TWITTER- TRADITIONAL IPO OR ONLINE AUCTION

Twitter- Traditional IPO or Online Auction An initial public offering (IPO) is when a company wants to offer its privately held stock to the general public to raise capital for operations and growth. There are two types of IPOs, traditional and auction based. The traditional IPO is much more common, however auction based IPOs are gaining some favor. In 2004, Google Inc. launched its massive and widely publicized IPO via a Dutch auction and in the aftermath of the IPO, Googles stock nearly tripled in price. This publicity led to Morningstar Inc. using a modified Dutch auction method in 2005. One of the most significant benefits of using the auction based IPO is that it is small investor friendly and designed to minimize the increase between the offer price and the deals opening price, which means more profits for the company as opposed to large, commercial investors (Windham, 2005). Twitter Inc. could very well be the perfect candidate for an auction based IPO. Twitter is a social networking site which provides a micro blogging service that lets users post updates, or tweets, of up to 140 characters (Womack and Valerio, 2010). The purpose of this paper is to establish a clear argument in favor of Twitter using an online auction based IPO. Traditional IPO

TWITTER- TRADITIONAL IPO OR ONLINE AUCTION In a traditional IPO, a company hires an investment bank to underwrite the IPO. The company and the investment bank determine the likely market value of the company and based on that market value and the amount of capital the company wants to raise in the IPO, the

number of shares to be offered and the price per share of the offering is established. This price is usually discounted from what the company and investment bank estimate the true market value will be. After the number of shares and share price of the IPO are determined, the company and the investment bank conduct a road show, in which they present the offering to large investors, who will commit to buying a number of shares at the offered price. After the road show tour is complete, shares will be allocated and investors will not necessarily be allocated all the shares they committed to buy. The investment bank collects a percentage of the IPO sale as commission, in addition to other fees charged to underwrite the IPO. These investors can then start trading the stock on the first open trading day (Clinton, 2011). The most significant advantage of using the traditional IPO method is that it is an established and credible process. Large institutional investors have better access to the information necessary to price shares appropriately and they rigorously scrutinize the company and its use of funds to be raised to determine the quality of the investment. The disadvantages of using the traditional method are that it favors large investors and basically shuts out the small guy. Public confidence in the traditional methods is low and this is exacerbated by the significant difference in the IPOs offer price and its open price which benefits the investor while shortchanging the company (Hensel, 2005). Auction Based IPO

TWITTER- TRADITIONAL IPO OR ONLINE AUCTION Auction-based IPOs are similar to traditional IPOs in that they still need an investment bank to underwrite the IPO, but the costs are usually much lower. A road show may still be part of the process to educate large investors about the company however there is no share allocation as there is in a traditional IPO and instead the Internet is used to open the purchase of IPO stock to a larger set of potential investors. Companies will determine how many shares they are offering, as well as a reserve price and when bidding opens, investors will enter a bid for the price and number of shares they want to buy. A Dutch auction format is often used where the

company sets a price well above what any investor is expected to bid, and then reduces the price incrementally every time someone bids. The bidder is sold the number of shares he or she bids, and then the price is lowered again incrementally, until all of the shares offered have been sold. All bidders pay the price bid by the final bidder (Clinton, 2010). The advantages of an auction based IPO are the lower fees associated with the process; the IPO is more likely to end with a share price closer to market value- which means that the company profits and not large institutional investors; and it allows many more people to participate, instead of limiting the opportunity to a few large investors (Clinton, 2010). There are definitely disadvantages to the auction based IPO and the first is that it is an uncommon practice and therefore draws skepticism from potential investors. As Hensel points out, it gives the perception on the part of the investors (which may or may not be true) that the process is used by firms which would be unsuccessful using the traditional route (2005). Another disadvantage is that smaller investors, which are primary in this method, may lack access to enough information to accurately price the stock based on fundamentals rather than name recognition. In addition, if the company overestimated its value, there is also increased risk that it will raise less capital than expected (Clinton, 2010).

TWITTER- TRADITIONAL IPO OR ONLINE AUCTION Twitter An auction based IPO for Twitter could be a great match. Twitter has become a global brand and is quickly becoming one of the fastest growing brands in the history of the world

according to Twitters Chief Operating Officer Dick Costolo (Womack and Valerio, 2010). This kind of publicity and name recognition would garner tremendous interest from small and large investors alike. After Googles IPO, it has been proven that an auction based IPO can be successful especially with a well-known company, like Twitter. A Twitter IPO is likely to draw large institutional investors, technology investment firms, and also small investors who would normally be shut out of a traditional IPO. While there was definitely some mispricing involved in the Google IPO, it is an issue that can be avoided with future auction based IPOs. Mispricing occurs for several reasons, the lack of information available to the small investor, less rigorous scrutiny by investment banks, and cautiousness on the part of investors over the online auction process in general. These issues can be overcome by Twitter providing explicit information on the uses of the capital being raised, its corporate governance, solutions it has for dealing with potential challenges, the reasons why they are using the online process as opposed to the traditional IPO, and their involvement in any current or future litigation (Hensel, 2005). Conclusion By using the online auction IPO, Twitter would increase the ability of small investors to participate in its IPO and would minimize the dominance of larger institutional investors which are favored clients of the underwriters. If Twitter discloses detailed information to potential investors, large and small, as previously outlined it decreases the likelihood that mispricing will

TWITTER- TRADITIONAL IPO OR ONLINE AUCTION occur and leave money on the table for investors instead of the company. Twitter could realize huge profits from its IPO and be the model for future auction based IPOs. Hensel (2005) explains, As involvement of investors and issuers broadens, the online process will become a

more egalitarian and transparent alternative to traditional processes for providing new companies with capital.

References Clinton, L. (2011). Traditional IPO vs. Auction Based IPO. Essortment.com. Retrieved August 24, 2011 from http://www.essortment.com/traditional-ipo-vs-auction-based-ipo24886.html. Hensel, N. (2005, April 11). Are Dutch Auctions Right for Your IPO? HBS Working Knowledge. Retrieved August 24, 2011 from http://hbswk.hbs.edu/archive/4747.html. Windham, C. (2005, July 11). Dutch Auction IPOs Could Lure More Takers: Attraction Grows as Google Hits $300 a Share. The Investment Dealers' Digest: IDD, 13-14. Retrieved August 25, 2011, from ABI/INFORM Global. (Document ID: 865443511). Womack, B. & Valerio, C. (2010, January 20). Twitter Operating Chief Says IPO Is Still Way Out (Update1). Bloomberg.com. Retrieved August 24, 2011 from http://www.bloomberg.com/apps/news?pid=newsarchive&sid=afhiY_eWZq8M

TWITTER- TRADITIONAL IPO OR ONLINE AUCTION

TWITTER- TRADITIONAL IPO OR ONLINE AUCTION