Cracks in Traditional IPO Process Widen

January 8, 2021

It was inevitable. The power of Wall Street is finally showing its weaknesses.

For decades, we’ve had a broken IPO system.

Wall Street banks have acted more like Ticketmaster with its huge fees than like underwriters helping out new-to-market companies.

This week, we’ve already seen two cases where companies listing for the first time are contemplating a side step.

Traditionally, the process works like this…

  1. A company wishing to IPO goes to banks like Morgan Stanley and Barclays for help.

  2. The banks, which become known as underwriters on the deal, go out and find prospective investors.

  3. The banks then work out a price and amount of shares they feel meet that investor demand.

  4. Then, when shares hit exchanges, the banks rake in a fortune for their work.

That seems pretty fair and logical until you look at just how disgustingly high those fees by the underwriters are.

Typically, underwriters take up to 7% of the proceeds from a public listing. For IPOs like the recent ones from DoorDash Inc. (NYSE: DASH) and Airbnb Inc. (NASDAQ: ABNB), that can go into the hundreds of millions or even billion-dollar range.

And here’s the thing. The underwriters on those particular IPOs didn’t even do their jobs right. They were wrong about investor interest, which ended up about 100% more costly for investors.

Meanwhile, the companies themselves didn’t get that difference. They didn’t get any actual benefit.

But the underwriting banks got their large cuts and continue to prey on new-to-market companies.

Well, as I wrote just two weeks ago, a new SEC ruling could be changing this broken system. And already, in just this short amount of time, one of the hottest IPOs of 2021 could be paving a new path.

How About 100% of the Pie?

Roblox Corp. is an online gaming company that, if you have kids, you already know all about.

It hosts a platform for just about anyone to use to build their own games, virtual forums and meeting grounds.

It’s incredibly popular for children as young as five or six to teenagers.

The game development side is just as mind-blowing. Those as young as 13 or 14 have already built successful games on Roblox’s platform, which actually make money.

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Roblox, of course, gets a cut from that money as the host. With an estimated 40 million games hosted on there, not all are winners. But enough certainly are.

One year ago, back in February 2020, the company completed a round of funding that valued it at $4 billion.

Remarkable, right?

Well, this week it completed another private round of funding that values it at $29.5 billion.

And it has been planning to IPO this quarter. It could be a monster deal. So, of course, its underwriters were salivating over their cut.

This morning, Bloomberg broke the news that the deal is off. Oh, Roblox shares are going public. But they are going to use a direct listing. Meaning, they are cutting out the banks and keeping 100% of the pie.

Now, prior to this SEC rule change, direct listings were fine. But companies couldn’t actually raise capital through them. Now they can.

It’s yet to be determined if Roblox will raise any capital. After the latest round of funding, the company really doesn’t need to. But if it does, it would be the first to test drive this new rule circumventing big banks on Wall Street.

It’s certainly one to watch. But it isn’t alone.

Robinhood Does What Robinhood Always Does

Not much info is out yet on this one. But it’s definitely an interesting story to watch.

Robinhood, the hugely-successful brokerage disruptor is set to IPO sometime over the next few months. But it too may be screwing the banks out of some of their lucrative underwriters’ fees.

Robinhood, valued at about $12 billion, is considering pre-selling some of its shares to its users before they ever get listed.

This would act like a different kind of direct listing in the sense that it cuts the banks out of those fees too.

You can sign up for a Robinhood account for free. So, there’d be no obstacle to frontload into these shares avoiding the prices and fees of the underwriters.

Now, this hasn’t been confirmed. And even if Robinhood goes forward with it, we just don’t know how many shares would be offered to its users.

But it is still a story that would crush the banks that have been preying on IPOs for decades. And it’s not out of the realm of possibility.

Airbnb did a similar move. While not many took advantage of it, those that did made a fortune. One Airbnb host netted $15,000 on just 200 shares.

2021 is already shaping up to be a consequential and game-changing year for IPOs. Keep this story in mind as new and unique profit opportunities arise from it.

To your prosperity and health,

Joshua M. Belanger

Joshua M. Belanger
Joshua Belanger is founder of CounterVest and the editor of Hot Money Trader. He has been providing ordinary investors blockbuster returns since 2008. In 2018, the average return of Hot Money Trader beat the markets by over 15%

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