Direct Listings and Board Track Record Bias

Cost of Direct Listings May Be a Lower Valuation (The Information, 2020-10-21)

Common Assumptions

  • IPO underwriters are very greedy and cost the company and early shareholders a lot of money.

  • Shares at IPO are undervalued (to satisfy the demand) and thus existing shareholders (who are locked in for 6-12 months) are losing on the “pop”. There’s no discount for direct listed shares.

Is It Really So?

  • Probably not, as the companies that went the traditional IPO route had valuation multiples higher than the direct listing ones. We’re talking the average 6.6x revenue multiple for Sep 2020 IPOs vs 18-33x for the underwritten companies.

  • Investment banks put much more effort into marketing the IPO, build/exploit relationships and make the company sellable. The company that chose the direct listing route is unlikely to have these presentation skills (which are very unique).

  • Equity analysts also put way more effort into covering the traditional company.

  • There’s an opinion than held well until recently (when, it looks like, you can actually raise primary capital in direct listings): a direct listing is nothing more than a public secondary offering with all its downsides (an investor who wants to get out gets less than the round price due to the large block size).

Trading Volumes and Liquidity

  • An IPO is a burden if there’s no liquidity (i.e. the shares don’t change hands and one can’t freely sell their shares).

  • In traditional IPO ~12% of the company’s outstanding shares trade on the first day; it’s closer to 20% in direct listing. And the volatility is lower in direct listing.

  • But “price discovery” (i.e. finding what’s the “fair price” for the stock) in traditional IPOs happens 1-6 weeks prior to the event; it’s after the event for direct listings. So getting to the “fair” share price will take longer (we’re talking 12mo+) than in traditional IPOs (6-8mo+).

  • Direct listing, though, allows buyers to get the needed number of shares without being constrained by the block allocations by underwriters (in traditional IPOs one usually doesn’t get as many shares as they ask for, and it’s a ballroom dance experience to get around other contenders).

  • A big “pop” may not be too good for employees, as their stock options should have a predictable, but not insane, trajectory.

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The board directors’ track record bias (INSEAD blog, 2020-10-20)

  • Observation: of more than 600 Directors of 20 largest banks 73 had experience in emitting companies and only a handful – in sustainable / renewable companies.

  • Board expertise and prior affiliations of Directors correlate very well with the level of investment into “emitting” or “renewable” energy companies.

  • So many “emitters” are given the task of promoting “renewables”. Hm… what could go wrong here?

  • This leads to the “track record bias” arising from successful past experiences with the then dominant business models – all in good faith! When it comes to, say, the Paris Climate Agreement, these successful Directors (CEOs and ex-CEOs) may not be up to date with the requirements and obligations.

  • The lack of Board thought diversity may lead to undue influence (maybe even subconscious) of the experienced Directors thinking alike on the evolving matters requiring constant challenges.

  • [MK: As Boards tend to attract people past the age of 45, these candidates increasingly become more set and invested in their tried ways of doing business and thus have to be offered help and guidance from proactive knowledgeable staff – and streamline the path to learning.]

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