Unliking the IPO price range hunger games

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HONG KONG (Dow Jones Banking Intelligence) – The Facebook IPO and its confusing messages have, once again, highlighted differences in IPO market practices between the U.S. and the rest of the world. ECM bankers in New York and the Silicon Valley could in fact take some lessons from Asian ways to send clear guidance to investors – and avoid causing IPO bubbles.

Take the price ranges within which institutions place orders to build a book of demand. These are typically only about 15% wide (the recent attempted IPO of Graff Diamonds in Hong Kong – on which little guidance was provided – being a rare exception), to indicate the levels at which the offer price may later be set. Much wider than that would only convey vague pointers. Conversely, a narrower band would not offer accounts enough flexibility to “walk their way up” and secure allocations, should over-subscription at a higher prices warrant it.

Price ranges are typically determined after a period of pre-deal investor education, commonly abbreviated as “PDIE” these days, but previously known as pre-marketing. This is the stage when research analysts and salespeople engage portfolio managers on the key tenets of the investment case and, importantly, obtain feedback from them on where they may pitch valuation.

At least that’s the theory. In the U.S. these days, it seems price ranges are simply used as a device to compile demand – and that these can be adjusted at will and, more often than not, increased, as a deal gathers momentum. This is compounded by the fact that, unlike in other markets, underwriters in the U.S. cannot publish written pre-deal research ahead of an IPO. Investors are therefore, to some extent, kept guessing as to what constitutes an appropriate valuation other than through (not necessarily well-informed) wider “street research”.

[See my column “In defense of pre-deal research”, on 26 July 2011]

The situation is different in Europe, as well as in Asia – one of the most active markets in the world for IPOs over the last few years.

There, price ranges generally better reflect fundamentals, and almost always remain at the same level throughout the marketing phase. Clear guidance is therefore communicated at the outset. A hot deal can get priced at the top end, while a transaction that fails to capture the imagination of investors, or simply exhibits price sensitivity, will be priced at, or towards, the bottom end.

Price ranges in Asia are hardly ever increased in the light of demand. But they can, on occasion, be lowered if enough interest hasn’t been canvassed for a deal to clear.

In the case of quasi-IPOs in Hong Kong of Chinese companies already listed on the mainland, one often sees a narrowing–but not an increase – in the price range, to finally steer investors towards an appropriate discount to the 20-day volume weighted average price (VWAP) of the shares traded in the domestic market – that final discount, typically, does not exceed 10%.

Similarly, in Asia, while an IPO can sometimes be increased in size, this possibility is usually flagged at the outset by way of an upsize option (as distinct from the over-allotment option used to stabilize a new issue) rather than introduced as a new parameter towards the end of bookbuilding.

It’s natural that underwriters – whose fees are, after all, expressed as a percentage of the IPO proceeds – and issuers should consider this if the quality of demand and the shape of the book can justify it. However, taking investors hostage by flagging it at a late stage only smacks of greed and short-term interest.

Lastly, while the Asian practice – surprisingly pretty much unknown elsewhere – of pre-covering part of a transaction ahead of launch through the securing of cornerstone investors can put pressure on allocations for the hoi polloi in a hot deal, it also sends an unambiguous message to all that an IPO has the early backing of major players.

In the U.S., the long-guessing hunger game on valuation and demand – evolved in part from a restrictive regulatory regime – could ultimately end up doing more harm than good.

(Philippe Espinasse worked as an investment banker in the U.S., Europe and Asia for more than 19 years and now writes and works as an independent consultant in Hong Kong. Visit his website at Readers should be aware that Philippe may own securities related to companies he writes about, may act as a consultant to companies he mentions and may know individuals cited in his articles. To comment on this column, please email [email protected]).

[This article was originally published on Dow Jones Banking Intelligence on 9 June 2012 and is reproduced with permission.]