ill Hambrecht discusses how initial public offerings have, and have not, changed over the years and what WR Hambrecht + Co is doing to bring IPOs into the 21st century.

WR Hambrecht + Co OpenIPO^® auction process is leveling the playing field among investors, issuers and the investment banks and has been called one of the few disruptive innovations in modern finance.

In addition to WR Hambrecht + Co, Bill co-manages Hambrecht Ventures I focused on disruptive technologies.

If you would like more information on this series of conversations with Bill, contact Peter Morrissey at 415-551-8613.

That's a great question because the evolution of the IPO is a paradox: what investment bankers do during an IPO has dramatically changed, but the structure of the offering process is the same as forty years ago. The problem is that the structure has fallen far behind how the world really operates today.

The best way for me to illustrate that is with an example.  In 1906, when Goldman Sachs and Lehman Brothers underwrote the Sears, Roebuck IPO, it took them three months to complete the distribution.  Back then it took much longer for information to be distributed out to regional broker dealers and then to their clients and for orders and payment to make their way back to the underwriter.  It was in this context that the firm commitment underwriting was developed.  The underwriters would buy the stock from the issuer first and then take the risk that they could resell the shares to their clients over several months.

The process that took three months in 1906 now takes only three minutes. In a firm commitment underwriting today the underwriter only holds the shares for a few minutes while distributing them to clients who have effectively pre-ordered the shares before the underwriter purchased them from the issuer.

No! I am not saying that.  It would be foolish to make underwriters take risks that they can now mitigate with speed and technology. But underwriters are still getting paid like it is the old days

When you think about it underwriters are in the communications business and the risk taking business: they allow buyers and sellers to connect and they take the risk that one side or the other will not deliver. Well, the cost of communications has been in a free fall for the last ten years and the underwriters no longer take on as much risk as they did in the old days because the distribution of the shares is so much faster. That sounds like a recipe for lower costs and lower prices, but it hasn’t happened yet.

For a couple of reasons. First, underwriters started to bundle additional services in order to protect their margins. Sell-side research departments expanded subsidized by investment banking fees. Second, investment banking became a "Tiffany's" type of sale, where companies wanted to hire the best brand name

they could regardless of the cost.  The cynical explanation would be that CEOs and CFOs wanted to be able to brag that a high prestige underwriter took them out, and their shareholders picked up the bill.  But it also, I think, had to do with the rapid expansion of equity issuance driven by the same technology that lowered costs for the underwriters.
In the 1940s, 50s and 60s the New York Stock Exchange listed about a thousand companies. After the launch of NASDAQ in the early 1970s the number of public companies increased so that we now have about 6,000 listings between the NYSE and NASDAQ. That rapid expansion of business effectively lowered the competitive pressures on underwriters: new underwriters like Hambrecht & Quist focused on floating companies on the NASDAQ and didn’t use lower pricing to try to win business from the old guard.

In situations like Apple Computer, a technology company, but one that any underwriter would push to take public, there would be one underwriter from each camp. Apple was taken public by Morgan Stanley and Hambrecht & Quist.

We are starting to see the IPO process change to take advantage of the new technologies, just as the trading business already has. The road show has changed from a series of lunchtime presentations introducing a company to potential investors into a series of Q&As with portfolio managers who have already done substantial due diligence on the offering. More and more of that process will move online resulting in better information flow at a lower cost.

As part of the evolution IPO costs are starting to be unbundled: the SEC has already required that research be completely separate from the underwriting process. Here at WR Hambrecht + Co we are allowing our customers to choose whether they want to pay more for a firm commitment underwriting where we take on some placement risk, or to pursue a lower cost agency transaction. We have also unbundled the co-manager fees from our own underwriting fee allowing issuers to accurately assess the costs of having additional investment banks working on their deal.

Finally, we expect the information technology revolution to encourage more companies to go public.  Lower underwriting fees and lower IPO discounts using auction-based underwriting will reduce issuance costs and will make the public markets even more attractive to companies and their investors. In the future we expect that the proliferation of software standards like XBRL will reduce the costs of both preparing and analyzing public filings.