Picking the Players: Selection of Underwriters and Advisors

Chapter 2—Picking the Players: Selection of Underwriters and Advisors

An initial public offering requires close collaboration with the underwriters, legal counsel and auditors. Knowing the roles that the underwriters and advisors play and the right questions to ask them will help in choosing the right IPO team.

Top Questions to Ask When Selecting Underwriters

After company management, the underwriters will play the most critical role in theIPO—managing the marketing and sale of the company’s stock to public investors. An IPO typically has one but sometimes two lead underwriters. The lead underwriter or the com- pany may select one or more additional underwriters to co-manage the offering, depending on its size and complexity. The lead underwriter has primary responsibility for and control over the underwriting of the offering, including providing comment on the offering pro- spectus, running the road show, agreeing with the company on the price per share for the IPO, determining the number of shares that co-managers may sell in the IPO and control- ling the allocation of shares among purchasers in the IPO.

Peek at the Process

“Know What You Need to Know”: Factors to Consider in Underwriter Selection

Primary factors to consider when choosing the underwriter are:

•Track record. Has the underwriter led other recent, successful IPOs of companies similar in size, stage of development and industry? Has the underwriter recently begun IPO processes for companies that were not completed? Why?

•Reputation and experience. Does the underwriter enjoy a strong reputation with investors? Does its experience in the company’s industry enable the underwriter to provide special insights and quality advice and research? Does the underwriter have strong, sustained relationships with investors active in the company’s indus- try?

•Commitment to the company. Aside from reputation and experience, will the un- derwriter make the company’s offering a priority? What are the offering schedules of other, possibly larger or more valuable, offerings the underwriter is working on?

•Aftermarket support. Life as a public company only begins with the IPO. How has the stock price of other companies the underwriter has taken public per- formed in the months and quarters after the IPO? Is the underwriter willing to make a market or use its own capital after the initial offering distribution to support trading in the company’s stock? Will the underwriter continue to provide advice, introduce the company to potential investors and help interest other ana- lysts in covering the company?

•Analyst coverage. While the underwriter is not allowed to promise analyst cover- age while securing work on an IPO, does the underwriter have prominent analysts that cover the industry and similarly situated companies? How likely are those analysts to cover the company?

7

8 THE INITIAL PUBLIC OFFERING HANDBOOK

Peek at the Process

“Know What You Need to Know”:

Factors to Consider in Underwriter Selection (cont’d)

•Distribution strength. Can the underwriter build a strong syndicate? Does the underwriter have strong distribution capabilities with retail (individual) investors and institutional investors? How effective is its retail sales force and its institution- al sales force? Is the underwriter’s reach regional (e.g., only one coast), national or international?

The choice of underwriting firm is important, but perhaps just as important is the team that will actually work on the IPO. Getting the underwriter’s “A” team, and a team that is motivated about the particular IPO, will increase the likelihood of a smooth, orderly and professional offering and a positive reception from investors on the road show.

The underwriter will spend considerable time analyzing how to “position” the com- pany with investors to achieve a successful offering. This marketing task involves more art than science. However, the company should engage in a dialogue with potential un- derwriter candidates to gauge how well the underwriters understand the company and its industry, and the factors that investors will focus on in deciding whether to invest in the shares at the offered price. For example, discuss with a potential underwriter which companies the underwriter believes are the company’s “comparables.” The discussion will help the company understand the sophistication of the underwriter’s knowledge about the industry and the competition, as well as how keenly it grasps the unique value proposition the company offers the market. Other areas to probe with a potential underwriter include how would the company’s stock pricing compare to the “comparables,” what other recent offerings have occurred in the company’s industry group, what factors drive the pricing of stocks in the industry, and to what extent will pricing of the company’s stock depend on historical earnings, future earnings projections or revenue trends.

The company should seek a potential underwriter’s view of the company’s valuation and related offering price range for the IPO. The analytical rigor and persuasiveness of the underwriter’s response will help the company assess whether the company valuation prof- fered by the potential underwriter when pitching for the IPO work is likely to hold up dur- ing the IPO, or erode after the company becomes well engaged with the underwriter during the IPO process or worse, when the company is on its road show with potential investors. A company should also take with a grain of salt what it perceives as an overly-optimistic valuation offered by a potential underwriter, however flattering. Remember that once the company has publicly filed for the offering there may be pressure to complete the IPO, even if the company valuation slips to a more realistic level, rather than face the unfulfilled expectations and questions that can follow an abandoned IPO.

PICKING THE PLAYERS 9

Practical Tips

“Let Me Ask You This”:

Key Questions to Ask Potential Underwriters

•How have the underwriter’s previous IPOs performed historically? How often does the underwriter price the IPO within the filing range? In general? In the industry? If not, what were the reasons?

•What other firms would the underwriter anticipate adding to the syndicate? Will the underwriter allow co-managers in the syndicate? What does the underwriter think are the advantages and disadvantages of a co-manager?

•What does the underwriter recommend as to the IPO’s timing? Is one part of the year, or one part of the business cycle, better than another? How sensitive will the offering be to a drop in the stock market from current levels? How positive does the company’s earnings trend need to be in order to make the IPO desirable? What financial statements need to be included in the IPO prospectus?

•What would the underwriter recommend for the offering’s size? What should be the minimum number of shares offered in the IPO? Will the underwriter support allowing stockholders to sell shares (so-called “secondary” shares) in the IPO?

•Will any recent hiring of key officers and their lack of track record with the com- pany affect the timing or pricing of the offering? Which officers do the underwrit- ers expect to be involved in the offering process?

•What are the underwriter’s views on whether to list on Nasdaq, NYSE or AMEX?

•What is the expected underwriting discount? Confirm that the underwriters will bear their own expenses (except for blue sky law legal fees) as part of the un- derwriting discount. Will the underwriter accept suggestions for underwriter’s counsel?

•Does the underwriter suggest marketing the offering to retail (individual) inves- tors, institutional investors or both? Institutional investors may be less likely to hold shares as long as retail customers. Retail purchasers can stabilize the

aftermarket of a stock because they tend to hold stock for longer periods of time. However, institutional investors may understand a complex company or technol- ogy more readily than retail investors.

•What is the underwriter’s view of the time commitment and cities involved in the road show? Can the underwriter accommodate management’s schedule and time demands?

•Will the underwriter be able to grow with the company after the IPO by handling financings and M&A once the company is public? If the company needs addition- al capital, would the underwriter support a follow-on offering after the IPO?

A Note About Analyst Coverage

Reforms in the early 2000s sought to address potential conflicts of interest by chang- ing the role a research analyst can play in certain investment banking activities. As a re- sult, underwriters cannot guarantee research coverage to a prospective IPO candidate. The regulations also limit a research analyst’s involvement in an IPO (for example, research analysts cannot attend road shows) and restrict the timing of when research reports can

10 THE INITIAL PUBLIC OFFERING HANDBOOK

be published in conjunction with an IPO. Despite the change in regulations, it is still im- portant to determine whether an underwriter has respected analysts with expertise in the company’s industry. If the investment bank’s research analyst in the industry has a high stature, it reflects well on the investment bank’s decision to underwrite a company’s IPO, and investors will gain confidence from the fact that the company could receive expert, sophisticated analyst coverage after the offering.

The Statistics

“Lonely at the Top”: Lead Underwriters in IPOs

Each IPO has one, and many times two, “lead” underwriters, even if ultimately a number of underwriters participate in the syndication of the offering. The company’s pri- mary contacts in the marketing effort are the lead underwriters, who provide input on the prospectus, identify and help the company resolve marketing concerns, and organize the company’s road show. In 2007, 61 firms led or co-led an IPO. However, there is a reason “bulge bracket” investment banks make that bracket bulge: the top 10 firms led the vast majority of offerings; 24 firms led or co-led only one IPO.

Lead Underwriter* Number of IPOs Percent of IPOs
     
Merrill Lynch 49 17.40%
Morgan Stanley 49 17.40%
Lehman Brothers 41 14.50%
Citi 40 14.20%
Credit Suisse 36 12.80%
Goldman Sachs 36 12.80%
JPMorgan 32 11.30%
UBS Investment Bank 31 11.00%
Deutsche Bank Securities 23 8.20%
Banc of America Securities 15 5.30%

Source: http://www.IPOVitalSigns.com, © 2008 CCH, a Wolters Kluwer Company. Used by permission.

*If there is more than one lead underwriter, each will have an IPO listed

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