Unity went public last Friday through a unique twist on the traditional IPO process. Instead of allowing the bookrunning banks to price and allocate IPO shares, Unity maintained control of the book and set the final price of shares before allocation to the primary investors. This is an exciting development because the pricing of IPOs, and the famed first day pop, has been a topic of discussion over the past year, particularly in the tech community.
The tactic was effective based on other recent IPOs. Unity shares closed the first day of trading up 31%, which compares to IPOs earlier in the week of Snowflake, up over 100% from IPO price, and JFrog, up 47%. However, Unity’s first day pop was slightly above the equal weighted average of all IPOs in 2019, courtesy of Jay Ritter’s work at UF. Net-net, we believe you have to adjust expectations for the times. We’re in a tech bull market, and there is significant retail interest in new issues. We view the 31% first day move in Unity as a win for the company and its investors.
Before Unity’s use of what we think of as a semi-auction strategy, the talk of innovation in going public centered around direct listings. In a direct listing, the company going public doesn’t raise new capital as part of the offering and instead lets existing investors, employees, and management sell stock on the open market to initiate the listing. The benefit of a direct listing is that all shareholders are able to sell at the time of the listing, meaning the full float is available for trade on day one. In a traditional listing, existing shareholders are generally locked up for 180 days, which necessarily limits public float until the lockup expires. The full public float of a direct listing theoretically means that real price discovery can happen sooner. If only 10% of a company’s shares are available to be traded after a traditional IPO, supply is constrained artificially, and that constraint can cause wild fluctuations in the face of strong demand. See Snowflake.
There is certainly some underpricing engaged in by the bookrunning banks on an IPO. The banks are incentivized to take care of their best investing clients who will keep doing business with them in perpetuity versus a company that only goes public once, and maybe raises secondary once. That said, we think it’s unfair to position the first day pop as the true measure of the underpricing because of the aforementioned supply and demand dynamics. Public fluctuations in price on the first day of trading aren’t true discovery of price. If Snowflake’s entire float were available for trade, we do not think that first day trading would have ended with a 100%+ gain.
Taking the discussion back to Unity’s IPO process, we see their semi-auction as a new tool in the toolbox of companies looking to go public. In some ways, the semi-auction is the best of both IPO and direct listing: an ability to raise new capital and exercise some control over price. The semi-auction will likely only be available to the best companies with strong competition from banks to run their IPO. Ceding price control is not something we expect banks to do willingly, but Unity has laid the groundwork.
As it stands today, direct listings also only really work for the best companies that don’t need new capital given strong balance sheets. If direct listings ultimately evolve to incorporate the ability to raise primary capital, perhaps the semi-auction loses favor to the direct listing, and more efficient pricing becomes the norm on a public offering. Until then, we expect to see more strong tech companies follow Unity’s playbook in the future.