Tim Hortons IPO was built to make the rich richer

The pump and dunk scheme left a small fortune on the table. It was also nasty. The rich guys — the hedge funds — got a lot richer; the poor schlubs who make the Tims shops their second home were largely shut out of the stock market bonanza. So much for shareholder democracy. Remember that concept?

The Globe and Mail
March 25, 2006

Tim Hortons IPO was built to make the rich richer
Eric Reguly

It seems churlish to consider one of the hottest IPOs since the invention of capitalism a botched affair, but Tim Hortons absolutely qualifies. The pump and dunk scheme left a small fortune on the table. It was also nasty. The rich guys — the hedge funds — got a lot richer; the poor schlubs who make the Tims shops their second home were largely shut out of the stock market bonanza.

So much for shareholder democracy. Remember that concept?

There's no doubt investors made a nice buck yesterday. The problem is, they were the wrong investors. For that, you can blame Wendy's. If it's any consolation, Wendy's itself could have done better if its overriding ambition went beyond pleasing the underwriters and their hedge fund buddies.

Wendy's, the third-biggest American hamburger chain, sold 29 million shares of Tims at $23.16 (U.S.) in the United States and $27 (Canadian) in Canada, raising $672-million (U.S.). Even though the underwriters — Goldman Sachs and RBC Dominion Securities — raised the price this week by some 20 per cent, the shares shot out of the gate faster than your fat uncle can chomp through a Maple dip. In the morning, they climbed as much as 42 per cent. They finished in New York at $28.17, for a gain of $5.01 or 21.6 per cent.

Let's do the math. The money left on the table — the difference between the first-day closing price and the IPO price, times the number of shares — works out to $145-million. That's loot that could have gone to Wendy's if the deal had been more realistically priced. Put another way, the IPO transferred $145-million of wealth from Wendy's investors to Tims' investors.

By "investors," of course, we mean the hedgies in good part. The hedgies, among them Pershing Square Capital's William Ackman, were not happy with Wendy's performance. They put pressure on the company to sell Tims — the IPO unloaded 17 per cent and the rest will go by the end of the year.

It's impossible to tell how much of the IPO went to the hedgies. But we do know the underwriters allocated about 74 per cent of the deal to institutional investors, 16 per cent to the retail crowd and 10 per cent to the franchisees. Jay Ritter, the University of Florida finance professor who tracks IPO performance, says hedge funds in recent years typically have gobbled up 40 per cent of the value of IPO issues.

If you apply the figure to the Tims deal, the hedgies walked away with a gain of close to $60-million yesterday. The retail investors who were lucky enough to get into the deal made proportionately the same amount. Unless you were shacked up with a Goldman or RBC broker, luck had everything to do with it. As the ballistic share price proved, many more small investors — the patrons who unfailingly dump their coins on Tims' counters every day — got shut out of the IPO than not. You could assume most of the hedgies wouldn't be caught dead in a Tims shop.

So Wendy's left a load of dough on the table. Retail investors were more wannabe than real. What could Wendy's have done to scatter a few more smiles around? A share auction might have done it.

Share auctions, as opposed to the usual method of "book building" by the underwriters, are rare in North America, less so in Europe. In an auction (sometimes called a Dutch auction), the number of shares to be sold is set, but not the price. Investors simply bid for the stock. The deal goes out the door at the price that will clear the number of shares the company wants to sell. Google's 2004 IPO was an auction.

Auctions have advantages. The first is that they tend to raise more money for the issuer because the traditional underwriters' discount is eliminated (underwriters like to price low to ensure the issue flies off the shelf, as Tims did). The second is reduced underwriting fees, because the underwriters do less work. An auction might pay them 2.8 per cent against the usual 4 per cent. The biggest advantage is fairness. Since auctions are open, anyone who pays the clearing price, whether he wants 10 shares or a million, gets into the deal.

Auctions aren't perfect, of course. Creating an unstable shareholder base is one problem. Since anyone can get in — day traders and other quick-buck artists — the post-IPO share price can be volatile for some time.

Still, the good outweighs the bad. So why did Wendy's choose a traditional IPO? You could argue it was designed to buy peace with the hedge funds, who had been making life uncomfortable for management and who won big yesterday. The underwriters obviously pushed hard for a traditional IPO for the same reason.

Hedge funds are great clients because they will pay higher trading commissions than pension funds. A pension fund might pay 3 or 4 cents a share; the hedgies double that amount. In exchange, they get to the front of the line when the hot deals come along. This is why auctions will never take over.

Too bad. In the meantime, the rich IPO buyers will get richer. You won't, because the underwriting system is basically unfair. Life sucks. Have a doughnut.

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Risks: Royal Bank of Canada, RBC, Initial public offering, IPO, Dutch auction, Pump-and-dump scheme, Canada, United States, 20060325 Tim Hortons

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