Lemonade quenches thirst of banks and hedge funds

Daniel Schreiber and Shai Wininger

The Israeli digital insurer's share price rose 140% on its first day but the public didn't benefit because the system favors the investment banks and hedge funds.

Last Wednesday, digital insurance company Lemonade (NYSE: LMND) completed its Wall Street IPO, raising $319 million at a company valuation of $1.6 billion, after money. The share price of $29 was higher than the $23-26 range at which Lemonade had priced the shares the previous week, but still well below the $42 price per share of its final private financing round last year.

But by the close of the digital insurance company's first and only day's trading on Thursday, (the market was closed on Friday, the eve of Independence Day), the share price had risen 140% to $69.40, with a market cap of $3.8 billion. It might have been a public offering but the public did not benefit from this sharp rise.

Even $1.6 billion had seemed somewhat high for a company with just $82 million revenue in the last four quarters and from Lemonade's prospectus it is unclear just how successful its business model actually is. Certain data did not appear, for example figures that could help investors understand how efficient and what are the advantages of buying Lemonade's home insurance policies. And the company has only been operating several years and it is still too early to draw conclusions from the figures it does provide.

Last week I spoke with somebody who knows Lemonade's founders and only has good things to say about them. "You have to look at what the company is trying to do," he said, "You're right if I were a venture capitalist," I responded. But at the stage we are at now and with the company about to hold its floatation for a substantial valuation, I want to be able to rely on data and an ability to analyze the company." Maybe the person I spoke to was right and Lemonade will create a revolution and conquer the market. For me the information and data are still lacking.

Is a rise of 140% on its first day of trading a success? In my opinion not necessarily for there are several considerations in setting a share's price. The desire of the existing shareholders to dilute their holdings as little as possible, to allow new investors to profit, or in other words to provide them and the share with a positive opening and that the share price won't fall in the first few days, the desire to bring in long term investors to the company, and not those who will toss the shares back into the market at the first opportunity, and of course whether the company can raise at a higher price without risking a failed offering.

So how did things unfold? During the roadshow the company received indications that were apparently positive, because Lemonade raised its share price for the IPO but frequently it's difficult to understand how investors will behave after the capital has been raised. Currently major backing is being given to companies offering digital services due to the Covid-19 crisis, which according to forecasts (and the hopes of those buying Lemonade's shares) will boost the use of services like these.

Another point that cannot be ignored, is the structure of the IPO and the role of underwriters and banks in them: those who support the company in all the stages leading up to the IPO - from drafting the prospectus, through meetings with investors and onto the pricing.

In other words, those who manage the very demand for the shares are the bankers like Goldman Sachs, JP Morgan and others. They are in contact with the customers, institutional bodies and hedge funds, who buy large packages of shares, very often, at a lower price than the rank and file investors can buy it for. It is important to dwell on this point. The institutional investors bought Lemonade's shares at $29 per share but the public was only able to purchase shares after the opening of trade by which time the share price had jumped to $50 (the opening price is set according to real-time demand).

Prof. Jay Ritter, of the University of Florida, who specializes in corporate finance, has researched this topic and reached several conclusions. In the decade ending in June 2019, 1,155 companies left 'on the table' the huge sum of $47 billion - an average of $37 million per company. This amount is the gap between the closing price of the offering on the first day times the number of shares. For example, Lemonade 'left' $440 'on the table' - the share price rose $40 x 11 million shares.

It is by no means certain that it is correct to look at the overall sum (in other words to look at every day's jump in price) because there is no certainty that it will stay that high, even in the short term, let alone the medium to long term. For example Snap soared 44% on its first day trading to $27 - a peak it has never again reached. Israeli freelance services platform Fiverr (also cofounded by Shai Wininger, one of Lemonade's founders) jumped 90% to $40 on its first day of trading but three months later, the share price was back down to $18 and it took 10 months to get back to $40, in the midst of the coronavirus crisis, which has boosted the company. Fiverr's share price is currently $76. Generally speaking, a share's price at the end of its first day of trading is no indication of direction - six months at least must be taken into account. This is when the lockdown period ends in which the existing shareholders are prohibited from selling their shares.

And yet, it cannot be ignored that money has been left on the table. Ritter and other critics of the existing model stress an important point: these huge amounts of money find their way to the strong institutional investors and hedge funds.

One of the most vociferous and persistent opponents of the current model is Benchmark general partner Bill Gurley, who is considered one of the world's leading venture capital investors, who invested in Uber, among other companies. Gurley supports a model of direct listing for trade as Spotify and Slack did, a model in which companies list on the market, without actually raising money, and thus weakening the power of the banks.

In a conference on the subject held a year ago, Ritter presented claims that the banks (underwriters) deliberately underprice the shares. He says that a higher price would force them to work harder to bring in investors, and would increase their marketing expenses.

In addition, institutional investors who are interested in participating in attractive IPOs pay high fees to underwriters in order to get preference. He presented calculations to show that the underwriters prefer to receive fees from investors for the IPO, than the fees they would receive for a higher share price. So why doesn't the model change?

Published by Globes, Israel business news - en.globes.co.il - on July 5, 2020

© Copyright of Globes Publisher Itonut (1983) Ltd. 2020

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