Insight Into the Future of G-Series Through COINBASE’s Direct Listing Series: Direct Listing vs. Traditional IPO

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  • Translator: Ranting

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For many years, the greedy Wall Street has been controlling the throat of enterprises listed in the United States, pursuing the concept of “this road is open to me, this tree is planted by me, if you want to cross this road, leave the money to buy the road”, and formulating the corresponding capital rules of the game, as the end of the capital chain of enterprises, to say “no” is as difficult as to reach the sky. From the direct listing of Spotify, the world’s leading streaming music service provider, on the New York Stock Exchange three years ago, to the recent direct listing of Coinbase, the nation’s largest cryptocurrency exchange, on the NASDAQ in the public market, it marks a new era of saying no to Wall Street and other powerful forces and someone behind it, the advent of the era of “capital pricing”.

On April 14, 2021 EST, cryptocurrency exchange Coinbase (COIN.US) went public on NASDAQ in New York, offering 114,850,769 shares at an offering price of $250, opening at $381, up 52.40% from the offering price, and reaching a high of $429.54 during trading. By the close of trading, shares were trading at $328.28, up 31.31%, with a market capitalization of $61.1 billion.

What is a direct listing?

Direct Listing is different from traditional IPO listing, which is a type of listing that is directly traded on the stock exchange without issuing securities through an underwriter. There are two general categories:

  1. Selling Shareholder Direct;
  2. Primary Direct Floor Listing.

The former is more common and can be freely traded on the open market without the need to issue new shares, but simply register existing shares as long as the conditions are met.

The direct listing of IPOs is a new NYSE regulation that was only approved by the SEC on December 22, 2020. The new rules allow direct listings to raise capital by issuing new shares without going through an underwriter. This move directly undermines the authority of the traditional IPO process and reduces the opportunity for individual investment banking firms to divide up the corporate IPO pie.

Direct Listing vs Traditional IPO

In the past IPO cases, you can often see news that the stock price has soared on the day of listing. On December 10 last year, Airbnb, a global shared accommodation platform, went public on NASDAQ in the United States. On its first day of trading, Airbnb opened at $146/share and closed at $144.71/share, up 112.81% from its offering price of $68/share, with a total market capitalization of $86.46 billion. While everyone was basking in the joy of Airbnb’s skyrocketing stock market value, no one seemed to notice the fact that the IPO was underpriced and costing the company a huge amount of money in financing.

IPO price suppression offerings appear to be the norm, with the average range of first-day IPO gains ranging from about 5% to 25% between 1990 and 2020, according to data from a study by Professor Jay R. Ritter of Florida, USA. Converting this increase into a cumulative amount of about $171 billion if the company loses money due to underpricing the IPO.

This wealth, which should have belonged to the company’s founders, the company’s employees, and the early investors who accompanied the company, was transferred to the investment banks and the public market investment institutions associated with the investment banks’ interests on the day of the stock’s first day surge.

Data source: Initial Public Offering: Underpricing

The traditional IPO process is very long and complex, and the investment banking firm is the most critical player as the underwriter throughout the listing process. From the preliminary preparation of the S-1 or F-1 form to the post-execution roadshows and arranging one-on-one meetings between the issuing company and investors, the investment bank will control every process of the company’s IPO. Two of the most critical processes are the pricing and allocation of new shares by the investment bank before the company’s new shares enter the public market. Theoretically, the investment bank will infer the current supply and demand equilibrium point in the market and give a reasonable issue price range based on basic research, market research and road shows.

However, in fact, in the IPO process, there is an agent problem (Principal-Agent Problem) due to the inconsistency of interests between the issuer and the investment banker. It is pleasing to companies that IPOs are priced high, meaning they can raise more money.

But for investment banks, an IPO that is overpriced requires them to take the risk if the financing does not meet the target, and they must buy all the remaining shares themselves, as per the agreement they signed with the company. In this way they tend to be extremely cautious when pricing. Lower IPO pricing not only allows for overselling, but the news of a sharp rise in stock prices on the first day of trading can also numb the nerves of the issuing company, allowing them to overlook the benefits lost due to mispricing.

Direct listing can be effective in alleviating such problems to some extent, which stems from its simpler and more straightforward listing process. After meeting the different criteria for listing, companies still need to follow the basic steps of preparing a prospectus and a series of other documents to the SEC for review and approval, and need to conduct roadshows for investors in both online and offline formats.

The core difference from a traditional IPO is that a direct listing removes the process of underwriting securities, and the investment bank no longer participates as an underwriter in the process of quoting, pricing and underwriting securities, but acts as a “financial advisor” to assist the company in the listing. In this way, the company’s stock skips the investment banking pricing process and chooses to follow a strict price-time algorithm based on the real supply and demand situation in the market to precisely achieve the issuance and placement of shares.

On the other hand, in the traditional IPO process, most of the shares are already placed by the investment banks to a certain number of interested investment institutions before entering the market, and the number of shares that can finally enter the public market is very limited. A direct listing, on the other hand, does not have this problem, and the shares can be freely traded directly into the market, where any investor with a securities account can participate. Such an issuance mechanism, may lead to a more realistic pricing mechanism and can somewhat improve the efficiency of securities pricing and allocation.

Advantages of direct listing

Save on listing costs

For companies, the most obvious benefit of choosing a direct listing is that it saves them the cost of going public. According to PricewaterhouseCoopers (PwC) research data, underwriting fees range from approximately 4% – 7% of the capital raised. The underwriting fee rate for Ideal Auto, which went public in the U.S. at the end of July last year, was about 4%, while the underwriting fee rate for another shell house hunter was also around 3.5%. Even giant companies that face investment banks with higher bargaining power still have to pay high underwriting fees.

Data source: PwC

In the case of Alibaba, although the underwriting fee rate is only 0.25%, the fee is quite impressive as its fundraising amount is as high as HK$88 billion and if we include the over-allotment of 75 million new shares, the underwriting fee will reach HK$253 million.

So companies choosing a direct listing will save a significant portion of their underwriting costs, which they can choose to use for roadshows or investor relations building, etc.

Flexible lock-up period

On the other hand, a direct listing can reduce the lock-up period restrictions and create more liquidity for the stock. A lock-up period is generally a period of time, ranging from 90 to 180 days, during which the holder of a share may not transfer the shares held. In fact, these provisions are not mandated by law, but rather by a series of lock-up agreements entered into by the underwriters to stabilize the current market conditions or to enhance market confidence.

A direct listing places no such restrictions on the stock held by the company’s existing shareholders and does not require a pre-IPO quiet period during which company executives can publicly discuss the company’s situation prior to the listing. This reform has given companies greater freedom and pre-IPO exposure, which has had a positive impact on subsequent stock offerings and pricing.

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