Why firms want direct listings and SPACs instead of IPOs —

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A funny side effect of the boom in US stocks is that a growing number of executives are considering whether to sidestep the traditional IPO.

There are several reasons for this, ranging from regulatory changes to old hangups about investment-banking fees. But the main reason, says University of Florida professor Jay Ritter, is that public offerings have left a lot of money on the table lately.

So far this year, listings have jumped by an average of about 40% on the first day of trading, according to Ritter’s data. That’s the highest average of any year since the dot-com bubble two decades ago.

That opening pop signals that some deals were underpriced. Given the pandemonium the coronavirus pandemic caused early on, pricing conservatively may have been understandable a few months ago. But the stock market has been on fire lately, with the S&P 500 index of large US companies trading at multiple record highs in recent months.

With tech shares so perky, and with so much money being left on the table, Ritter says that’s driving executives to consider other ways of going public—like the direct stock listing planned by Palantir, the data-mining firm backed by Peter Thiel.

The direct listing bandwagon

In a regular IPO, bankers go on a roadshow with company executives, meeting with investors in different cities to drum up interest in the deal. At the end of the process, bankers set the initial offering price for the shares. They typically set the price a little below what the market will bear. If everything works as hoped, this ensures the shares jump on the first day of trading, handing the banks’ investor customers a quick return. That’s nice for banks and their institutional investor clients (who have taken some risk by buying shares in the IPO), but the money comes out of the pocket of the issuing company’s founders and other early investors.

Direct listings are an attractive alternative for some issuers. There’s no roadshow, the fees are lower, and the offering price gets set on an exchange, not by investment bankers. Spotify, the streaming music service, pioneered direct listings in 2018, and messaging service Slack followed in 2019, with Goldman Sachs playing a key role in both deals. Despite the buzz around this kind of fundraising, there hasn’t been a direct listing in more than a year—but that’s likely to change soon. In addition to Palantir, the corporate-software maker Asana is planning a direct listing, and plans to join Spotify and Slack on the New York Stock Exchange.

Until recently, US regulators didn’t allow companies to raise fresh capital through a direct listing—the main purpose was to let existing investors sell their shares. But in August, the Securities and Exchange Commission gave the New York Stock Exchange the go-ahead to let companies list directly and issue new shares at the same time. The Nasdaq exchange is working on a similar type of listing.

This week, however, the SEC paused the new permissions given to the NYSE after the Council of Institutional Investors urged the regulator to reconsider, according to a Wall Street Journal report (paywall). Investors represented by the lobbying group may be concerned that the NYSE plan for listings would make trading more volatile, or, thanks to a legal difference in how shares are registered, would be used to avoid shareholder lawsuits. The SEC said on Aug. 31 that it was staying its rule change after receiving notice of a planned petition.

SPAC in action

“Blank check” companies are another alternative to traditional IPOs. These deals—technically known as special purpose acquisition companies, or SPACs—kind of work in reverse. A SPAC raises money through an IPO and then goes out and finds an acquisition target. Similar to a direct listing, a SPAC doesn’t have a roadshow.

SPACs used to comprise a relatively small piece of the market, with a questionable reputation. After a spate of frauds in previous decades, SPACs are suddenly much more popular. More than 70 SPAC offerings, a record, have taken place this year, according to Ritter’s data. Oakland A’s executive Billy Beane and Bill Ackman, the billionaire who runs hedge fund Pershing Square, are among those to have gotten in on the action.

With SPACs, people who invest can typically get their money back if they don’t like the acquisition target that gets picked, or if the SPAC doesn’t find anything to buy. Promoters usually keep 20% of the equity that gets raised—a massive chunk of investor money. But the blank-check company formed by Ackman says it won’t do this; Ackman argues that his SPAC is better aligned with investor interests than its predecessors.

The queue of billion-dollar tech unicorns waiting to go public could provide a rich field of targets for these black-check companies to acquire.

“A lot of those SPACs are going to be doing mergers with companies that otherwise would have gone public in a more traditional manner,” Ritter tells . While blank-check companies have a reputation of being quicker, and of having a lighter regulatory touch than traditional listings, Ritter points out that all public companies have the same reporting requirements, regardless of how they get there.

As for the blank-check companies themselves, it remains to be seen whether the renaissance will improve their reputation, or if the surge is just a sign that investors are getting carried away in a red-hot stock market.

Will any of these new maneuvers make the traditional IPO obsolete?

Despite the interest in alternatives, experts think old-school IPOs will remain a core part of the financial markets, as direct listings remain better suited to large, well-known companies that don’t need as much support from a Wall Street bank.

“There’s going to be a lot of options,” Will Connolly, a banker in capital markets at Goldman Sachs, said last year in a podcast hosted by the investment bank. “There’s no cookie-cutter approach that should be employed for every company.”

Ritter, meanwhile, thinks the interest in direct listings and SPACs is mainly born out of dissatisfaction with the expense of doing things the old way. “I view it as a response to the greed of investment bankers,” Ritter said.  Wall Street financiers have been “leaving too much money on the table.”

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