“Going Public…and Beyond: A Primer on the IPO Process and an Assessment of the Future of Stock Exchanges.” The Johnson School’s European Alumni Symposium.
Enterprise Magazine , Summer 2001
The habitual underpricing of IPOs, mounds of money left on the table, and the prospect of a Bill Gates stock exchange were among the tantalizing highlights of the Johnson School’s European Alumni Symposium: “Going Public…and Beyond: A Primer on the IPO Process and an Assessment of the Future of Stock Exchanges.” Two eminent Johnson school professors were the main speakers at this year’s event, which was held in March in London.
Although few IPOs now put their heads above the parapet, not long ago companies were stampeding to the market. Dean Robert Swieringa noted in his introductory remarks that nearly 3,000 U.S. and 5,000 European IPOs were launched. in the five years starting from 1996. Numbers in the last year are dramatically down.
Investors were understandably just as eager as startup companies to play the IPO game: “Investment bankers allow venture capital firms and some institutional clients to purchase IPOs at the offering price, with close to a guarantee that they will double or triple their money on the first day of trading,” said Swieringa. Other beneficiaries included company managers, who increased their own personal net worth, and, of course, investment bankers.
“Typically IPOs are priced about 15 per cent below the anticipated opening price to ensure that the offerings are sold,” Swieringa continued. “But huge disparities between the offering prices and the first-day closing prices raise important questions. Are investment bankers making big mistakes in pricing issues? Or is this all part of the relationships between venture capital firms, institutional investors and investment bankers?”
Presumably the IPO process not only determines a company’s value but, by doing so via the market rather than by private valuation, provides an accurate valuation. Actually, “the IPO process is not without criticism, particularly about the roles played by investment bankers, lawyers and accountants—and their potential conflicts of interest.”
Professor Roni Michaely dissected the IPO of The Globe.com, which went public on November 12, 1998 at $9.00 and had a closing price that day of $63.50--a seven-fold increase. Although The Globe.com had negative earnings, negative cash flow, and revenues of only $6 million, its value at the end of the first day was $562 million. This valuation would have been considerably higher if the shared closed at their high for the day, which was $97.
In this, as in many IPOs, “a lot of money—$170 million—was left on the table,” said Michaely. But while underpricing is rampant, the reasons for it are not entirely clear, especially as it occurs when the company going public is itself an investment bank. “Researchers have examined investment banks going public and found that the underpricing is exactly the same. So it can not be a principal-agent problem, although the principal agent is at least one factor,” he added. Michaely is a prolific author, associate editor of the Review of Financial Studies and the Financial Management Journal, director of the Israeli Securities Authority, and winner of the Distinguished Teacher Award.
The part played by research analysts has also come under scrutiny: “Other studies concluded that when it is your own IPO, the analysts don’t see it accurately. The ‘buy’ recommendation is higher when recommended by the non-underwriter, whether because of psychology or cynicism.”
Money on the table means more work for lawyers. “The Security Act of 1933 put a lot of liability on the underwriters, resulting in many class action lawsuits against underwriters for underpricing,” Michaely said.
In some circumstances, however, legal sanctions are not necessary to guarantee fair dealing: “The institutional investors and the bankers deal in trust. If an investor says that they will buy one million shares and in the event only buys 10,000, they won’t be let in on the next sale.” Trust of this sort is backed by a promise of punishment as much as by pure honor.
For the breakout session, the entire audience assembled in small groups around half a dozen tables, each formulating explanations for IPO underpricing. Their cumulative findings were comprehensive and almost unanimous:
Buyers lack information possesses by the investment banks;
Bad goods don’t knock out good goods;
Collusion within the banking community, and less than perfect competition;
Client impotence on the final pricing day;
Management fear of failure;
Sunk costs;
Management difficulty intensified by poor support from their venture capitalist;
Brand management for the bank and client alike, pressured to give a positive signal to the market via upward stock prices;
Some fees are paid in equities so the recipients want a higher price later on.
The revolutionaries at table five were having none of this: “we question the whole premise. Who says IPOs are underpriced,” they asked rhetorically, “especially if viewed over the long term?”
Anyone wishing to use The Globe.com as an example of long-term valuation will probably be disappointed. With a share price of $0.25 on March 12, 2001, it probably won’t survive into the long term.
Michaely led a wide-ranging discussion which compared IPOs around the world and also touched on questions involving possible price-fixing, the pros and cons of IPO auctions, the impact of roadshows, and conflicts between institutional and retail investors.
When Professor Maureen O’Hara conjured up visions of a Bill Gates stock exchange, she was thinking neither of the vast wealth or the megalomania of Microsoft’s founder, former C.E.O. and current Chairman. Technology, not ambition or money, is the main mover here.
“Regardless of the stock exchange and regardless of its location, all of them live in fear of the future,” O’Hara said. “Stock exchanges are in turmoil, trying to determine the business they are in. Technology brought about this change, and technology will increasingly dictate how and where securities will trade.” O’Hara is executive editor of the Review of Financial Studies, recipient of three best-paper awards and two distinguished teacher awards, and a member and former chair of the Economic Advisory Board of NASDAQ.
She enumerated the three sources of revenue of the typical stock exchange: listing services; execution services; and peripheral services. “The NYSE admits to profits of $100m,” said O’Hara, with revenues that break down into approximately $267m for listings and $300m on the sum total of the small per-trade fees and information. Listing services comprise 38% of NYSE revenues, compared with 10%. for Deutsche Bourse.”
“But it is really not clear that stock exchanges are not commodities,” she added. And with the arrival of ECNs--Electronic Communications Networks—it is not clear, as the term itself suggests, that there is a need for a trading floor. “These trading systems need not be exchanges or markets, as we know from the rise of ECNs, such as Island, Instinet, Strike and Jiway. New York is worried about London who is worried about Frankfurt and so on, but all will be overtaken by the ECNs. They are the Huns.”
In this rapidly-evolving world, what looks like a solution might actually exacerbate the problem. “Governments around the world are waking up to the fact that their exchanges are in trouble, and Australia, for example, did not let Instinet operate there.” But the restriction only drove Australian business out of Australia. “Many Australian companies traded via Instinet in Hong Kong instead of Sydney.”
The jury is out on globalization. More Israeli technology firms are listed on NASDAQ than in Tel Aviv, and Japanese companies are starting to list outside Japan, but “Italian eyeglass manufacturer Luxxotica is now delisting in New York and going to Italy. Firms are deciding that where you list is where your investors are. Ninety-seven percent of DaimlerChrysler is traded in Germany,” O’Hara observed.
The ultimate success of ECNs and the new start-up stock exchanges are by no means certain, O’Hara believes, but there is little doubt that the future does belong to those who can execute at lower cost.”
Reuters is an information provider, just like the stock exchanges, she observed, “and so is Microsoft. There might be a Bill Gates stock exchange. To paraphrase Charles Schwab, you don’t need a trading floor anymore, you just need an electronic platform.”
As was demonstrated by the vigor and independence displayed by the breakout groups, the symposium was anything but a series of one-way lectures. Sharp questions and observations came frequently from the floor, many from graduates who now earn a crust as investment bankers, analysts, market makers and venture capitalists, among others. At this symposium, academia and the coal face met head on, and the discussions were enriched by the varied perspectives and experiences.
A few days after the symposium, NASDAQ took a 58% stake in EASDAQ, the troubled Brussels-based bourse, and a few weeks later, the London Stock Exchange announced that it was contemplating a move to smaller quarter. Events quickly vindicated many of O’Hara’s analyses.
KEYNOTE ADDRESS – AMY SELWYN
Dinner at the venerable Naval and Military Club was enlivened by guest speaker Amy Selwyn, a 1981 Cornell graduate who majored in psychology before earning an M.B.A. from N.Y.U.’s Stern School of Business.
Tackling the question, “Can Stodgy Old Companies Compete in the Digital Age?,” Selwyn admitted to detecting signs of stodginess herself, especially when her own values remind her of her mother.
Her currently employer, the BBC—Selwyn is Head of Rights and Commercial Exploitation for BBC News—is renowned for being stodgy, a quality also evident in her two previous jobs, first at the New York Times for seven years, and then the Associated Press, initially in strategic planning in New York and then with T.V. news in London, her home since 1998. Selwyn joined the Beeb in May 2000.
She admits that the technology upsurge in recent years presented “groovier and greener pastures,” but she stayed where she was, suspicious that technology alone was as dominant as it was cracked up to be.
“Like the ice age or industrial age or other major epochs, the digital age poses the challenges of adaptation. It is not primarily about a technological boom. The main question involves those companies which will change, be flexible and establish real brand equity and value. Stodgy old companies like the BBC and the New York Times will be leaders if they can change.”
Can they?
Two decades ago, “the New York Times had no idea who read its newspaper. Its buyers were newsstand readers. This stodgy company realised it needed home delivery.” Through home delivery, “the Times obtained a database which it then managed.” At last, the New York Times started to learn about its customers—and was startled by much of what it learned. It reached out in new ways to its new-found readers.
When CNN brought sudden competition to the BBC, the latter’s market share dropped from 40 to 28 per cent. “The corporation embarked on a huge cultural and operational change and also started catering to special interests and audiences, such as food and children,” Selwyn explained. “The BBC website is the most heavily visited non-porn site in Europe, with 95 million hits per month.”
With reporters and cameramen around the world, the BBC sells content to other news providers, such as Yahoo, and it also buys in some content. “With a high quality brand, it will be easier to sell to other providers, but it is not as easy as it sounds,” she said.
“These stodgy news organizations have to take their business models and re-think them. They need to focus on digital rights and syndication, think creatively, partner with organizations that they never thought they would partner with, and become commercially savvy. “The market impetus is there. Companies like Yahoo want us to figure this out because they want good quality reliable interesting material.”
The impact of interactive television, mobile phones and other technological wizardry remains to be seen. “It is not clear what platform will predominate. But if you are not in it now, chances are that you won’t be a player when it does take off.”
Selwyn believes that stodgy companies that can be flexible in times of change will not only succeed but “will achieve leadership positions. As the evidence of the last twenty years indicates, this is working with change, not walking with dinosaurs.”
www.robertliebman.com