Going, going ... sold to the highest bidding block; do Dutch auction IPOs help issuing companies capture more value?

• Author: Horowitz, Alan S.
• Position: Feature

The Dutch, already commonly associated with windmills, tulips, beer, painters, blessings, dates and uncles, have now yet another claim to fame bestowed upon them--the "Dutch auction" IPO method. Dutch auction initial public offerings are all the talk of Wall Street, thanks to Google Inc.'s recent Dutch-auction IPO.

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A Dutch auction is designed to level the playing field by allowing potential investors the chance to help set the price of the IPO through bidding prior to the date of the offering. It's a way of democraticizing the IPO process, making it fair game for everyone, not just a small group of Wall Street insiders. By reducing the "hurdle rate" (the size of the minimum investment), Dutch auctions give many individual investors--who were largely excluded from IPOs of the late 1990s-a chance to jump into the game at the opening whistle.

Dutch auctions aren't new; Treasury bonds, for example, are sold this way. Salt Lake City-based Overstock.com, an Internet-based retailer of excess inventory and other low-priced items, used a Dutch auction to go public in 2002 to raise nearly $40 million, and has used it again to raise additional funds.

Traditional auctions, such as those found at Sotheby's and eBay, start at a low price that then rises to the highest bidding point before being sold. Dutch auctions used with IPOs, which are also called uniform price auctions, work somewhat in the opposite direction.

On August 20, Google raised $1.67 billion in its initial public offering of stock, among the largest ever in the technology sector. Shares jumped 18 percent in the first day of trading to close at $100.34. The much-anticipated public offering left Google's market value at more than $27 billion.

The Dutch Auction Way

Let's assume investors commit to buying an aggregated nine million shares at $135 each, seven million at $130, nine million at $120, 10 million at $110, etc. After bids from all investors are compiled in a huge list, with the highest bid first, the bankers go down the list and allot IPO shares until they run out. When all available shares have been spoken for, the bankers take the price of the last bid that made the cut and call it the clearing price.

In our example, at $120 a share, 25 million shares have been committed to. This becomes the clearing price because that's the highest price at which all the shares will be sold. All who bid $120 or more get shares at this price. Those who bid below $120 get no...