When Snowflake (SNOW 7.80%) went public and ended its first day of trading roughly 112% higher than its offering price of $120, it reignited a growing debate over traditional IPOs and direct listings. Some believe that traditional IPOs result in the listing company leaving money on the table -- in Snowflake's case, naysayers argue the company left billions on the table.
A few weeks later, Palantir (PLTR 4.80%) and Asana (ASAN -0.44%) went public in a direct listing process. Their performance wasn't nearly as successful as Snowflake, which is the largest software IPO of all time, but they still saw some success. Let's take a look about what these IPOs taught us about the debate between traditional IPOs and direct listings.
In a traditional IPO, the company going public hires an investment bank to serve as the lead underwriter, which tries to attract interest from institutional investors that it can sell blocks of new shares to. Snowflake's team and underwriters did a good job at this. Not only did they secure concurrent private placement offerings with Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) and the venture arm of salesforce.com (NYSE:CRM), which signaled confidence to the market, but the underwriters also helped grow the offering price to $120 per share. The thing to understand about a traditional IPO is that the issuing company sells all of its shares in the morning for the offering price.
By selling its shares for $120 per share, Snowflake made $4.4 billion in the offering. Some argue the company could have made more had it done a direct listing, which removes the underwriters from the process and has existing shareholders sell their shares directly to the market. If it had done a direct listing and shares had closed the first day of trading around $254 like they did in the traditional IPO, then Snowflake would have raised a total of $9.2 billion, or an additional $4.8 billion, which brings us to the center of the controversy between traditional IPOs and direct listings.
"In many ways, $SNOW is the final proof of just how broken [the IPO] process is," Bill Gurley of the venture capital firm Benchmark tweeted following Snowflake's first day of trading. However, Snowflake CEO Frank Slootman disputes this, saying, "if you think you could have sold this offering at $245 (the price of the first public trade), I mean, people are smoking something."
Looking at performance
At the crux of the debate is whether direct listings can really drum up the same level of investor sentiment -- and therefore price appreciation -- as a traditional IPO. Could Snowflake really have offered shares at $245? Or seen them close the first day of trading at $254 per share without doing its road show and having the underwriters pitch the company to their wide rolodex of contacts? Many people say only companies with really strong brand reputations should go public via direct listings, but this is the question.
In its direct listing, Palantir closed its first day of trading at about $9.50 per share, roughly 31% above its reference price of $7.25 per share, but below the first public trade of $10. It was up 38% after its first week of trading. Asana closed its first day of trading at $29.96 per share, 43% above its reference price of $21 per share and about 11% above its first public trade of $27 per share. It was up 26% above its reference price after its first week of trading.
Obviously, Snowflake outperformed Palantir and Asana, but it was also the largest software IPO ever, so probably not the best comparison. So far this year, U.S. companies that have gone public have seen a one-day gain of 23.7% on average, according to Dealogic. The average one-week gain has been 25.4%. Both of these performances are much better than in the past few years. However, Reuters reported these numbers before Snowflake and another software company, JFROG (FROG 3.55%), went public in September. Between July 1 and Sept. 16, the 44 companies that went public saw their stock increase by an average of more than 57% on the first day, according to Jay Ritter, a finance professor at the University of Florida.
One of the more prominent direct listings, Spotify, closed its first day of trading in April of 2018 at just above $149 per share, close to 13% over its reference price of $132 per share. Its one week return was about 17%. Another direct listing, Slack (WORK), closed its first day of trading in June of 2019 48% higher than its reference price of $26 per share. Its one week return was about 39% .
What we have learned
On the surface, traditional IPOs and direct listings do not appear that different to your average investor. On their first day of trading, both don't start trading until midday, and by the time the public markets can have at them, much of the price appreciation has already happened. Also, both tend to see nice gains above their offering or reference price.
I am not sure the jury is quite out on which one performs better, because there still haven't been enough direct listings to accurately compare with all of the traditional IPOs. While investors haven't yet seen any direct listings jump on day one like Snowflake, I wouldn't rule it out just yet. Additionally, given that the returns of direct listings have been somewhat comparable to traditional IPOs, I also can't say that the price discovery in them is more accurate than traditional IPOs either.
Ultimately, both methods can be successful, and I think both have likely performed better this year than they would have, because investors are looking for returns. You will probably begin to see more direct listings, especially after the Securities and Exchange Commission recently enabled companies going public through a direct listing to also raise capital -- and not just sell existing shares -- more like a traditional IPO. Given the simultaneous popularity of special purpose acquisition vehicles, representing yet another way to go public, companies that wish to raise capital for the first time are going to find themselves with more options than ever before.