three lead deals so far
But W.R. Hambrecht is off to a slow start. Bill Hambrecht, the entrepreneur who started Hambrecht & Quist, promised to provide the capital and, perhaps more important, the brand name behind an entirely new type of investment bank. Exactly two years ago, he and three others set up W.R. Hambrecht.
Book-building investment banking does a good job of establishing institutional interest. But retail interest is harder to gauge. "Technically it was very expensive to communicate with the capital that was in the hands of the individual,” Delafield said. Hambrecht figured technology had made it easier to reach all investors electronically and wanted to put that to use.
After a year mulling its options and staffing up, W.R. Hambrecht chose the Dutch auction distribution method and set up the OpenIPO auction site last February. Its first public offering, Ravenswood Winery, came swiftly. The microcap wine maker debuted last April, selling 1 million shares at $10.50.
Investors can bid on OpenIPOs by opening a W.R. Hambrecht account with $2,000, or through accounts at brokerage partners such as Fidelity and DLJ Direct. Hambrecht also participates in conventional IPOs and secondary offerings when it doesn’t win the lead-manager slot, but investors have to have $25,000 in their W.R. Hambrecht account.
W.R. Hambrecht’s early success has been small-scale, leading just two other OpenIPOs last year. It also co-managed two deals and was in the syndicate on 11 other deals in 1999.
The startup considers that a success. Others say it points to how hard Hambrecht will find it to break into an entrenched world where a lot of people who make a lot of money don’t want to see it succeed.
Middling stock performance
Neither Ravenswood nor Salon.com, which sold 2.5 million shares in a June OpenIPO, has performed particularly well since their offering. Ravenswood (RVWD) trades in a very tight range and on Thursday closed at exactly its IPO price, nine months after the offering. Salon.com (SALN) was down $2.25, or 21 percent, from its $10.50 offering price.
W.R. Hambrecht attracted renewed interest with the successful launch of Linux developer Andover.Net’s shares last month. Andover.Net raised $72 million when it came out at $18 Dec. 8. It soared on its first day, closing up 252 percent, which many investors would see as a roaring success. It was still up 130 percent a month later.
But Andover.Net’s performance is paradoxically something of a failure for the OpenIPO system. Ravenswood and Salon.com, which closed slightly up and slightly down after their first day of trading, are closer to the ideal, which changes the definition of a "successful” IPO.
The shares don’t pop because they price at the level of demand, then swim or sink on their own. The market ignored microcaps such as Ravenswood last year, and tech-media companies such as Salon.com have had an unpredictable time, Delafield said, by way of explaining why they have not done well post-IPO.
First big success
Still, some IPO watchers think the Andover.Net validates W.R. Hambrecht, because of its size and its subsequent performance. "The first two were warm-ups,” said Jeff Hirschkorn, senior market analyst at IPO.com. "This was the real bellwether.”
Andover.Net’s runup also shows that investors don’t fully understand the OpenIPO process. Those investors who bought it at $63 in the aftermarket, or anywhere above $24 in fact, substantially overpaid. They could have bid for shares at a lower price in the offering.
Andover.Net, a Linux developer, actually priced at $24 using the OpenIPO method. But because that was more than 20 percent over the price range it had indicated, it would have had to refile with the Securities and Exchange Commission to raise its offer price. Andover.Net decided to go ahead at the top of its range and at a discount.
Why? It had already raised its offering once and didn’t want to go through that again. It also feared it would start a cycle. "There was a sense that if we priced at $24, then we’d have to take new bids, and the thing would have been seen as even hotter,” President and CEO Bruce Twickler said. Which would have caused another repricing, and so on. "We would essentially have been doing the market’s job in a private setting.”
Andover.Net also wanted to beat other Linux companies to market. VA Linux went public Dec. 9, the very next day. It set a record for a first-day pop for any IPO, closing up 698 percent. That grabs headlines.
But Andover.Net left a lot less money on the table. It also raised almost half the amount VA Linux (LNUX) did in its IPO despite having less than a tenth of the revenue. Andover.Net is now much closer to its opening price that first day than VA Linux, too.
Happy with the results of a risky move
Twickler is "very happy” with how the OpenIPO went. "If someone asked me, I would recommend it.” A major factor in using W.R. Hambrecht was that Andover.Net has a Web site for Linux users, Slashdot, which attracts a million users. The company wanted to make the IPO stock available to them if they wanted to buy it.
The OpenIPO let them bid on the stock if they wanted to, and the company ended up with a 50-50 split between institutional and retail investors, like Hambrecht’s other offerings. Twickler was also impressed to find that Hambrecht had three people who knew the Linux market well.
Then there was the more prosaic time factor. Investment banks such as Lehman Brothers, Bear Stearns and U.S. Bancorp Piper Jaffray also showed interested in taking Andover.Net public. But they wanted to wait for the second or third quarter of this year. W.R. Hambrecht was willing to take them public in 1999.
"Our view was that if we were the second or third Linux company out, it wouldn’t matter. But if we had waited ... there will be as many Linux companies as there are stars in the sky,” Twickler said. With Red Hat (RHAT) already public, time was of the essence.
Twickler liked the attention W.R. Hambrecht offered -- he thinks a larger investment bank might not have repriced Andover.Net’s shares at all. But speed and selling shares to the company’s affinity group were the deciding factors in picking the OpenIPO. It was a decision that was "very hotly debated inside the company and with the board," Twickler said.
He says the IPO achieved all the company’s major objectives -- raising more money than anticipated, creating an aftermarket people are participating in and seeing a runup, "not as great as VA or Red Hat, but it’s not clear that runups are that advantageous.”
Companies tend to see the runup as valuable promotion, "free advertising.” But the money a company gives up for that runup means it is actually very expensive advertising, Ritter pointed out. Akamai Technologies (AKAM) raised $234 million but left more than $1 billion on the table. Fully priced, the deal would have been a record raised by a startup, surely great promotion of its own, Ritter pointed out.
Skeptics and difficulties abound
W.R. Hambrecht certainly has its critics and, in even larger number, its skeptics. Many in the investment world are taking a "wait and see” approach.
Some are more vocal. Neither W.R. Hambrecht nor more-conventional IPO brokerages such as Wit are going to have "any real impact on the IPO market,” said Jim Marks, an online brokerage analyst for CS First Boston. "Who’s complaining about the current situation?” he asked rhetorically.
Investment banks taking companies public can already distribute shares to the public via Charles Schwab or other brokerages -- often and increasingly their own, such as Morgan Stanley Dean Witter Online. Almost all investment banks, including IPO leader Goldman Sachs, are developing online distribution capabilities.
W.R. Hambrecht is the most interesting new participant, Marks said, because of its model. But all the new IPO brokerages will be marginalized as the leading IPO market participants develop their online distribution, he said.
If they’re lucky, they will develop into boutique investment banks such as Montgomery Securities, Alex.Brown, Robertson Stephens and Hambrecht & Quist did in the ’70s and ‘80s. But those banks came of age at a time when the major Wall Street firms were ignoring technology and growth IPOs. All have, in any case, subsequently been bought out by big banks.
Like Bill Hambrecht himself, Thomas Weisel has started two investment banks. He founded Montgomery Securities, left after that was bought by Bank of America, then founded Thomas Weisel Partners last January. That was much the same time W.R. Hambrecht launched the OpenIPO site. But Weisel has chosen a traditional investment banking approach.
Weisel, who has had a highly successful first year building a technology-oriented boutique, thinks Hambrecht has it all wrong. Both Hambrecht and Scott Ryles, who is helping to set up an investment bank for an online-brokerage consortium including Charles Schwab, "are under the misconception that investment banking is about distribution,” Weisel said.
Distribution is on the list of the top-10 investment-banking functions, "But given the state of capital markets today, it’s at the bottom of the list.” No one has trouble selling IPO shares in the current market. Supply is the problem.
"The capital markets are not broken,” he said, and in fact they’re the most robust in the world, he added, voicing a familiar refrain. "Why try to fix it?” Individual investors are not shut out and can buy in the aftermarket, he said. Even a huge fund such as Magellan, which doesn’t get the IPO shares it wants either, has to buy in the aftermarket if it wants to build a sizable position, just as an aunt in Des Moines can, he said.
Weisel also thinks the roaring IPO market is not sustainable, which is when it would get trickier to get deals done and investment banks will prove invaluable. Even now, Weisel said, newly public companies will need the aftermarket services that investment banks provide.
Cutting investment-banking spreads, as W.R. Hambrecht does, means the investment bank shortchanges its clients in the long run, Weisel said. Well after the IPO, providing high-quality analysts coverage, trading the company’s stock and acting as a financial adviser to the company, for instance on merger and acquisition deals, "are all extremely labor intensive and expensive,” Weisel said. Lower spreads mean "there’s no profit or cost available to service a company after it has gone public,” he said.
Though the Dutch auction method works for secondary offerings, Weisel said it is a "greater fool theory” for IPOs that is "an absolute failed system.” The auction is driven by retail customers who don’t know what they’re buying, he said.
Without building up the infrastructure of a traditional investment bank, W.R. Hambrecht, which for instance only has six analysts at the moment, will find it very hard to win business, Weisel said. "There are certain elements of the investment banking business that the digital economy is not going to disintermediate,” he concluded.
Two forms of IPO can coexist
IPO experts say they can envision W.R. Hambrecht building a strong boutique business. The best-suited companies for the auction process are small issuers that have either strong brand names or identities or a strong affinity group, like Ravenswood with wine lovers or Andover.Net with Linux users.
W.R. Hambrecht does not have a retail sales force, though it does pitch institutions. So investors have to "pull” the stock toward them rather than having it "pushed” to them.
Twickler said the perfect candidate for an OpenIPO is a company with an identifiable community they can communicate to, such as a small company with strong brand loyalty or a company with a finite technology community, such as Andover.Net. That could apply to some secular and social communities, too, he said.
Size could also be an issue. "If I’m too big or I don’t have enough of a reputation, then I have to go with the traditional method,” DeGraw with WorldFinanceNet.com said.
Becoming a lead manager is much more difficult than getting in on a syndicate. But "if you’re a co-manager, you’re frankly not there, and if you’re in the syndicate you’re frankly not there,” Delafield said, a point Weisel agreed on.
Delafield said Hambrecht is building its business in all areas of investment banking, not just IPOs, and will staff up to handle more analysis, venture capital work, M&A deals and private placements.
Delafield thinks W.R. Hambrecht will find it easier with the Anderson.Net deal under its belt. It needs to find more Bruce Twicklers. "What’s difficult is going out and persuading a chief executive and a management team to put what’s at least a career event and perhaps a life event in your hands,” Delafield said.
Finding the right customers may also be tricky when they see other IPOs often leaping more than 100 percent that first day. Still, Andover.Net had 6,000 bids, pitching 60 institutions and the rest coming from retail.
Three lead underwriting deals, as well as the 13 others it was in on, may not be much to a big brokerage. But in dollar terms, the $109 million W.R. Hambrecht lead managed ranked them 28th out of 79 brokerages that lead a deal, according to Thomson Financial Securities Data. Delafield says its lead managing makes it the leader of the upstart IPO distributors.
"For a first year, for something this radical, I think they’re off to a pretty good start,” DeGraw agreed. By comparison, though, Thomas Weisel Partners ranked 19th in a very successful first year, lead managing six deals worth $264 million, again according to Thomson Financial Securities Data. In all it helped bring 53 IPOs to market, Weisel said.
It’s possible W.R. Hambrecht can succeed with its new type of deals alongside conventional IPOs. Auction IPOs do coexist with the traditional, book-building approach in other countries -- most notably France and, to a lesser extent, the Netherlands.
Other IPO methods live alongside book-building IPOs in places such as the United Kingdom and Hong Kong. Both have fixed-price offerings, where the price is set a week or two in advance of the stock sale and then investors declare their interest, though the popularity of fixed-price deals is waning.
Will Hambrecht see its IPO revolution succeed in the United States? Everyone who’s anyone in IPOs is watching, but no one can say they know. With a few high-profile successes, other issuers would line up. But CFOs may not want to risk their jobs betting on an untried method if tried and true Goldman or Lehman are also lining up.
Ritter, the University of Florida professor, joked that it’s an "unqualified maybe” that W.R. Hambrecht will make it. "I can see a scenario where they just don’t turn the corner,” Ritter, said. "I can also see a scenario where they revolutionize the way IPOs are offered in the United States.”