Strategic Financing IPO (Essay Sample)

Should AVG use a traditional IPO or an online auction?
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Introduction
AVG should utilize the traditional IPO allocation method as opposed to online auction because as initially intended, the auction process may not be as efficient in IPO pricing. Evidence from companies that have previously applied online auction including Google Inc. and Morningstar indicates that the strategy fell short of expectations in terms of earnings from the sale of shares as well as the receivership from investors. The fact that online auctions do not undergo thorough scrutiny by investment banks and this limits their credibility among investors who rely on investment banks for information on share prospects. While online auctioning is considered an effective strategy for IPO allocation, it is notable that a company must be willing to take the risk of the uncertainty of the process.
Discussion
Traditional vs. Online auction IPO allocation
The traditional IPO allocation method differs from the auction IPO allocation in that while a leading underwriter determines a price range at which to offer the shares through a process of valuations and contacts with investors, an auction IPO allows potential investors to bid the number of shares desired and the price they are willing to pay before determining the lowest price at which the shares will be sold. The auction method is considered more democratic as it offers equal chances for investors to bid unlike the traditional method where prices are fixed by the underwriters. The method of allocation chosen greatly depends on company objectives and consideration of benefits against risks of each method.
What type of IPO should AVG use?
AVG is likely to attract both individual as well as institutional investors. Each group of customers is profiled differently but AVG must establish an IPO allocation method that will cater for both.
In determining whether to use auction IPO allocation method, it is imperative to revisit experiences from companies that have used the method in the past; in this case Google Inc. and Morningstar.
Investor confidence in the online auction IPOs may have been tainted and risk aversion for online auctions is significantly high. This is a factor that can be attributed to information and outcomes of previous IPOs in companies such as Google and Morningstar. Hensel (2005b) notes that investors may have developed a negative attitude towards online auctions because it is believed that companies that use this method have no clear sense of what to use with the funds being raised and often provide incomplete information to potential investors (Hensel, 2005a). This implies that risk aversion by investors is likely to be high and this would require the company to discount the initial offer price to adjust to low demand.
Online auction IPOs are not subject to scrutiny by investment banks and therefore the information available to the investor is limited. Furthermore, the online process does not obligate the company to disclose much information as in the case of traditional IPO process where sufficient information is required before the offer. Morningstar for example was being investigated by the SEC for inaccuracy of information and this may have created less confidence in auction IPOs. Google was also highly criticized for being ‘secretive’ on how funds from the IPO would be used. This may have contributed to the mispricing of shares to $85 as opposed to the projected $108–$135 range (Hensel, 2005a).
The results of the Google IPO are an indication that the process may not be effective in pricing the IPO as initially thought. There was an enormous increase in post-auction price whereby instead of the $85 offered at its debut, the IPO opened at $100 and soared in the following months reaching a high of $201.06 (Hensel, 2005b). This was despite the fact that there were no news releases to warrant stock price increases. This means that while the online auction method was meant to handle the plummeting of prices that follows an IPO, this may not always occur and online auction is therefore not a solution to this problem.
The online auction IPO allocation can be used to the advantage of the company to raise as much earnings as the market is willing to pay. It provides companies with an opportunity to create instant boon by taking advantage of market demand (Weinberg, 2004). Given the stock ‘pops’ where prices shoot up following IPOs, auctions allow companies to tap the gains instead of ‘leaving money on the table’ as is often described, by setting a price that reflects investors’ ability to pay.
The online auction IPO allocation method can be risky for companies that are not well known to investors or whose image is not highly regarded. This means that if initial demand is not there, a company may find it difficult to set an initial price due to low bid prices or lack of enough bids (Weinberg, 2004). Such companies would therefore miss on the support derived from the traditional IPO allocation.
A company ideally focuses on obtaining shareholders who will retain share ownership and minimize on speculators as this assures commitment to the organization. In using online auctions, the risk is that there is little control on the investor’s buying an...