Entrance of More Underwriting Banks Could Herald Virtuous Cycle for Reg A+
Reg A+ IPOs have been off to a slow start, but it’s worth remembering their cousins needed a little time to hit their stride. Given the soft opening performance of Reg A+ IPOs, it’s been easy for any observer with a cheap calculator to call them a failure. Indeed, journalists at outlets such as Barron’s and The Wall Street Journal have been quick to dash off stories pointing out that almost all of the listed Reg A+ IPOs have declined since going public last year. Case closed on the Reg A+ category, they blithely suggest. Barron’s has made a similar journalistic shortcut before – with now-thriving structures known as special purpose acquisition companies (SPACS) or blank-check companies. In this piece from 2005, Barron’s warned that is was “too early to consider SPACs to be a permanent part of the IPO landscape” and coined them “just Wall Street’s latest casinos.”
But in the years that followed, SPACs would thrive. After raising about $2 billion in 2005, they reached $12 billion in 2007, according to Dealogic. While the entire IPO market shut down for a while following the financial crisis, SPACs resurged, reaching $10 billion in 2017.
An important part of the SPAC story is the role of major investment banks. In the early days, SPACs were underwritten entirely by boutique investment banks such as EarlyBirdCapital that focus on blank-check companies. While EarlyBirdCapital has remained a significant player, bulge-bracket banks rose to the top of the league tables just as soon as they entered the SPAC arena in 2006. Today, Citigroup leads the all-time league table, with nearly $12 billion in deals or 26% of the transaction volume between 1995 and 2017.
Naturally, the larger banks followed the scent of hefty underwriting fees. Once deals began to break the $100 million mark, the likes of Citigroup and Deutsch Bank took interest. SPACs tend to generate lower underwriting fees than traditional IPOs, but bankers have a shot at M&A advisory fees if the SPAC is able to find an acquisition target.
There have been a number of marquee SPAC deals that have probably contributed to investor confidence in the structure. In 2016, a SPAC acquired Twinkie-maker Hostess Brands (TWNK). Just this week that company posted better-than-expected results as its sweets outsold the broader category. Hostess had filed for bankruptcy amid mismanagement and the SPAC offered a path for a seasoned executive team to nurture it back to health.
In a March 1 investor note titled “A multi-year revenue and cash flow growth story”, leading consumer analyst David Palmer of RBC Capital Markets issued estimates for 4% sales growth in 2018, supporting an $18 price target for the stock, which was trading around $13.50. Indeed, the company has come a long way from just a few years ago when the Twinkie-maker said it planned to shutter for good.
Major investment banks played a key role in the success of a SPAC like Gores Holdings, whose IPO was underwritten by Deutsche Bank before it ultimately purchased Hostess Brands. A bank like Deutsche has key relationships with institutional investors and a robust equities research team to launch coverage of companies, reassuring investors.
Could the same Cinderella story be in the future for Reg A+? There’s no doubt the benefits of a major investment bank would be similar with a Reg A+ company. The question is what it would take to get one onboard.
The obvious answer is for a Reg A+ company to raise a larger amount of money. The current ceiling is $50 million and there are multiple pieces of legislation floating through Congress that would raise the cap to $75 million.
Raising the limit to $100 million might just be enough to attract more underwriters and some industry participants think it’s the right number. David Feldman a Partner at Duane Morris LLP and known in come circles as the “Godfather” of Reg A+, has suggested such an increase.
Another idea: simply allow banks to charge a bit more, even if the deal size is smaller. IPO fees have fallen steadily over the last couple of decades, from 7.3% for U.S.-listed issues in 1995 to 6% today, according to Dealogic.
“I’m sure today’s underwriters would love that extra point back,” Mr. Feldman says. He explains that while there aren’t hard limits on fees, regulators don’t allow them to be “excessive” so it’s tough to charge significantly more.
Ultimately, what Reg A+ may really need is a success story like Hostess. The market is littered with half-baked ideas that make it hard for some investors to find the real businesses. The likes of FAT Brands (FAT) and iPic Entertainment (IPIC) have such stories to tell. Once one of those businesses begins to deliver for investors, the larger banks may take notice.