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OpenTable - VCs Waste Another IPO
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VCs lamented the dead IPO market ’round the clock at the AlwaysOn Venture Summit two weeks ago, where the theme of conference was the search for liquidity. Yours truly participated on one of three panels dedicated to raising the four horsemen from the dead. The NVCA has published a position paper on the national IPO crisis, recognizing the need for a viable underwriting ecosystem — and even calling for government intervention. So we are to understand that VCs, in their infinite wisdom, altruism and patriotism recognize that a sound IPO market is critical for the economy. So critical, in fact, that they are ready to champion government involvement to fix the machine. I completely agree that our IPO market needs fixing. But the venture community needs to get out of its Aeron chair and pitch in before calling the “Obama Phone.” Benchmark, Integral and Impact threw another shovel of dirt on the IPO market with OpenTable, when they paid 70% of the deal fees to Merrill Lynch – a firm that is too big to care about small cap IPO’s. Does anyone with half a brain think that the OpenTable deal fees will have any effect on Merrill’s allocation of resources? Big banks like Merrill, Goldman, JP Morgan, Morgan Stanley can not afford to focus on the small-cap IPO market. You don’t need a calculator to do this math! Investment banks should use IPO deal fees to cover the long term costs of research analysts, market makers, institutional sales, non-deal roadshows, investor conferences. All of these services are required to have a sustainable IPO market. Benchmark Capital, Integral Capital Partners and Impact Venture Partners followed the VC herd that has prioritized brand over service since the Internet bubble. “Why pay IPO fees to a small growth focused firm like Thomas Weisel when I can get a cool helicopter ride to Merrill’s palatial headquarters?” The venture herd has turned its back on the firms that have committed 100% of their talent and capital to the real IPO market – firms like TWP, JMP, Cowen, Needham, and Piper Jaffrey. That is what has killed the IPO market. When the IPO market worked, prospectus covers were dominated by firms that were totally dedicated to small cap offerings. Firms that provided all the required services because that was their #1 line-of-business. It was common to see three underwriters splitting fees 40%-30%-30% because each firm was going to dedicate the needed resources to support the new public company for years! Ok, ok – I get why VC’s turned to the bulge bracket in the bubble. The four horsemen got sloppy and VCs needed bulge bracket financial advisors to manage the personal fortunes they were pulling out of IPOs. Plus – during the bubble – IPOs were kinda automatic thanks to Daytraders et al. But that was a moment in time that ended in 2000. The real IPO economics were back by 2001 and, while it will come as a shock to the venture community, you can’t maintain a full-service, growth-focused investment bank without revenues. Seventy percent of the deal fees to Merrill – Really???? Another 10% to Allen & Company for no research or trading – Really????? You want to call Obama to fix the IPO market – REALLY??????? Want a solid IPO market – try paying for it. Chris is the founder of Bulger Capital, before which he spent three years at Needham & Co. as a senior partner and head of technology banking. He also is a Robbie Stephens vet, having run its Boston office and its global technology banking group. Read Chris’ earlier posts here. |
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June 3rd, 2009 at 12:14 pm
I completely agree with Chris Bulger. What small cap companies need is good small cap coverage. Giving the lion’s share of the IPO fees to a bulge bracket firm does not make sense. They will take your money, but you won’t get the service. Also, how many of the buyers were allocated OpenTable shares by Merrill have already sold for a quick profit? When the VC lockup comes around, the short term holders will have been selling off and pushing the price down. PLUS, if you go with Merrill or a bulge bracket, how is it that they can misprice the offering so badly that the shares shoot up 60% on the opening day. Who benefits: those being allocated shares by Merrill, NOT the existing shareholders who sold. Existing shareholders got $20 per share. At the end of the first day of trading the shares were almost at $32 per share. Shouldn’t existing shareholders try to avoid this kind of behavior? Shouldn’t VCs try to be a bit more careful?
June 3rd, 2009 at 1:02 pm
I posted last month on the sorry state of the tech IPO market, with my theory on the IPO market’s collapse being: 1) the whole IPO market is busted, so as a side effect technology IPOs are broken; 2) the big buyers of small-cap technology IPOs have left the building - I’m not 100% sure why but I bet it has something to do with the fact that in the late 90’s a bunch of crap was sold to them; and 3) something about trading fees being too low to support research analyst coverage of $250 million market cap companies, thus making these small technology companies harder for mutual funds to actively follow.
I’d love people’s comments/opinions; you can read my entire post: http://www.startable.com/2009/05/08/technology-ipo-market/
June 3rd, 2009 at 3:06 pm
I wish I could chime in with an “amen”, but I can’t. Fixing the IPO market is far more complex than deciding how to shovel out fees. In the old days brand mattered because of distribution, while I agree in principle that choosing the right cover can make a huge difference (that’s one of the things we preach) the reality of fixing this goes much deeper.
Not to re-iterate, but “Tornado Spitzer” fueled the first leg of the implosion when he seperated banking and research in his “global settlement”. As much as many banks denied post settlement they were using a black box methodology to distribute, ipso facto you only had to look at the book to see that the largest fee generators were getting the largest allocations..hence the flippers and hedgies got the bulk of the trades.
Folks like us who were generally long term holders and low fee generators got shut out or such small positions that it really didn’t make for a good position to build on.
The second leg came with the Sarb-Ox mess which was well meaning but mis directed to the small end of the market caps. Finally reg FD nailed the coffin shut. We were expected to buy positions in the public markets from holders in the private market after a 30 minute pitch where we could not ask any questions that didnt fit the script. Who wants to buy fo the long term after that…hence the effort we started 4 years ago to buy into private firms before the IPO roadshow and get a good tenure track with management and their models.
If you want to fix it, then you should go deep into the analsyt coverage, distribution models, trading history and manage the distribution of the stock to a large share of long term holders.
Beyond that we have to fix the market process…and that will take a lot of work if we want to get the rat out of the snake’s belly (large bolus of companies held by venture and PE that should or could be publice).
Believe me, its not an appetite issue, we want to buy the best GARP companies that are held privately..we need to put the capital to work.
June 3rd, 2009 at 4:50 pm
As a venture capitalist who would like to see a robust IPO market for technology companies, i read Chris’ article with great interest. I understand his rant against 70% of the fees going to a bulge bracket firm and don’t disagree with its logic. The part i’m having an issue with is the idea that venture firms en masse are saying ‘No’ to having any of their companies going public with very good, investment growth oriented firms. I guarantee you that every reputable venture firm would claim to have one to five companies in its portfolio that could/should go public in Q3 or Q4 of ‘09. Either they aren’t doing a good job of marketing their services to us or there is a more systemic problem that we should acknowledge and address.
Finally, on the Obama front, something we could ask of the administration wrt IPOs is to rethink the Sarbanes Oxley requirements for these small growth oriented firms. Why should a $30 million revenue company share the same burden as a $30 billion in revenues.
June 5th, 2009 at 2:00 am
Greg — are you serious? Can you connect two dots? And who taught you the meaning of the phrase “ipso facto”. Blaming Spitzer for this mess is like blaming Marlene Dietrich for WWII.
June 5th, 2009 at 9:39 am
As Phil, Greg and Healy all point out - the factors contributing to the deterioration of the IPO market are manifold and complex. The same could be said for the initiatives required to rebuild this vital part of our economy. But use complexity as an excuse for VC’s failure to spend underwriting fees wisely is like not bothering to recycle because the environment is so complicated.
The point of my “rant” was to suggest that to have a healthy IPO market we need healthy investment banks who focus on this business. The government wont rebuild the ipo market and bulge-bracket-money center-financial supermarkets who make less than 1% of their revenue on small growth companies (and who are supported by the government) sure as hell wont fix it. Unfortunately, the growth focused IB’s have been running on fumes for 8 years with few IPO’s happening and their share of the underwriting fees slashed by 80% from the level typical in the 80’s and 90’s. Firms like TWP, Cowen and JMP have assembled the proven talent and capital to serve the venture community and rebuild an IPO ecosystem - but being starved for revenue they trade at close to their cash value.
The venture industry is the most well funded and vocal interest group calling calling for an IPO market resurrection. This group has had the power and opportunity (and dare I say responsibility) to facilitate this change by directing the underwriting fees to the IB’s who are committed to providing the services an IPO market needs. Like much of America, the VC community has spent the last 8 years throwing their money at fancy brands instead of more valuable partners.
So let’s agree that this is a complex issue, but that is no excuse for not “shoveling” fees with intelligence.
June 9th, 2009 at 5:02 pm
Gee Randolph….a little bit of vitriol huh…well for sure I am a dumb farm boy, but I lived the moment. All of a sudden you couldn’t talk to an analyst on the elevator anymore without going through compliance first. You bet I blame Spitzer in part for the breakdown of the capital markets. On top of that all you need to do is read the WSJ today for how well his disruption has played out over time.
Look at the facts…almost 64% fewer analysts today covering 71% fewer stocks.
Banking fees fell off of the cliff…
The markets always punish those over time who do not produce lasting quality deals…always works that way. Had he left things alone we would have had a whole new class of banks that would have filled in the gap. The symbiotic relationship between bankers and analysts had proven itself out over decades. Excess certainly occurred but that would have been punished over time if allowed to play out. On the opposite side, same reason H&Q rose to prominence…they produced lasting companies that were good deals.
Bottom line Spitzer destroyed for the sake of destroying,…not for building anything of lasting value. Damn right he cost the capital structure billions of dollars of inefficiency, and that’s a crime HE will bear the judgment for in the coming decades.
June 10th, 2009 at 10:03 am
Your central point that small cap IPOs mean nothing to bulge brackets is well-argued and undeniable in my view. The people at Benchmark Capital, Integral Capital Partners and Impact Venture Partners may even agree with you, too, Chris - in principle. The fact of the matter is, they had one shot at taking OpenTable public, and they were going to do what they felt was best for themselves and their limiteds. In a bad market for IPOs, they did what they felt would get them the best valuation/highest number of buyers… which was use a big, brand name shop.
It’s the Prisoners’ Dilemma. OpenTable’s VCs weren’t willing to take one for the team; frankly, I don’t have the chutzpah to blame them.
June 17th, 2009 at 3:19 pm
Aaron,
I am as big a fan of game theory as the next MBA - but I’m not sure Prisoner’s Dilemma captures the central issue on the poor selection of OpenTable underwriters for a couple of reasons.
VC’s get most of their real return via secondary selling or through follow-on offerings - not at IPO. IPO’s and follow-on offerings for great/big cap companies are easy. However, IPO’s for “pretty good/small-cap” companies are either hard or impossible - depending on market conditions. Follow-on offerings for “pretty good/small-cap” companies are very difficult and are hugely facilitated by demand generation and liquidity support from investment banks. Frequent research, knowledgeable sales, non-deal roadshows, conference slots and active market makers are necessary components of the IPO social network - this is the stuff that provides liquidity for real VC returns.
So who is going to provide the support necessary to let VC’s get liquidity for their “pretty good/small-cap” companies? Morgan Stanley just can’t give a prime conference slot or major sales attention to a company with only a $400M market cap. It doesn’t matter that they lead the IPO. When the going gets tough, the Bulge Bracket gets going.
Any investment bank can sell a Google IPO or follow-on, because they sell themselves. So logically VC’s should direct those “easy” fees to underwriters who will support them in other ways. And for the deals that are less than Google - well VC’s can throw that money to the big boys, but just look who is locked in your “prisoners” cell when it comes time for some real liquidity.
June 23rd, 2009 at 12:00 pm
The real wonder is that OPEN is still in the upper $20s after pricing at $20 up from the initial indicated range of $12-$14.
Hard to fault the VCs for picking and paying for a strong lead horse that could get a marginal story out. If the VCs can cash out in the secondary at anything north of $12, it will have been a winning move in the short run for them and their LPs.
When the markets become more receptive it’ll be easier to throw a bone to the 2nd and 3rd tier firms. Until then it’ll be M&A time.
As to the implicit notion from some of the commentators that the capital markets are self-policing/regulating and there was/is no need for Sarb-Ox, the Spitzers of the world, increased SEC/FINRA oversight, and/or FD, I was hoping that canard had been laid to rest given the events and revelations of the last year or so. I suspect there is no evenet or series of events that will ever dislodge these folks from their position unless and until they’re Madoffed, WorldComed, Enroned, or ZZZZBested. Until one of these affect you directly, it’s all a cost of capitalism rounding error.
There will be movement to adjust Sarb-Ox for small cap companies and everyone will pitch in with hand-wringing rhetoric that Sarb-Ox is “ruining” the market. Personally, I’m happier knowing that the CEO and CFO face jail time for filing false public statements. I suspect that the numbers are tighter and more accurate.
Left to their own devices, investors don’t want a level playing field, they want a competitive advantage through information asymmetry favoring them, insider information. etc. Actually a level playing field is exactly what they don’t want: they just want to be on the better side of the equation.
June 23rd, 2009 at 4:44 pm
JHL,
A couple of thoughts on you comments - to illustrate their absurdity.
If SarbOx is so effective at policing financial statements and leveling the playing field - then how the hell did we get meaningless financial statements out of AIG, BofA, Lehman et al? Forget a small time crook like Madoff - we have had the global economy brought to its knees by meaningless financial statements that were SarbOx compliant. SarbOx has been effective at improving revenues at accounting firms and nothing else.
Perhaps it isn’t the right goal to strive for a world a where every investor has equal understanding of the prospects of a rapidly changing complex emerging businesses - just perhaps. Maybe professionals who dedicate significant resources to understanding these complex IPO stocks will always be better informed.
June 26th, 2009 at 6:02 pm
Chris,
I was thinking your lead-in would be ala Triumph the Insult Dog, but no such luck. I thought you’d expand your comments on all my points, but you focus on a tidbit, so I assume that you agree with everything else. Thanks.
As to your comments on the applicability of Sarb-Ox. It doesn’t cover every situation. If the CEOs and CFOs of the companies you mention had been charged, brought to trial, convicted, and sent to jail, it would have underscored the fraudulent nature of the filings. But there were no actions taken (yet - I’m not sure of the statute of limitation issues) and, that may be, because there wasn’t any actionable offenses committed. Criminally stupid perhaps; feloniously obtuse, probably; positively misunderstood by the companies in question, undoubtedly: but not behavior which was sanctionable. We’ll see about the civil and administrative fall-out, but let’s assume a pass, for now, on fraud.
As to your third paragraph: uh…you need to re-read my comments because you’re proselytizing about something else. At least you aren’t talking about the misunderstood efficacy of capital market self-policing and the theory that a strong market adjusts for insider information.
Maybe comment on the sketchy deals coming to market which require powerhouse firms to get them done. But if it was easy, everyone would be doing it, wouldn’t they?
June 29th, 2009 at 6:54 pm
One of the problems with measuring the efficacy of deterrents is that one is always trying to prove a negative that something prevented something from happening.
I think that initiatives such as FD, Sarb-Ox, increased SEC/FINRA oversight, Spitzers/Cuomos have lessened the incidence of financial fraud among reporting companies. Common sense would lead one to the same conclusion although the compliance “cost” to businesses, some would argue, is not worth the cure.
It’s easy to dismiss Chris’s point about Sarb-Ox not preventing the demise of companies which issued “meaningless financial statements.” Chris fails to appreciate that those financial statements, albeit meaningless, weren’t necessarily fraudulent and actionable under Sarb-Ox. Meaningless does not equal fraudulent. I’m not a securites attorney so I’ll leave it to those folks to correct me. I suspect Chris is not holding out for more regulation of the derivatives markets or to have “meaningful” be the new benchmark for Sarb-Ox compliance.
What Chris ignores is the broader issue about the “need” for a bulge-bracket to get a sketchy deal like Open Table done. Given OPEN’s current price of $30+ and the shaky market conditions when it went out, to say nothing about a shaky story, the “outrageous” fees paid to the top banks appear to have been worth it, although we’ll have to see at what price the insiders get liquid or if there’s enough float for everyone to collar.
July 2nd, 2009 at 4:02 am
I listed a previous company of mine on the London Stock Exchange Alternative Investment Market and it worked for me. Ultimately it was taken private by an American company and we all lived happily ever after.
What struck me from the article above was the fact that the complaint was about fees, lack of support for post-launch road-show and coverage but fails to realize the advantages that such exposure of being only a handful of IPO’s completed this year has.
There is a cost for the expose you get when you are in the WSJ when you compare it to the monthly Idaho Magazine. So going with the Merrills or Barclays of this (ever decreasing) finacial world seems like a great idea to be promoted instead of a smaller house (albeit 100% dedicated) who may not be around to promote the company next year.
At the end of the day SOX is a pain but it is there to deal with, just as the recession is. However as an Entrepreneur these are just obstacles to be overcome. Frankly I would take all offers for an IPO but still early stage. However given the option I would not hesitate to jump at a Merrill IPO over a smaller house every time.
With LogMeIn IPO it shows too that even in a nuclear winter there are still some investors out there looking for great tech stories.