Let's play a game. I'm going to discuss some recent hurdles placed before three companies, and you try to find the common thread. Ready? First, Google (NASDAQ:GOOG) had a tough time going public last year, battling everything from brandishing too much bravado in a popular girlie magazine interview to a boneheaded regulatory omission. Then, just months after filing to go public, the mutual-fund mavens at Morningstar come under fire for a data snafu and a potential conflict of interest in its consulting unit. And finally, we have Overstock.com (NASDAQ:OSTK) CEO Patrick Byrne, who has no problem naming names in arguing that his company has been attacked by naked short-selling tactics.
Did you guess what Google, Morningstar, and Overstock.com have in common? Well, all three companies took a pass on going public through the traditional investment-banking channels. Instead, they opted for the individual-investor-friendly practice of going public through Dutch auctions.
Could all three companies be paying the price for snubbing their noses at the financial market's ridiculous rite of passage? Is that a barely discernible, shadowy outline of an investment banker lurking out on the grassy knoll?
Before you begin poking holes in my thesis, allow me to make Swiss cheese out of my own Dutch auction conspiracy theory. Morningstar came under scrutiny well before it dumped Morgan Stanley (NYSE:MWD) in favor of Hambrecht's Open IPO approach. Google was so prolific that every breath it took was going to get a close look -- and it didn't totally betray the investment bankers, as it went public in a quasi-auction format that let in both the institutional fat cats and the self-guided bootstrap investors. But, if you will indulge me, what if I'm right?
Public schooling
Fraternity hazing has nothing on the way companies go public. Promising upstarts -- and junky ones, too -- go through the humiliating process of having their underwriters take them around institutional investing circles to come up with a share price that's just a few shades shy of fair. It's the best way to make sure that the market debutante will leave room for the big money when the stock rises from its first day of trading. The financial press loves to talk about IPOs that shoot out of the gate, instead of applauding the rightfully valued new offering that opens exactly where it was priced.
If you argue that the company that goes public with a whimper does so because it's a deserving dud, I'll argue that the great ones should do the exact same thing -- if they are priced to market.
It's a silly hazing ritual. Newbie after newbie falls into the same trap. And the market has no problem admiring the Greek lettering on the wooden paddle as it drops its drawers and says, "Thank you sir, may I have another?" between the snaps of sawdust.
Most companies smartened up to surrendering just a sliver of new shares for the IPO before tapping the market with a meatier secondary offering. But what ever happened to getting something right the first time?
Getting things out in the open
Google and Overstock aren't the only companies to have opened up the IPO process by letting lay investors in on the action. However, those companies happen to be the most successful alumni class. Perhaps that's why the market wouldn't mind seeing them fail. Having more market hopefuls following in those companies' footsteps would be akin to putting the gravy train up on concrete blocks for investment bankers and their preferred client allocations.
Yes, investment bankers do provide valuable services as underwriters, but why should their choice accounts be privy to the market markups on underpriced stock deals? Until we get to the point where stocks consistently open at their offering prices -- both the hot and cold ones -- wouldn't we all be better off if we let the investing community have its say first?
Google and Overstock are trading much higher today than they did when they went public, yet that's been the case with gradual market appreciation. Google was set to be priced as high as $135 a stub before initial auction demand marked it down to $85. It opened at $100.01 and closed out its first trading day at $100.34. Yes, it's nearly doubled since then, but it earned those upticks. Overstock went public at $13 in May of 2002. On its first publicly traded day, it closed at $13.03. The recent Rule Breakers stock recommendation went on to produce an amazing run after going public -- quadrupling in less than three years -- but like Google, it earned the market's confidence by delivering after it went public, rather than by giving itself away before that.
The real shame here
The one teary-eyed footnote here is that many of the companies that have opted for the Dutch auction IPO did so because an underwriter wouldn't ask them out to the prom. It's not a move done on principle so much as it's a way to raise principle. That's a pity. No investment banking traditionalist is going to try to pick a fight with upscale steakhouse chain Smith & Wollensky (NASDAQ:SWRG) with its stock mired in the mid-single digits. For starters, I hear the chain packs some really sharp knives. Yet, seriously, it's not worth the trouble.
Google? Overstock? The individual investor empowering Morningstar? Those targets make sense. Until more quality companies catch on and body-surf toward the public stage on the hoisted arms of the mainstream, why shouldn't the old school undermine the liberating efforts of the new wave by sticking it to the success stories?
Then again, with Google's market cap now topping $50 billion, and with Overstock's CEO being both a former boxer and black belt in martial arts, does the market know who it's picking on here? These cats know how to fight back. In time, they will not be fighting back alone.
Longtime Fool contributor Rick Munarriz doesn't know whether he would like to go public -- or whether anyone other than his wife would bid on him in a Dutch auction format. He does not own shares in any of the companies mentioned in this story. The Fool has a disclosure policy. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.
