The recent $7.5 billion IPO of South Burlington’s own Beta Technologies intrigued many of our clients at Hanson + Doremus, particularly those in Vermont, a state which rarely generates new sizable public companies. While the hype and excitement surrounding IPOs have been a staple of both the financial and general media since the dotcom boom, the actual mechanics, processes, and outcomes for IPOs remain hidden behind the curtains for many investors. I’ll try to raise those curtains to shed a little light.
An Initial Public Offering or IPO endures as the most conventional method in the U.S. for private companies to access public equity capital. The reasons for undergoing this process can vary but commonly include raising money to run or expand the business instead of issuing new debt and offering a more liquid market for the current investor base to monetize all or some of their stakes in the firm.
Whatever the rationale, the decision to “go public” also comes with some potential downsides. These include increased public scrutiny; greater emphasis on short-term financial performance; a larger board with increased power; potential loss of control of the firm; and the increased time and money spent on financial reporting and investor relations.
Firms begin the IPO process by first selecting investment banks that provide due diligence, valuation, underwriting and marketing services. They must also issue an S-1 Registration Statement (also known as a prospectus), undergo due diligence from their key regulator, the Securities and Exchange Commission (SEC), and go on a roadshow to market the shares to institutional investors like mutual funds and hedge funds. This part of the process can take a few months to over a year depending on the market conditions and the back and forth with the SEC.
As the effective trading date draws closer, the underwriters (i.e. investment banks) use the prospectus, roadshow, and their own client networks to gauge interest from potential investors about not only pricing but also on the offering size. For example, Beta planned to sell 26 million shares for between $27 to $33 per share for its IPO. Due to the IPO being oversubscribed, the firm and its bankers priced the stock at $34 per share and increased the number of shares to 29.9 million shares.
So, how do investors get allocated shares in an IPO? The first key is to look at the cover page of the prospectus (see below). The banks are ranked in importance there with top as most important and then by left to right position. The actual fees generated also follow this same pattern with the majority accruing to the top line. So, for Beta, its lead underwriters were Morgan Stanley and Goldman Sachs. Clients, both institutional and retail, of those two banks had the best chance of gaining access to the Beta shares. While some companies prefer to sell to institutional clients for a more stable ownership base, other companies like to spread out the wealth to retail clients. Beta asked its underwriters to allocate shares to the roughly 1,000 Vermonters who indicated interest via its banking partners.
After this long process, the IPO becomes effective and starts trading on an exchange. One oddity is that trading on the “effective date” rarely starts at the open, but around midday or later. Beta began trading on November 4 at around 1:50 pm Eastern. The double-digit opening day pop for IPOs was typical during the dotcom boom and the more recent “unicorn” era of Uber, Airbnb, and Pinterest. However, more than a few IPOs subsequently trade at or near their IPO price including Beta, which closed up around 6% on the day.
Longer term, the case for getting in early on any IPO is shaky. A study from Nasdaq Economic Research found that roughly 64% of IPOs from 2010 to 2020 underperformed by 10% or more versus the relevant index at three years after their IPO date. Even within six months, 42% were more than 10% down versus the index. However, the range of outcomes is skewed towards the names we remember the most, with top 10% of IPOs in the study earning an average market-adjusted return of over 300%. For most investors, a diversified portfolio would likely outperform one made up of IPOs.
