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What is a Dutch Auction IPO?

I remember that Google did its IPO this way, and it was supposed to be an unconventional choice. Why did they follow that route, and will Facebook do the same?

Feb 07, 2012 by Ranjit from San Diego, CA in  |  Flag
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In finance, a Dutch auction refers to a market clearing process where the auction price starts high and declines until supply and demand are in equilibrium. Dutch auctions are used in a number of financial markets: U.S. Treasury auctions, auction-rate municipal securities, and most Japanese cash and futures markets, to name a few. Here is an example of how the auction process works: a seller has 500 shares of stock to sell. The following bids are solicited from buyers: 100 at 55, 200 at 54, 300 at 53, 300 at 52, 500 at 51. The clearing price is the price at which the seller can unload all 500 shares of stock, at a price of 53 in this example. All buyers pay the lowest clearing price. If the seller had 300 shares to sell instead of 500, the price would be 54; if 700 shares, 52. A Dutch auction can be an effective way to source liquidity, establish a true clearing price, and fairly allocate securities among buyers, especially in markets where the participants are well-known and information is freely available. Proponents of the traditional underwriting process would argue that a Dutch auction offers less price stability and promotes short-term speculation compared to a traditional underwriting, because shares do not necessarily end up in the portfolios of long-term, buy-and-hold investors. The counter argument is that the traditional underwriting process is manipulated by the underwriters to reward certain investors with "sweetheart deals" --- favorable allocations of "hot" new issues at the expense of the issuer and the other investors who receive less than a fair share. Google was the most notable IPO to use a Dutch auction process, but there have been a number of other companies that also have gone public with this format. Since Facebook has already chosen Morgan Stanley, a bulge bracket securities firm, to lead its IPO, and given the size of the offering and current market conditions, I expect that the Facebook IPO will be a conventional deal. However, you may see some co-managers utilize a Dutch auction to allocate shares they receive among their clients. I must admit that I have not studied the Facebook S1; if there is a plan to use an unconventional underwriting format for the entire issue, there would generally be references to it in the official filing.

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