The headline-grabbing IPO of search engine Google has flipped the floodlights on new-issue underwriting-Wall Street's most lucrative line of businesses and one of the last to become automated.
Google's electronic, Dutch-auction IPO contrasts with a lack of transparency and access that many say is endemic to the IPO process in an industry waning under unprecedented scrutiny, both for equities and for bonds. And it's more than just Google that's fighting IPO traditions.
Demands for increased transparency, efficiency and oversight are coming from all sides-regulators, vendors, institutions hungry for access to new offerings, and rival dealers fighting for a scrap of the underwriting business long dominated by major investment banks.
Electronic transactions like Google's IPO are making it clear that control over capital-raising does not rest entirely with the major dealers: It lies with the issuers too. If Google's e-auction is successful, observers say, other corporates could follow suit and go Dutch. Such a shift may not be specific to equities. Google, for instance, will likely want to tap the debt markets and may seek to issue bonds in the same all-access, Web-based way it has with its IPO.
Dutch auctions, say supporters, offer a truer price based on more accurate demand of a wider market, because the issuance is open to any potential shareowner with an Internet connection, instead of select institutional accounts favored by individual underwriters. The auctions benefit issuers too, supporters say, because allocating shares in computerized bidding based solely on price can curtail the sharp spike-and-ebb price volatility typical of traditional offerings and its aftermarket. The open access, they say, lessens the ability of a quick-flip profit to the favored few allowed to buy low during the offering stage, and sell high to the masses in the secondary market.
Yet whether the market is truly on the cusp of an "e-evolution" is debatable. It's been four years since the World Bank said its foray into e-issuance would give "for the first time, mid-sized and retail investors ... access to the kind of market information and type of product that was only available to the institutional investors."
That effort went nowhere. An initial slew of "me-too" announcements in early 2000 from major brokers quickly ceased, and many now dispute how electronic these transactions actually were. Most dealers do not offer Web-based pricing or fully automated book-running for stocks and bonds-and neither does the World Bank, according to a staffer-despite the longstanding capability to do so.
So far it's the scant few early "e-auction" adopters-mostly lesser known firms like WR Hambrecht, i-Deal and Dealogic-that stand to benefit if more IPOs and bond offerings "go 'Net."
Hambrecht, a co-manager on the Google deal, has offered a Dutch-auction-style Web system for equities, called OpenIPO, since 1999. Officials at the San Francisco-based dealer refused to comment on whether OpenIPO was being used, in part or whole, to bring Google public. A source no longer with the firm, but close to the initial development of OpenIPO, says he's unaware if the September 2003 patent on the system was compelling its use in the auction, or if Hambrecht would assert ownership claims over the mechanism Google ends up using.
OpenIPO modifies the traditional Dutch auction by allowing investors to submit bids within or close to a minimum and a maximum price range. Investors of any stripe can submit single or multi-tiered bids through the Internet, phone or fax via Hambrecht or another participating broker. In OpenIPO, the lead manager and the issuer see the name of the bidder, the price and the quantity bid, but prospective investors don't.
OpenIPO was developed by Thinkbank, a Berkeley, CA, consulting and software firm, under contract to Hambrecht. The effort drew from the auction-modeling work of Nobel prize-winning economist William Vickrey. The system uses a pro-rata allocation, or "Vickrey algorithm, to award shares to bidders. The kicker: allocations go to all investors-institutional, retail, and individual. If one and a half million shares are bid at or above the clearing price and one million are offered, everyone receives two-thirds of his bid. If bids indicate twice the demand than what's offered at the clearing price, every investor gets 50 percent of what he wanted.
Hambrecht allows issuers to discount the offering price from the clearing price to satisfy certain investors. The broker gives three reasons for this: It rewards shares to investors who undershoot the clearing price but for which the issuer had spent weeks in road shows prepping for long-term investment; issuers still value the psychological boost of a first-day price increase; and dissatisfied buyers can complete their position in the aftermarket, cheaply if they're quick. Hambrecht has completed nine OpenIPO auctions; three more are pending.
Hambrecht's bond system, OpenBook, is based on a "full-fill algorithm," meaning investors get exactly what they bid for based on prices and time stamps, which determine order and break any ties. Bidders are also allowed a feedback mechanism via a graph that shows bid sizes and a rough indication of their prices, but not investor names. The Securities and Exchange Commission (SEC) won't permit names in OpenIPO, the banker says. Investors submit bids within a minimum and a maximum price or spread range.
Business has been sluggish-the last auction on OpenBook occurred two years ago. Hambrecht faces challenges in convincing traditionally conservative corporate treasurers that the established process of allocating new issues undercuts issuer proceeds. According to the banker, the rise in prices concurrent with typical spread-tightening that takes place in the aftermarket reflects the amount of funds the issuer has left on the table, or could have realized if access to the primary market was wide open. He says the dealer is targeting mid-sized to large companies in the U.S. and Europe, and discussing domestic partnerships with other underwriters.
Taking a more conventional approach is i-Deal. Backed by Merrill Lynch, Citigroup, Thomson Financial and Microsoft, i-Deal enables lead managers to simultaneously share order, allotment and allocation information over the Web. Lead managers choose the data they want to impart over the system. The New York vendor completed last month what i-Deal CEO Scott Ganeles called the first "global, real-time, joint book-run IPO."
Merrill and Citigroup used i-Deal's Syndicate Connect and i-Deal Equity to electronically manage IPO orders for Halfords Group, a British car and cycle accessories retailer. Merrill used the systems again in June to lead-manage an offering for Czech Republic pharmaceuticals firm Zentiva.
But i-Deal was rebuffed in its offer to help e-issue Google shares by the search firm's lead underwriters, Morgan Stanley and Credit Suisse First Boston. Electronic Dutch auctions are not among the current demands of the dealer-backers to which i-Deal has more conservatively pegged its innovation, Ganeles says. In fact, i-Deal backer Merrill bolted from its Google underwriting role for reasons that, he says, included "technology constraints." "We're not here to change the way business is done," he emphasizes.
Instead, i-Deal is aiming efforts at helping brokers better reach, allocate and document new issuance through retail branch networks, where, Ganeles says, "compliance becomes a capital C." The firm plans a Labor Day launch of a new retail-focused platform at Wachovia. Similar to Hambrecht, i-Deal is hoping to attract banks and other firms trying to boost underwriting business.
Dalcomp, i-Deal's more popular bond system, is being moved to a Web-based ASP format from its networked PC, or client-serve, legacy environment. Thomson traded the municipal-pricing system for an equity stake in i-Deal when it was formed in 2001. Corporate debt issuance system i-Deal Fixed Income is fully Web-based, but the firm has yet to complete a joint-run deal similar to its equity offerings.
Rival Dealogic, which has long and quietly supplied new issuance data to the market and went public itself in May, would not respond to requests for an interview, though a staffer confirmed it was not involved in the Google IPO. London-based Dealogic remains a formidable competitor to i-Deal, Ganeles says, because most dealers, besides Merrill, use the system.
Another platform, Communicator Inc.'s portal ComplianceHub, seeks to lessen the regulatory and paper burdens for underwriters. The firm electronically stores and distributes documents like master swap agreements, and manages more than 25,000 "letters of attestation" ensuring dealers' customers are qualified institutional buyers (QIBs). The validity of such documents generally expires every 14 months, says Communicator CEO Leo Schlinkert.
Other systems have shifted more directly to satisfying regulators. The Grant Street Group, parent of largely shuttered new-issuance platform MuniAuction, petitioned the SEC last month to use another of its Internet auction-hosting services, ARCauction, to surveil the $200 billion auction-rate market, which is under investigation for market manipulation.
Regulators could upload data electronically via the system using the file transfer protocol (FTP) standard, says Myles Harrington, Grant Street's president. Wilmington Trust, Wachovia and Wells Fargo use ARCauction sites as auction agents on more than 300 CUSIPS.
