Class 11 IPOs

Jay R. Ritter

University of Florida

April 2009

How are IPOs sold?

Fixed Price Offerings

BookbuildingInformation acquisition (Benveniste and Spindt (1989))

Agency problems (Loughran and Ritter (2002, 2004))

Auctions

Hybrid Mechanisms

Pricing and Allocation

• Is the offer price set before or after information about the state of demand is acquired?

• Are shares allocated in a discriminatory or non-discriminatory manner (favoritism vs. pro rata)?

5

August 1992, Shenzhen: Before the rioting started,crowds waited for the new share subscription forms

The Growth of IPO Auctions in the U.S.

Gross Gross Name of IPO (ticker) Date of IPO Spread Proceeds 1999: (3 out of 476 IPOs) Ravenswood Winery (RVWD) 19990408 4.00% $10.5 million Salon.com (SALN) 19990622 5.00% $26.2 million Andover.net (ANDN) 19991208 6.50% $72.0 million 2000: (1 out of 381 IPOs) Nogatech (NGTC) 20000518 6.50% $42.0 million 2001: (2 out of 80 IPOs) Peet's Coffee (PEET) 20010125 6.50% $26.4 million Briazz (BRZZ) 20010502 6.00% $16.0 million 2002: (1 out of 66 IPOs) Overstock.com (OSTK) 20020529 4.00% $39.0 million 2003: (2 out of 63 IPOs) RedEnvelope (REDE) 20030925 6.00% $30.8 million Genitope (GTOP) 20031029 7.00% $33.3 million 2004: (2 out of 174 IPOs) New River Pharmaceuticals (NRPH) 20040805 7.00% $33.6 million Google (GOOG) 20040819 2.81% $1,666.4 million 2005: (5 out of 161 IPOs) B of I Holding (BOFI) 20050315 6.00% $35.1 million Morningstar (MORN) 20050502 2.00% $140.8 million CryoCor (CRYO) 20050714 7.00% $40.8 million Avalon Pharmaceuticals (AVRX) 20050928 7.00% $28.9 million Dover Saddlery (DOVR) 20051117 5.00% $27.5 million 2006: (2 out of 156 IPOs) Traffic.com (TRFC) 20060125 6.00% $78.6 million FortuNet (FNET) 20060131 4.50% $22.5 million 2007: (3 out of 159 IPOs) Interactive Brokers Group (IBKR) 20070504 1.88% $1,200.4 million Clean Energy Fuels (CLNE) 20070525 5.85% $120.0 million NetSuite (N) 20071219 5.75% $161.2 million

Google’s IPO

• File price range of $108-135/share• Auction result: $85/share offer price• Closing first-day price of $100.33/share

1. (10 points) Bookbuilding has become increasingly popular around the world for selling IPOs, in spite of greater underpricing and higher gross spreads than for auctions. What are the advantages of bookbuilding relative to auctions for selling IPOs? Answer this from the perspective of an issuing firm.

2. (10 points) What are the disadvantages of bookbuilding relative to auctions? Answer this from an issuer’s perspective.

3. (10 points) Were there any unusual valuation issues with Google’s IPO? What is the impact of the dual class share structure?  

 

4. (10 points) The case mentions that Google’s implied valuation of $29 billion was below Yahoo’s valuation of $38 billion at the time. What assumptions would be needed to justify a $29 billion valuation in a DCF analysis?

  

5. (10 points) Should Google have used an auction? Should other firms going public do so?

What went wrong?

• Out of equilibrium disclosure strategy

• First post-IPO earnings announcement on Oct. 21, 2004, with revenue up 105% from the year-earlier quarter: price jumped 15.4%

• Second post-IPO earnings announcement on Feb. 1, 2005 , with revenue up 101% from the year-earlier quarter: price jumped 7.3%

IPO Underpricing

• Is it equilibrium compensation for risk-bearing or providing information?

• Is it excessive, with rent-seeking behavior common?

Scandals (SLAC): 

Spinning: Allocating hot IPOs to the personal brokerage accounts of top executives in return for company business

 Laddering: Requiring the purchase of additional shares in

the aftermarket in return for IPOs 

Analyst conflicts of interest: Giving “buy” recommendations in return for underwriting and M&A business

 Commission business in return for IPOs: Underwriters

allocated IPOs primarily to investors that generated soft dollar commissions on other trades

Academic Evidence on SLAC Problems : 

Spinning: Xiaoding Liu and Jay Ritter’s“The Economic Consequences of IPO Spinning”

 Laddering: Grace Hao’s 2007 JFE paper “Laddering in Initial Public Offerings”

 Analyst conflicts of interest: Mike Cliff and David Denis’s 2004 Journal of Finance paper and Liu-Ritter paper

Commissions: Jon Reuter’s 2006 Journal of Finance paper