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Through it all, the house always wins.
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SPACs are so Q1 and other takeaways from a disorienting year in tech IPOs

Amid the frenzy of tech IPOs this year, a few surprising discoveries stand out.

2021 is shaping up to be a disorienting year for tech IPOs. The first six months brought us the Alex Rodriguez SPAC, an $85 billion Coinbase debut and a mysterious delay in the Robinhood S-1 filing that was ultimately cleared up when the firm paid a token fine.

Amid the recurring frenzy, it's easy to slip into a familiar pattern of analysis: Wait for an S-1 to drop, react to the financial disclosures, then see whether the stock "pops" after its trading debut. By the time one stock starts trading, several tantalizing new S-1s are already up for inspection. The problem with this cycle is that it stops too early: A stock's opening-day pop only really reflects the extent to which a few overworked investment bankers underestimated investor demand. A pop makes for headlines. It doesn't make a company.

We wanted to break free of this cycle to reflect on the state of tech IPOs. In doing so, we hope to provide more clarity on some of the big-picture questions facing the tech IPO market: Have SPACs lost their luster? A bit (sorry, Chamath), but tech companies still want alternatives to the traditional IPO. Are company narratives still important? Yes, and breaking free of conventions can pay off in a big way. And what's up with all the stock pops anyway? Turns out, tech companies still come crawling back to Goldman one way or another.

SPACs or no SPACs, companies want alternatives to the traditional IPO

At the start of 2021, there was a lot of public anxiety surrounding SPACs. Critics saw SPACs as a dangerous form of financial wizardry and a symptom of easy money being pumped into markets by the Federal Reserve.

These concerns were exacerbated by the blistering pace of blank-check deals at the start of the year. January saw a record-setting 86 SPAC IPOs. This record was surpassed with 97 deals in February and yet again with 109 deals in March. And just to send SPAC naysayers over the edge, WeWork — everyone's favorite harbinger of market delusion — agreed to a $1.3 billion SPAC acquisition deal at the end of the quarter.

The SPAC market has since slowed down, with deals occurring at a frequent but less conspicuous pace. SPAC naysayers were right to identify loose monetary policy as one of the drivers of SPACmania, but it's worth considering a more generous interpretation: The traditional IPO process just isn't a good fit for many otherwise viable IPO candidates.

There are dozens of reasons a company might not want to go public via the traditional channels. IPOs are expensive, for one, since investment banks take an underwriting fee typically in the 3.5% to 7% range on the funds raised. There are also hefty legal fees, audit fees and opportunity costs associated with having employees prepare for the IPO. Traditional IPOs can sometimes force companies to dilute their stock more than necessary or commit to lockup agreements that could otherwise be avoided.

But SPACs aren't always a good fit, either. SPACs exact a heavy cost in dilution, with deal sponsors typically earning a fifth of the company as part of the deal. If you're waiting around for a Chamath figure to anoint your company with a SPAC, you're inevitably ceding some control over the timing of any deal. And some companies are simply too big for SPACs. Coinbase, for instance, went public through a direct listing and garnered a valuation that was nearly three times that of the largest SPAC deal. Palantir, Spotify and Roblox also opted for direct listings — the process generally limits investment banks' fees and allows investors to avoid lockup agreements.

Robinhood is resurrecting a very old idea from the dot-com era with its IPO Access feature. The feature allows retail traders to participate in the roadshow that would typically be reserved for institutional investors — something E-Trade first tried in the 1990s. A company would typically go through the traditional IPO process at the same time — IPO Access and similar offerings are just about opening up sales to retail investors at the opening price, so they don't have to wait for the shares to start trading and miss out on any initial pop.

What's unusual about what Robinhood plans to do is the large portion of shares it's reserving for retail investors, including its own customers. The company intends to reserve as much as $770 million worth of shares — about a third of the total amount being raised for the IPO — for its customers on IPO Access. That's what makes it a development worth watching: If Robinhood succeeds, it could set a precedent for big-name tech companies further reducing their dependence on investment banks and institutional investors during the IPO process.

Expect more experimentation with IPO methods in the second half of 2021. And with that experimentation, also expect to see the SEC attempt to draw some lines in the sand. Earlier this month, for instance, the SEC halted Pershing Square Holdings' attempt to acquire Universal Music Group for $40 billion via SPAC. Pershing Square Holdings, which is backed by the prominent financier William Ackman, had structured the deal such that it could avoid the typical speed bump of receiving shareholder approval.

Narrative still matters

Tech companies have always relied on stories. And though many on Wall Street would have you believe they're only engaged in empirical IPO analysis, the truth is that they're just as often investing in a story, not a balance sheet.

Tech companies typically settle for simple narratives that elicit dollar signs in the eyes of investors. They might say, "We're going to disrupt the commercial real estate market," or "We're just like Amazon, but better and in Korea."

While simple stories often do the trick, it's worth paying attention to attempts at more-complicated narratives. Tech companies inherently need to simplify their narratives to appeal to a wider audience of investors, but to what extent? What types of complicated narratives resonate with investors?

This year, Roblox and Bumble provided two of the most intriguing IPO narratives, and they pulled it off in a spectacular fashion:

Roblox managed to garner a $45 billion valuation through its IPO. At the time, this valuation made Roblox larger than gaming juggernaut Electronic Arts and nearly as large as Ford. So how does a children's video game that looks like a crossover between Lego and Minecraft become as valuable as a 100+-year-old automaker? Roblox worked hard to sell investors on the idea that it wasn't just a game, but a "metaverse," a "human co-experience platform," and even a "new category of human interaction."

If you strip away futuristic terminology, Roblox's pitch was that it allows developers to build games within the Roblox virtual world — so whereas a game like Club Penguin might grow stale, Roblox could continually reinvent itself.

Though some skeptics might say that this specific pitch is grandiose, Roblox did an excellent job conveying the potential of its platform. Its financials are also incredibly impressive, if not a concerning reflection of today's youth.

Bumble likewise managed to convey that it wasn't just a dating app, but a lifestyle brand. Dating apps tend to have finite life cycles. This is why other companies in the space — most notably Match Group — maintain a portfolio of dating platforms to appeal to different demographics and capture migrating audiences.

Bumble's insistence on being a broader community-building platform helped turn a potential source of risk (its unified brand) into a competitive advantage. The company hopes to capitalize on this positioning by building services outside the dating sphere. For instance, it launched the Bumble BFF in 2016 and Bumble Bizz in 2017. Later this week, Bumble is even set to launch a branded coffee shop in New York.

The narrative seemed to resonate with investors: Bumble raked in $2.15 billion through the IPO process, more than double the amount it had originally hoped to raise.

The house always wins

Many of the companies that went public this year experienced a pop on the first day of trading. To name a few: Coupang jumped around 80%, Affirm 96%, Poshmark 145%, Bumble 85%, UiPath 22%, 50% and Roblox 43%.

While public companies ultimately want their stock price to go up, a pop isn't necessarily a desired outcome. It would be far better for a company to have priced its IPO higher in the first place, as this would allow it to raise more money without diluting existing ownership stakes to the same extent.

Investment banks act as market makers in the fundraising process, so they bear some responsibility for an underpricing of shares. Their customers — typically large mutual funds and other institutional investors — like it when IPO shares rise, of course, and see the pops as a form of compensation for buying into deals that don't work out. The investment banks earn fees based on the price they set for shares, not the pop when they start trading, so they don't have any direct incentive to underprice shares, besides keeping those funds happy.

Because relationships with these money managers are so important, a select few investment banks keep coming out on top. They are the usual suspects: Goldman Sachs, J.P. Morgan, Barclays and Citigroup. Goldman Sachs is so dominant in this space that it was actually difficult to find an S-1 in which it wasn't listed as an underwriter. Some other investment banks, like Nomura and HSBC, showed up more sporadically.

SPACs are often pitched as a way to circumvent Wall Street gatekeepers. But even Goldman is in on the SPAC game now, with its Permanent Capital Strategies division. SPAC transactions also often involve lending and private placement transactions — these present even more opportunities for big Wall Street banks to get involved. And with direct listings, tech firms often work with the same cast of banks. Coinbase, for instance, worked with Goldman Sachs, J.P. Morgan, Allen & Company and Citigroup on its blockbuster stock debut. So even as tech firms look to find new ways to go to market, it seems that for now, at least, the house keeps winning.