Wanted to write on private equity for long. One of my article on Private Equity can be read at
http://www.insightory.com/view/45/golden_age_of_private_equity
It details the complete functioning of private equity model alongwith the recent happenings and their implications.
Thursday, November 8, 2007
Saturday, September 8, 2007
Credit Crunch..subprime mortgage Crisis..What are they?
Since the last few months we have a heard a lot the terms like “credit crunch, sub-prime mortgage crisis, re-pricing of risk etc”, which are sometimes difficult for non-finance background people to understand. In this article I will try to make sense of these things in simple language.
The whole system works like this. Banks take deposits from people on which they have to pay interest, to earn their income these banks then lend the money to people who need them at a interest rate higher than they pay, thereby earning their income. Since 2001 the interest rates in US were very low which led to US banks having lot of money. The money which lies with a bank (other than that required by regulations) is like a deadwood, it doesn’t earn anything for the bank. So banks are desperately in need for avenues to look for the investment.
Obviously when the banks have lot of money, the first place of investment are ventures (people or commercial enterprises or propositions) with good standing. But when there is lot of money the banks tend to look for avenues which happen to be more risky. What banks in this case did was offered loans to people who had bad credit history or less income, to purchase houses.
From the month of July 2007, the credit market started to collapse as financial panic spread the world over, the reason being “re-pricing of risk”: a phenomenon when assets that were fundamentally sound are hit by “supply demand imbalances” in the market. As a consequence liquidity evaporated and market turmoil in a risky sub-sector of the US mortgage market spread to impact market conditions globally. Such loans were called NINJA loans i.e. loans to people with No Income, No Jobs and No assets.
To entice these people to avail themselves of loans, the loans carried a interest rate which was below the prime-lending rate ( rate at which banks normally lend). Apart from that various innovative methods were devised like initial low rate and later on a teaser rate which is few points higher than initial rate. (other such products are 2/28 loans, balloon mortgage, piggyback loan etc)
Now it would be stupid of banks to have such “risky” loans on their own portfolio. So they turn these loans into securities which can be sold to investors (in 2006 $450 billion worth of such loans were converted into securities. A security purely consisting of a ninja loan is risky in itself so there investment bankers come to the rescue. They bundle such loans with other types of debt like credit card and auto loans and call the end result as an “asset backed security”. These securities are then bought and sold in the commercial paper market.
Things were going on perfectly fine till the time the houses which were bough on such loans were commanding loft valuations. Then by start of 2006, the housing market stagnated i.e. the prices of houses remained the same and in same cases they infact fell. Bankers stopped refinancing of loans and consequently many borrowers started defaulting. Asset-backed commercial paper, which accounted for half the market, tumbled $59.4 billion to $998 billion in the week ended yesterday, the lowest since December, according to the Federal Reserve
CASUALITIES
During this turn of events there have been many high profile casualities. At the last count close to 90 lenders in US had gone out of business. Many include high profile outfits run by many of big investment banks like Lehman’s BNC Mortgage Unit, Capital One;s Greenpoint mortgage company, two outfits run by Bear Stearns.
IMPLICATIONS
This has now made lenders more risk averse and made them wary of making further commitments to various deals and primary casualities have been Private Equity firms which depend on banks to carry out their leveraged buyouts to an extent. Plus the strain it has put on finances of so may banks, jobs and more prominently - SENTIMENTS! The financial world to an extent run on sentiments as well.
NOT GLOOMY EVERYWHERE
However in some quarters the credit crunch is being seen with positive connotations. Its being said that its has put some breaks in irrational lending frenzy and will bring some sense to the market. Also its felt that a slowdown in mergers & acquisitions will again create a space for venture funds to prosper. The great ideas might get backing to flourish again. Keep watching this space !!!
The whole system works like this. Banks take deposits from people on which they have to pay interest, to earn their income these banks then lend the money to people who need them at a interest rate higher than they pay, thereby earning their income. Since 2001 the interest rates in US were very low which led to US banks having lot of money. The money which lies with a bank (other than that required by regulations) is like a deadwood, it doesn’t earn anything for the bank. So banks are desperately in need for avenues to look for the investment.
Obviously when the banks have lot of money, the first place of investment are ventures (people or commercial enterprises or propositions) with good standing. But when there is lot of money the banks tend to look for avenues which happen to be more risky. What banks in this case did was offered loans to people who had bad credit history or less income, to purchase houses.
From the month of July 2007, the credit market started to collapse as financial panic spread the world over, the reason being “re-pricing of risk”: a phenomenon when assets that were fundamentally sound are hit by “supply demand imbalances” in the market. As a consequence liquidity evaporated and market turmoil in a risky sub-sector of the US mortgage market spread to impact market conditions globally. Such loans were called NINJA loans i.e. loans to people with No Income, No Jobs and No assets.
To entice these people to avail themselves of loans, the loans carried a interest rate which was below the prime-lending rate ( rate at which banks normally lend). Apart from that various innovative methods were devised like initial low rate and later on a teaser rate which is few points higher than initial rate. (other such products are 2/28 loans, balloon mortgage, piggyback loan etc)
Now it would be stupid of banks to have such “risky” loans on their own portfolio. So they turn these loans into securities which can be sold to investors (in 2006 $450 billion worth of such loans were converted into securities. A security purely consisting of a ninja loan is risky in itself so there investment bankers come to the rescue. They bundle such loans with other types of debt like credit card and auto loans and call the end result as an “asset backed security”. These securities are then bought and sold in the commercial paper market.
Things were going on perfectly fine till the time the houses which were bough on such loans were commanding loft valuations. Then by start of 2006, the housing market stagnated i.e. the prices of houses remained the same and in same cases they infact fell. Bankers stopped refinancing of loans and consequently many borrowers started defaulting. Asset-backed commercial paper, which accounted for half the market, tumbled $59.4 billion to $998 billion in the week ended yesterday, the lowest since December, according to the Federal Reserve
CASUALITIES
During this turn of events there have been many high profile casualities. At the last count close to 90 lenders in US had gone out of business. Many include high profile outfits run by many of big investment banks like Lehman’s BNC Mortgage Unit, Capital One;s Greenpoint mortgage company, two outfits run by Bear Stearns.
IMPLICATIONS
This has now made lenders more risk averse and made them wary of making further commitments to various deals and primary casualities have been Private Equity firms which depend on banks to carry out their leveraged buyouts to an extent. Plus the strain it has put on finances of so may banks, jobs and more prominently - SENTIMENTS! The financial world to an extent run on sentiments as well.
NOT GLOOMY EVERYWHERE
However in some quarters the credit crunch is being seen with positive connotations. Its being said that its has put some breaks in irrational lending frenzy and will bring some sense to the market. Also its felt that a slowdown in mergers & acquisitions will again create a space for venture funds to prosper. The great ideas might get backing to flourish again. Keep watching this space !!!
Sunday, September 2, 2007
Analyzing Blackstone's IPO
Blackstone Group is a global asset manager and a provider of financial advisory services, however it’s known primarily for its Private Equity (PE) business.
The $31 a share IPO which opened on June 22, 2007, valued Blackstone at $33.48 billion which is about a third of Goldman Sachs Group Inc.’s market value and around three-quarters of that of Lehman Brothers. During the IPO 12.3 % stake was offloaded. The IPO mopped up around $3.48 billion for Blackstone and a separate deal to sell around 10% stake to China added $3 billion to IPO Proceeds.
The Blackstone IPO had great names of financial markets as its underwriters, like Morgan Stanley & Citigroup which have the option to buy 20 million more shares on top of 133.3 million already sold through IPO. That would mean an additional $620 million in Blackstone’s kitty.
Blackstone co-founders Stephen Schwarzman, 60, and Peter Peterson, 81, earned $2.4 billion between them from the IPO. Schwarzman's 23% stake in the company is worth $7.74 billion alone. However after the IPO Pete Peterson now holds just 4% of the equity.
Brief profile of Blackstone
Mr. Schwarzman and Mr. Peterson founded Blackstone with $400,000 in 1985 after leaving top posts at Lehman. Initially started as a merger advisory boutique, Blackstone grew into a private equity giant with more than $78.7 billion under management as of 1 March 2007. Based in New York, the firm has offices in Atlanta, Boston, Chicago, Dallas, Los Angeles, San Francisco, London, Paris, Mumbai and Hong Kong.
The Assets under management (as of March 1, 2007) and net income before tax (for year ended December 31, 2006) has been shown in Exhibit 1.
(Source: Form S-1 filed to SEC under The Securities Act of 1933)
The assets under management of Blackstone have shown a CAGR of 34% (Exhibit 2)
Exhibit 2 (Source: Form S-1 filed to SEC under The Securities Act of 1933)
Blackstone’s business is organized into four business segments:
1. Corporate Private Equity. Established in 1987, this business has managed five general private equity funds and is largest of its kind ever raised, with aggregate capital commitments of over $18.1 billion as of March 1, 2007.
2. Real Estate. Managed six general real estate opportunity funds and two internationally focused real estate opportunity funds. The real estate business has grown assets under management from approximately $3.0 billion as of December 31, 2001 to approximately $17.7 billion as of March 1, 2007, representing compound annual growth of 41.1%.
3. Marketable Alternative Asset Management. Marketable alternative asset management segment, established in 1990, management of funds of hedge funds, mezzanine funds, senior debt vehicles, proprietary hedge funds (Distressed securities hedge fund & Equity hedge fund) and publicly-traded closed-end mutual funds. It has grown assets under management, from approximately $3.5 billion as of December 31, 2001 to approximately $29.9 billion as of March 1, 2007, representing compound annual growth of 51.3%.
4. Financial Advisory. The financial advisory segment comprises the mergers and acquisitions advisory services, restructuring and reorganization advisory services and fund placement services for alternative investment funds. Over the last five years, the financial advisory business revenues have grown at a compound annual rate of 22.7%.
There isn’t a trend of Private Equity firms coming out with an IPO though this was not the first case. The first Private Equity group to take the IPO route was Fortress Investment Group, which had an offer price of $ 18.5 to a share and rose to $ 35 by the time shares opened for trading. The FIG has around $ 30 billion under management. Though the shares have fallen back since, closing at $ 24.4 on 15 July 2007.
Implications for investors
One major implication of Blackstone’s IPO on its investors is that they have/will have no say on how the company is run. Since Blackstone Holdings has been structured as a master limited partnership, investors are devoid of any voting rights. They are infact mere unit holders and not shareholders. The difference is critical in the sense that unit holders are not entitled to vote to elect directors and master limited partnerships don’t require to have a majority of independent directors on the board.
Current status of Blackstone Shares
Blackstone stock rose as high as $38 a share on New York Stock Exchange on listing and the volume traded was more than 113 million shares. However since then Blackstone’s shares have weakened after gaining 13% on opening. Currently they are trading in the range of $29-30.
The trend Blackstone shares have followed is depicted in Exhibit 3
Exhibit 3 (Source: http://www.forbes.com/)
The reasons for this drop in share price are manifold and have to do primarily with future performance indicators of Private Equity industry:
Tax proposal – The big money for PE players come primarily from “carried interest” which is 20% of gains they generate from buying companies and reselling them through IPOs or sales to corporates or other private equity firms. The firm pays capital gains rate of just 15% on them, as compared to 35-45% tax levied on corporate earnings. There is a proposal in US congress which would tax carried interest at regular income tax rate of 35% instead of present 15%. And this proposal if implemented would take a major part of their earnings.
Credit Crunch – Instead of using their own money PE firms raise money from other sources and invest them. However with interest rate marching upwards it will be harder for PE firms to raise money for further investment and that signals that the private equity boom may have peaked.
More PE IPOs in offing
However, the present state of Blackstone’s shares haven’t stopped other PE firms from joining the IPO bandwagon to raise money. One of biggest competitors of Blackstone, KKR (Kohlberg Kravis Roberts & Co) plans to raise upto $1.5 billion by listing itself on NYSE. The offering is expected to be complete by fourth quarter of 2007.
It would be interesting to watch how the IPO of KKR & Co. fares!!!
The $31 a share IPO which opened on June 22, 2007, valued Blackstone at $33.48 billion which is about a third of Goldman Sachs Group Inc.’s market value and around three-quarters of that of Lehman Brothers. During the IPO 12.3 % stake was offloaded. The IPO mopped up around $3.48 billion for Blackstone and a separate deal to sell around 10% stake to China added $3 billion to IPO Proceeds.
The Blackstone IPO had great names of financial markets as its underwriters, like Morgan Stanley & Citigroup which have the option to buy 20 million more shares on top of 133.3 million already sold through IPO. That would mean an additional $620 million in Blackstone’s kitty.
Blackstone co-founders Stephen Schwarzman, 60, and Peter Peterson, 81, earned $2.4 billion between them from the IPO. Schwarzman's 23% stake in the company is worth $7.74 billion alone. However after the IPO Pete Peterson now holds just 4% of the equity.
Brief profile of Blackstone
Mr. Schwarzman and Mr. Peterson founded Blackstone with $400,000 in 1985 after leaving top posts at Lehman. Initially started as a merger advisory boutique, Blackstone grew into a private equity giant with more than $78.7 billion under management as of 1 March 2007. Based in New York, the firm has offices in Atlanta, Boston, Chicago, Dallas, Los Angeles, San Francisco, London, Paris, Mumbai and Hong Kong.
The Assets under management (as of March 1, 2007) and net income before tax (for year ended December 31, 2006) has been shown in Exhibit 1.
(Source: Form S-1 filed to SEC under The Securities Act of 1933)
The assets under management of Blackstone have shown a CAGR of 34% (Exhibit 2)
Exhibit 2 (Source: Form S-1 filed to SEC under The Securities Act of 1933)
Blackstone’s business is organized into four business segments:
1. Corporate Private Equity. Established in 1987, this business has managed five general private equity funds and is largest of its kind ever raised, with aggregate capital commitments of over $18.1 billion as of March 1, 2007.
2. Real Estate. Managed six general real estate opportunity funds and two internationally focused real estate opportunity funds. The real estate business has grown assets under management from approximately $3.0 billion as of December 31, 2001 to approximately $17.7 billion as of March 1, 2007, representing compound annual growth of 41.1%.
3. Marketable Alternative Asset Management. Marketable alternative asset management segment, established in 1990, management of funds of hedge funds, mezzanine funds, senior debt vehicles, proprietary hedge funds (Distressed securities hedge fund & Equity hedge fund) and publicly-traded closed-end mutual funds. It has grown assets under management, from approximately $3.5 billion as of December 31, 2001 to approximately $29.9 billion as of March 1, 2007, representing compound annual growth of 51.3%.
4. Financial Advisory. The financial advisory segment comprises the mergers and acquisitions advisory services, restructuring and reorganization advisory services and fund placement services for alternative investment funds. Over the last five years, the financial advisory business revenues have grown at a compound annual rate of 22.7%.
There isn’t a trend of Private Equity firms coming out with an IPO though this was not the first case. The first Private Equity group to take the IPO route was Fortress Investment Group, which had an offer price of $ 18.5 to a share and rose to $ 35 by the time shares opened for trading. The FIG has around $ 30 billion under management. Though the shares have fallen back since, closing at $ 24.4 on 15 July 2007.
Implications for investors
One major implication of Blackstone’s IPO on its investors is that they have/will have no say on how the company is run. Since Blackstone Holdings has been structured as a master limited partnership, investors are devoid of any voting rights. They are infact mere unit holders and not shareholders. The difference is critical in the sense that unit holders are not entitled to vote to elect directors and master limited partnerships don’t require to have a majority of independent directors on the board.
Current status of Blackstone Shares
Blackstone stock rose as high as $38 a share on New York Stock Exchange on listing and the volume traded was more than 113 million shares. However since then Blackstone’s shares have weakened after gaining 13% on opening. Currently they are trading in the range of $29-30.
The trend Blackstone shares have followed is depicted in Exhibit 3
Exhibit 3 (Source: http://www.forbes.com/)The reasons for this drop in share price are manifold and have to do primarily with future performance indicators of Private Equity industry:
Tax proposal – The big money for PE players come primarily from “carried interest” which is 20% of gains they generate from buying companies and reselling them through IPOs or sales to corporates or other private equity firms. The firm pays capital gains rate of just 15% on them, as compared to 35-45% tax levied on corporate earnings. There is a proposal in US congress which would tax carried interest at regular income tax rate of 35% instead of present 15%. And this proposal if implemented would take a major part of their earnings.
Credit Crunch – Instead of using their own money PE firms raise money from other sources and invest them. However with interest rate marching upwards it will be harder for PE firms to raise money for further investment and that signals that the private equity boom may have peaked.
More PE IPOs in offing
However, the present state of Blackstone’s shares haven’t stopped other PE firms from joining the IPO bandwagon to raise money. One of biggest competitors of Blackstone, KKR (Kohlberg Kravis Roberts & Co) plans to raise upto $1.5 billion by listing itself on NYSE. The offering is expected to be complete by fourth quarter of 2007.
It would be interesting to watch how the IPO of KKR & Co. fares!!!
Friday, August 31, 2007
Concept of Private Exchanges
Bombay Stock Exchange (BSE), National Stock Exchange (NSE), New York Stock Exchange (NYSE), NASDAQ – We all must have heard these names, but PORTAL, Goldman Sachs Tradable Unregistered Equity OTC Market (GS TruE); probably majority of us might not have heard these names because these are exchanges which are out of bounds for retail investors, i.e. they are private exchanges.
Traditionally, whenever companies are in need of funds they hit the public markets and get listed on public exchanges. But recently there has been a trend of private exchanges being setup by big investment banks and other public exchanges as well. Goldman Sachs started its private trading platform in May this year and was followed by NASDAQ, which launched its own version, PORTAL. Many other big investment banks like Citigroup Inc., Lehman Brohers & Merrill Lynch have also established their own private exchanges.
In recent times, one of the big names in financial markets which decided to float on private exchange rather than on a public exchange is the alternative asset management firm Oaktree Capital Management LLC which raised $800 million by selling a 15% stake through GS TRuE. Furthermore Apollo Management, a private equity firm has expressed its desire to sell its shares on Goldman Sachs’ private exchange. American companies raised $221 billion last year by listing on private exchanges, which for the first time exceeded the amount raised through traditional exchanges. Globally this segment of securities market has touched $1 trillion.
Individual or retail investors are not qualified to trade on these exchanges, and are open only to large institutional investors. For example Goldman Sachs’ exchange is open only to institutional investors with assets of more than $100 million. Similarly Nasdaq’s portal is open to banks and insurance companies with at least $100 million in assets and brokers with at least $10 million in assets.
Its easy to understand why there is a rush towards private exchanges. Stocks of companies that trade in public exchanges need to be registered with Securities and Exchange Commission (SEC) and so are subjected to SEC regulations designed to protect individual investors. Additionaly such companies are open to a lot of scrutiny from regulators along with strict compliance with laws like Sarbanes-Oaxley Act (SOX), which requires numerous disclosures and adherence to other such regulations. So to save themselves from all such troubles the companies hit the private exchanges since stocks of bonds not registered with SEC (under Rule 144A) can trade on private exchanges. Many private equity firms and hedge funds which want to raise money but are reluctant to be lot more open to public prefer to be listen on private exchanges.
Though the amount of money a firm can garner is to some extent less on private exchange compared to public exchange primarily because the demand is much more on a public exchange. There is a growing criticism of private exchanges for the reason that they exclude individual investors from a growing proportion of financial market activity. Even the mutual funds that are main investment tools for individual investors, are allowed to trade in small number of unregistered securities thereby further alienating individual investors from market participation.
However still the idea that private exchanges might completely overtake public exchanges seems far fetched but its evident that they are going to snatch away a large chunk of their business. It would be interesting to watch this battle.
Traditionally, whenever companies are in need of funds they hit the public markets and get listed on public exchanges. But recently there has been a trend of private exchanges being setup by big investment banks and other public exchanges as well. Goldman Sachs started its private trading platform in May this year and was followed by NASDAQ, which launched its own version, PORTAL. Many other big investment banks like Citigroup Inc., Lehman Brohers & Merrill Lynch have also established their own private exchanges.
In recent times, one of the big names in financial markets which decided to float on private exchange rather than on a public exchange is the alternative asset management firm Oaktree Capital Management LLC which raised $800 million by selling a 15% stake through GS TRuE. Furthermore Apollo Management, a private equity firm has expressed its desire to sell its shares on Goldman Sachs’ private exchange. American companies raised $221 billion last year by listing on private exchanges, which for the first time exceeded the amount raised through traditional exchanges. Globally this segment of securities market has touched $1 trillion.
Individual or retail investors are not qualified to trade on these exchanges, and are open only to large institutional investors. For example Goldman Sachs’ exchange is open only to institutional investors with assets of more than $100 million. Similarly Nasdaq’s portal is open to banks and insurance companies with at least $100 million in assets and brokers with at least $10 million in assets.
Its easy to understand why there is a rush towards private exchanges. Stocks of companies that trade in public exchanges need to be registered with Securities and Exchange Commission (SEC) and so are subjected to SEC regulations designed to protect individual investors. Additionaly such companies are open to a lot of scrutiny from regulators along with strict compliance with laws like Sarbanes-Oaxley Act (SOX), which requires numerous disclosures and adherence to other such regulations. So to save themselves from all such troubles the companies hit the private exchanges since stocks of bonds not registered with SEC (under Rule 144A) can trade on private exchanges. Many private equity firms and hedge funds which want to raise money but are reluctant to be lot more open to public prefer to be listen on private exchanges.
Though the amount of money a firm can garner is to some extent less on private exchange compared to public exchange primarily because the demand is much more on a public exchange. There is a growing criticism of private exchanges for the reason that they exclude individual investors from a growing proportion of financial market activity. Even the mutual funds that are main investment tools for individual investors, are allowed to trade in small number of unregistered securities thereby further alienating individual investors from market participation.
However still the idea that private exchanges might completely overtake public exchanges seems far fetched but its evident that they are going to snatch away a large chunk of their business. It would be interesting to watch this battle.
Tuesday, August 28, 2007
Dutch Auction Process of IPO Allocation
Few companies take the much less treaded path of IPO allocation through a process known as “Dutch Auction”. We will analyze here the method and its implications along-with Google’s IPO Case that used modified form of Dutch auction for its IPO allocation & pricing in 2001.
Generally the sale of shares (Allocation and Pricing) uses one (or variants) of the following methods to allocate the shares:
- Book Building
- Auction Method
- Fixed Price Public Offer
Bill Hambrecht, an American investment banker and chairman of W. R. HAMBRECHT & CO., devised the Dutch auction method of share allocation and pricing, and is known as “open IPO” model.
In a Dutch auction, a company reveals the maximum amount of shares being sold and sometimes a potential price for those shares. Investors then bid for the number of shares they want and the price they are willing to pay. Once a minimum clearing price is determined, investors who bid at least that price are awarded shares.
Let us take an example to understand the mechanism of Dutch auction. Let the company XYZ wants to offload 100 shares in the market. 5 investors (A, B, C, D and E) have submitted their bids (price and no. of shares applied for) as per the table below:
Investor No. of Shares Applied for Bid Price per Share (Rs.)
A 15 500
B 30 480
C 25 470
D 35 465
E 20 462
Now we start accounting for all the shares starting from the highest bid received and stop when the total count reaches 100 (i.e. no. of shares on offer). The price at which we account for 100 shares is 465.
Investor No. of Shares Applied Cumulative Total Bid Price per Share (Rs.)
A 15 15 500
B 30 45 480
C 25 70 470
D 35 105 465
E 20 125 462
So the allotment price would be Rs. 465 and A, B, C will be allotted the shared they applied for, D will be allotted 30 shares (100-70) and E won’t get any share.
Though there hasn’t been a clear-cut proof but a Dutch auction method is supposed to have following benefits over traditional method of IPO allocation:
Minimization in “Spike” or “Pop”:
The increase between the offer price and the opening price is termed as “spike”. In the traditional IPO allocation process, investment banks handling the IPO process determine the appropriate price by taking the IPO through “roadshows” to possible investors (large mutual funds, or clients of investment banks) and gauging the demand. As a consequence these investors often receive the initial allotment of IPO shares and benefit from the price appreciation, which happens on listing. By Dutch auction method the spike can be reduced since the demand level has already been gauged and the price has been arrived at by market mechanisms of demand and supply.
Small investor participation:
Enables small investors to participate in the pricing by mentioning the price that they are willing to pay and the number of shares they are interested in buying. Thus it is supposed to democratize the process of share allocation.
Role of investment banks:
Since the investment banks are not involved in pricing of the IPO, the price is the lowest price at which all of the shares are sold; it minimizes the influence of investment banks. The value of IPO goes to the public rather than to the favored client of investment banks.
However there are few shortcomings in the Dutch auction process:
Lack of information to small investors:
Small investors who are supposed to be primary participant in this type of IPO allocation method may not have sufficient detailed information to price the shares based on fundamentals, as a result they tend to do it on basis of name recognition (brand of the company). On the contrary in traditional method of IPO allocation the price range is arrived at my investment banks that have access to detailed information and are experts in their respective fields. Moreover contrary to traditional method the online auction method is not required by law to disclose as much information as required in the traditional method
Mispricing:
Due to lack of rigorous scrutiny by investment banks there happens to be a mismatch on the pricing front. At times due to initial risk aversion by retail investors may lead to under pricing of the initial offer price.
Minimum Price Spike:
The price spike, which happens in traditional IPO allocation methods infact, does well for the stock. It imparts an aura of success to the stock, which in turn will boost the stock higher leading to the gains for investors. This doesn’t generally happen in case of auction method.
Dutch Auction: Google’s Case
Few companies like Salon.com, Overstock.com & Ravenswood winery have earlier adopted the Dutch auction method, however the IPO that brought a lot of limelight on this method was that of Google, the Internet search giant.
However one of the supposed advantages of Dutch auction method of having minimum spike didn’t stand ground in case of Google. Google's initial public offering took place on August 19, 2004. Total of 19,605,052 shares were offered at a price of $85 per share. The sale raised $1.67 billion, and gave Google a market capitalization of more than $23 billion. Google’s offer price was $85, but it opened at $ 100, a 17.6% increase. Thus the increase between offer price and open price was much greater than the increase for typical IPOs during that period. So the supposedly advantage of minimum price spike didn’t stand ground. And also it means that Google didn’t raise the full amount, which it could have, that means it left a substantial amount of money “on table”.
Lets see if there are other firms who follow in Google’s footsteps and embrace this lesser used method of IPO Share allocation. The more the number of companies use this method, the clearer the implications will be for each of us to observe and understand.
Further Reading: As per a research study conducted the book building is less risky then a sealed bid-auction. The study was conducted for two methods of IPO allocation. (Global trends in IPO methods: Book building versus auctions with endogenous entry Journal of Financial Economics, Volume 78, Issue 3, December 2005, Pages 615-649 by Ann E. Sherman)
Subscribe to:
Posts (Atom)
