A new element of risk

A new element of risk
Use of the Internet to implement an IPO remains a ‘highly speculative prospect,’ attorney says
By Erik Gunn, for SBT
Internet IPOs still turn heads, but IPOs conducted on the Internet may be an idea that has come and gone.
That’s the assessment of Thomas E. Hartman, an attorney at the Milwaukee law firm of Foley & Lardner and an expert in public and private equity and debt financing, and federal and state securities law.
Using the Internet itself as a medium to actually implement an IPO remains a highly speculative prospect, Hartman says.
Companies promoting the Internet as a means for pricing and selling IPO stocks have touted savings on the underwriting fees traditional investment bankers charge – typically 7% of the gross proceeds from an offering, Hartman says. Half of those fees go to retail brokers who sell the stock directly to the public. Internet underwriters hold their fees down by conducting the sales themselves, avoiding the retailers’ commissions.
But Hartman says companies making an IPO which try to save money by using Internet brokers may end up shortchanging themselves. Traditional underwriters have research departments, and a company making an offering typically picks a firm with a researcher well versed in the offering company’s industry. That lends credibility to an offering company that is “too small to otherwise attract attention,” Hartman says.
A year or so ago, financial pundits predicted Internet underwriting would supplant traditional investment bankers. But Internet underwriters still aren’t being used as lead underwriters, Hartman says. “Where they’re being used is in the underwriting syndicate – just like retail brokers there.” And in place of what people thought would be a revolution in the IPO market, “what is instead happening is an evolution. It’s just become another way of issuing shares of stock in an offering.”
So, too, the so-called Dutch auction method of pricing IPO shares favored by one Internet broker appears to have flopped, Hartman says. In a Dutch auction, potential buyers place bids on blocks of stock, which then are sold at the lowest price needed to sell all of the offered shares.
For instance, if 100 shares are offered, and five potential subscribers bid on lots of 25 shares at $20, $18, $16, $14 and $12 a share respectively, the top four bidders will get their full 25-share allotments, each paying $14 a share. The $12-a-share bidder gets nothing.
The Dutch auction was designed to get an opening price for an IPO company that more closely reflected the market’s value of the company. The method is aimed at avoiding what has happened in many recent IPOs, Hartman says: Companies have entered the market only to see the price soar astronomically over the course of the opening day — with the profits from the run-up going to traders rather than to the offering company.
In Dutch auctions, however, the opposite problem occurs, Hartman says. Stocks peak at their opening price, and the pressure switches to the selling side. Day trading, whose practitioners buy in order to sell as the price ticks upward, further fuel selling. As a result, the stock languishes. “You got the best price possible the first day on the market, and that’s it,”Hartman says.
Some of the innovations that the Internet could bring to the IPO market may yet prove themselves, Hartman says, but for now they remain untested.
“The question is,” he says, “Do you want your company to be the guinea pig?”
The point of any IPO is to give the offering company the wherewithal to make major advances – a major growth spurt, significant capital investment or a plunge into new markets, for instance.
“People don’t realize that an IPO is not a get-rich-quick scheme for the person who owns the business,” Hartman says.
For one thing, at least 65% of the IPO shares are brand new shares whose proceeds go straight to the company. And if current owners really expect the company to grow – and therefore its value to increase — they’d be foolish to get out at the offering. If Bill Gates had sold all of his Microsoft stock when the company went public back in the early 1980s, Hartman notes, he probably wouldn’t be the nation’s wealthiest man today.
To make any IPO accomplish its goals, planning is crucial, Hartman says. Wall Street and securities regulators typically demand from a company contemplating going public a track record of quarterly reports and up to three years of expensive annual audits. Private companies are often accustomed to skipping both.
And to interest institutional investors who give a publicly traded company the price stability it needs to ride out the market over the long haul, the offering company needs a solid business plan that clearly explains what it intends to do with the new resources it gets from the offering.
Tech and Internet companies — so-called Dot-Com companies — have been the darling of the IPO market in recent years, but not always with the long-time investment professionals, Hartman says. Professional investors deal in fundamentals, looking at earnings and long-term business plans. The current crop of Internet stocks, however, don’t have earnings records – they’re speculative in every sense of the word.
[Attorney Tom Hartman is one of six speakers on the agenda Tuesday Sept. 21 at “Taking Your Company Public,” an afternoon seminar co-sponsored by Foley & Lardner, Robert W. Baird & Co. and Ernst & Young LLP. The seminar will be held at the Midwest Express Center.To register for the seminar, contact Ronnie Jean Artero, Foley & Lardner, 414-297-5483. The fee is $50.]

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