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IPO market in flux as alternatives gain ground

Gone are the days when the tried-and-true initial public offering was the only route to the public markets.

Thanks to the direct listing, the blank-check company merger and the auction, private companies across corporate America have a variety of new or recently revamped alternatives to the IPO when deciding how to enter the U.S. equity markets.

"The beauty of 2020, from an IPO perspective, is that companies now know they have a lot of options," said Lise Buyer, partner and founder of IPO consultancy Class V Group, in an interview. "There's no blanket answer. Different companies are optimizing for different things, and no one other than the company itself can make that determination."

Of the 406 companies that debuted on a major U.S. stock exchange this year, more than half were special purpose acquisition companies, or SPACs, according to S&P Global Market Intelligence data. These blank-check companies conduct IPOs as skeleton organizations with only a management team and a plan to target and acquire a private company. Eventually, if all goes to plan, the SPAC's target takes over the listing and becomes publicly traded. But while some of the year's most notable public debuts, including DraftKings Inc., Fisker Inc. and Nikola Corp., went public through a SPAC merger in 2020, the direct listing and the auction offering have gained ground as viable alternatives as well. Palantir Technologies Inc. and Asana Inc. conducted direct listings on the same day in September. And at least three companies — Unity Software Inc., Airbnb Inc. and DoorDash Inc. — used an auction-style IPO not unlike Google's famous Dutch auction in 2004.

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For Buyer, previously an institutional investor with T. Rowe Price Group Inc., investment banker with Credit Suisse Group AG and venture capitalist, it has been clear for the better part of two decades that the IPO's stranglehold on how companies go public in the U.S. needed to be loosened. Buyer was on the team that helped construct Google's Dutch auction in 2004, when the company's founders Sergey Brin and Larry Page wrote that using the search giant's auction-based advertising system as a model could find "an efficient market price" and lower the barriers around who could own the stock and when.

While the Dutch auction never caught on in a way experts believed it could, Google's offering marked one of the most recognizable examples of a company detouring from the traditional IPO.

Now, venture capitalists, investment bankers, stock exchanges and others across Silicon Valley and Wall Street are picking up where Google left off by developing a mix of options for companies to consider when going public.

"I would expect there to be continued innovation," said Buyer, who recently advised Unity Software on its IPO. "We're not done."

Direct listings still rare

One of the biggest companies to enter the public markets through means other than a traditional IPO since Google was Spotify Technology SA in 2018.

The Swedish music streaming company, with the help of Wall Street bankers and the New York Stock Exchange, pioneered the direct listing as a way to list its shares overnight on a chosen day and sidestep many of the formalities of an IPO, including a roadshow, underwriters and a lock-up period. Proponents such as Benchmark's Bill Gurley have since championed the direct listing as a way to avoid a critique that early-round investors sometimes level at investment banks: that they underprice a company's shares so their institutional investor clients can profit from a stock's first-day pop.

Direct listings remain unusual in the U.S. Just five entities, including Spotify, have taken that route, in large part because companies going public via a direct listing have not been able to generate proceeds by selling shares. The publicly floated stock instead comes from existing investors, whether venture capitalists that got in early or former employees. Intercontinental Exchange Inc.-owned NYSE recently received SEC approval for a new take on the direct listing that would allow companies to also raise capital in the process, a tweak that exchange executives have said will widen the appeal of the IPO alternative. However, a potential issue with direct listings is that executives have a lack of control over what price their stock trades at or who their investors are, and the addition of a capital raise could exacerbate those concerns. Buyer said she would "question the thoughtfulness of a management team that would choose" the route of a direct listing with a capital raise.

Still, the direct listing has helped usher in an awakening of sorts for investors, who had for years resisted changes to the IPO model. Today, investors are much more willing to explore adjustments such as modified lock-up structures and different order-intake methods, according to Kristin DeClark, co-head of U.S. equity capital markets and global head of technology equity capital markets at Barclays PLC.

"I have seen more openness to innovation from the buy side in the structures of the IPO than I have in my entire career over the last six months," said DeClark, who has been in investment banking for 20 years, in an interview.

The blank-check year

But the greatest shift in the current IPO market has been the reemergence of SPACs.

Led by a new class of high-profile sponsors, SPACs, once a last resort for companies needing to access liquidity, have stormed into the equity markets in 2020 as another way for executives to take their companies public that provides more certainty than the IPO — something that became much more attractive after volatility ripped through the market in March and April.

"You get to figure out everything up front before you sign the papers and before you even have to tell anyone you've begun your process," said Bill Ackman, chairman and CEO of the largest SPAC of 2020, Pershing Square Tontine Holdings Ltd., in a September interview on Bloomberg TV. "Certainty and a $5 billion injection of cash is something I wouldn't walk away so quickly from. If I were the CEO of a private company that needed to raise a lot of cash to go public and had to do it in a reasonable time frame, I would take a very hard look at what we offer."

As of Dec. 18, there were a total of 218 SPACs that went public in the U.S., raising $74.49 billion in the process, according to S&P Global Market Intelligence data.

Pershing Square Tontine, which raised $4 billion in its July IPO, has reportedly had conversations with several high-profile private companies about a merger, including Airbnb. The home-rental company eventually opted to go public through a regular offering, but it was not a vanilla IPO.

Auctions and "euphoria"

Along with Unity Software and DoorDash, Airbnb went public in 2020 using an auction-style IPO where investors disclosed ahead of time how much stock they wanted and for what price. The model then allowed the companies to assemble a demand curve that ultimately provided them with more power when negotiating their stocks' opening prices with the underwriters in hopes of minimizing the amount of money being "left on the table," according to University of Florida finance professor Jay Ritter, who tracks IPOs.

But despite their intention of more closely matching a debut stock's price with investors' appetite for it, auction IPOs this year saw particularly high first-day price pops. And some market observers are beginning to caution that the demand for new stocks is running too hot, regardless of how those stocks get to market.

Unity's stock jumped about 30% on the day of its debut. DoorDash saw a more than 80% pop on Dec. 9 when it began trading, while Airbnb shares rose by more than 100% on its first day. Part of the reason why both Airbnb and DoorDash saw such big pops was from the increased role that retail investors are playing in the U.S. equity markets today. Goldman Sachs Chairman and CEO David Solomon and Securities and Exchange Commission Chairman Jay Clayton both referred to those price spikes as "euphoria" among individual investors in separate interviews on CNBC the week of Dec. 14.

Ritter said he was not concerned about valuations being too high in the U.S. equity markets for most of 2020, but his view has changed with recent IPOs generating such staggering first-day returns.

The average proceeds-weighted return of a company on its first day of trading in 2020 has been 48.8%, and at the height of the dot-com bubble in 2000, the average proceeds-weighted return for first-day trading was 45.8%, Ritter said.

"The last 14 IPOs at [Dec. 11's] close were up an average of over 100%. I had thought in early fall, when we were seeing the very high returns, that it was a temporary thing, that things would settle down," Ritter said in an interview. "But they haven't settled down. They've gotten more extreme lately."