Dutch Auctions and Their Fans

There is no better David vs. Goliath story in the financial markets than the battle between the Dutch auction IPO and the traditional IPO.

Pioneered by Bill Hambrecht at his firm, WR Hambrecht, the Dutch auction IPO has investors bid on what they would pay for shares. The price is set when it is low enough such that there are enough participants willing to pay for it so the proceeds will equal the amount the company wanted to raise.

In the more traditional IPO, the investment bank will usually set the price. The bank will set it low enough so that its large institutional customers (who generate the most trading commissions) get a price low enough so they can get a pop out of the gate. In the Internet boom, stocks were often doubling or tripling right at the open, presenting a substantial reward to the customers of the banks but unfortunately raising less money than was potentially available for the companies going public.

"I became uneasy with the traditional IPO process when Hambrecht & Quist went public," Bill Hambrecht says. "The institutions that were long-standing customers of H&Q couldn't get into the IPO. Only the favored customers of the banks could." Hambrecht eventually left H&Q and started up his firm where he brought winery Ravenswood public at $10.50 a share in the first Dutch auction IPO. Ravenswood got bought a year later by Constellation ( STZ) for $30 a share, almost triple from its IPO time.

Since that first offering, 11 more companies have gone public through the Dutch auction process, including Google ( GOOG). On average, buying a company at its Dutch auction IPO price would've resulted in a 90% return per trade. This is in contrast to the overall market, which has declined since the first Dutch auction IPO in 1999.

There have been two losers in the Dutch auction process: Briazz, which went public in May 2001 at $8 per share, and Salon.com, which went public in June 1999 at $10.50 a share. Both now are bulletin board stocks. In addition to Ravenswood and Google, the winners include Overstock.com ( OSTK) ($13 IPO, currently around $52), New River Pharmaceuticals ( NRPH) ($8 IPO, currently around $26) and Genitope ( GTOP) ($9 IPO, currently around $14.40).

The reason this topic is relevant today is that Tuesday saw the latest Dutch auction IPO, as Bank of the Internet ( BOFI) went public, selling three million shares at $11.50. Shares were recently trading at $11.36.

There are various pros and cons to investing in an online bank vs. a brick-and-mortar bank. Traditional banks have considerably more infrastructure expenses: more employees, physical facilities, etc. However, online banks don't offer the comfort that customers get when they can actually meet and physically interact with the bank's representatives at the local branch office.

That said, if you can add deposits at an online bank then you have a significant head start since your costs for servicing that account are not as great. You take in money in the form of deposits and then loan it out on a mortgage and make the spread between the interest rates. According to Bank of Internet's S-1 filing, it opened 6,408 new deposit accounts during the prior fiscal year ending on June 30, 2004. For the six months preceding Dec. 31, 2004, it opened 5,028 new accounts, representing a significant increase in run-rate.

Additionally, net income was up 79% year over year for the fiscal year ending June 30, 2004, leading me to expect another significant (greater than 50%) increase in net income for the current fiscal year. Total assets were up 67%, to $405 million.

With 5.2 million shares outstanding, this leaves the company with a market cap around $60 million and a P/E below 30 despite having a growth rate significantly higher than 50%. This growth rate should continue as people get a higher degree of comfort with banking online.

This is a micro-cap stock, so beware, but I do think it presents an interesting opportunity both based on its fundamentals, as well as the current success rate of the Dutch auction IPOs.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Bank of the Internet to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.
James Altucher is a managing partner at Formula Capital, an alternative asset management firm that runs several quantitative-based hedge funds as well as a fund of hedge funds. He is also the author of Trade Like a Hedge Fund and Trade Like Warren Bufffett . At the time of publication, neither Altucher nor his fund had a position in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback and invites you to send it to james.altucher@thestreet.com.

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