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In Snowflake's Wake, Unity Preps a Unique Debut

By Evan Niu, CFA – Sep 16, 2020 at 5:45PM

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The IPO market is hot and Unity wants to maximize its proceeds.

"No, higher," Elon Musk told investment bankers ahead of Tesla's (TSLA -0.28%) IPO in 2010, balking at the $15 offering price that they recommended. Most company executives defer to the bankers that they've hired when it comes to valuation matters, but Musk needed as much capital as possible to fund the electric-car maker's burgeoning operations. The eccentric billionaire insisted on an offering price of $17, threatening to call off the deal unless he got his way -- and won.

The anecdote illustrates the opposing forces at play in traditional IPOs, where companies want higher prices in order to maximize the deal's proceeds but investment bankers prefer to engineer a pop on the first day to reward the (predominantly institutional) investors that buy in. It's a delicate balance, one that has only grown more contentious over time, which is in part why many companies have been increasingly exploring alternative paths to the public markets in recent years, such as direct listings or special-purpose acquisition companies (SPACs).

Wooden blocks spelling IPO with a jar of coins and paper currency in the background

The traditional IPO process has come under fire in recent years. Image source: Getty Images.

In the wake of Snowflake's (SNOW -1.59%) huge splash in the public markets today -- with shares more than doubling from the offering price of $120 -- Unity Software is preparing its own debut at an opportune time. Investors can't get enough of hot tech IPOs, making it a rather favorable environment to go public. But this won't be just like any other IPO; Unity CEO John Riccitiello is borrowing a page out of Musk's playbook.

Greater influence over the offering price

Unity updated its prospectus today with a new pricing range, expecting the deal to price at $44 to $48 per share, up from the previous estimated range of $34 to $42. That would put the game-engine maker's valuation at $11.6 billion to $12.6 billion, based on the 263.4 million shares that will be outstanding after the offering.

Here's the kicker: Riccitiello and his team have secured greater control over how the deal prices and Unity will also have more say over which investors receive shares, according to CNBC and The Financial Times. Unity and its underwriters will reportedly try a novel bidding system where institutional investors submit indications of interest (IOI) that specify how many shares they are interested in purchasing and at what price, and the prospective investors can submit numerous bids at various prices.

Man looking at his smartphone and smiling

Unity makes the most popular mobile game engine. Image source: Getty Images.

Based on those bids, Unity will then pick the offering price and all investors who submitted bids above that price would be allocated shares in the primary market, according to FT. Additionally, Unity will have some influence on how those allocations are distributed to investors. The updated prospectus filed today does not mention this bidding process at all.

Alphabet subsidiary Google used a similar modified Dutch auction process when it went public in 2004.

A smaller pop?

The traditional IPO process is shrouded in mystery for most retail investors. Normally, investors submit an IOI to tentatively purchase some number of shares. The bankers then use those IOIs, along with other inputs, to help set a price based on the aforementioned balance. Once the IPO prices, prospective investors must confirm that they are still interested based on the new pricing information. Shares are then allocated, typically skewed toward institutional heavyweights, and allocations are not guaranteed.

While IPO investors like to see massive Snowflake-esque pops on the first day of trading -- who doesn't like doubling their money in a day? -- companies often view that as money left on the table since those pops indicate that there was sufficient demand for the IPO to command a higher price. While the market optics are nice, issuers would rather bolster their war chests and use that money to actually operate.

Unity's unique bidding process is designed to provide greater transparency to a notoriously opaque process, theoretically justifying a higher IPO price that might also limit the potential pop on the first day of trading. Unity's IPO is scheduled to price tomorrow.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Evan Niu, CFA owns shares of Tesla. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Tesla. The Motley Fool has a disclosure policy.

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