Splunk Underwriters Did Huge Disservice (SPLK, MS, CS, JPM, BAC)

Splunk Inc. (NASDAQ: SPLK) was touted as a hot IPO but became a sizzling hot IPO. The company priced 13.5 million shares at $17.00 per share, but this was a premium to the already-raised range of $11 to $13 per share after initially having been targeted at $8 to $10 per share. So, why did this one open up at $32.00 and why did it close at $35.48 with some 14+ million shares having traded?

The underwriting group just got this one very wrong and left millions upon millions of expansion capital on the table for Splunk to finance its growth. The book-runners of the offering were Morgan Stanley (NYSE: MS), Credit Suisse (NYSE: CS), JP Morgan Chase & Co. (NYSE: JPM) via JP Morgan Securities LLC, and Bank of America Corporation (NYSE: BAC) via BofA/Merrill Lynch. Other managers in the syndicate were UBS Investment Bank, Pacific Crest and Cowen and Co.

Splunk has a software platform that allows companies and large organizations to harness their data via real-time operational intelligence. The company has been growing rapidly and claims over 3,700 customers, which all pay license fees based on index capacity needs. Sales almost quadrupled from 2010 to 2012, with the most recent annual sales at $121.0 million. Even before the IPO came out the stock was given a boost by JMP Securities as it initiated coverage with a “Market Outperform” rating and with a $22.00 price target. The opening price was $10.00 above that! Shares rose another 2.9% to $35.79 on more than 130,000 shares in the after-hours session.

The leading underwriters could hardly argue that they did not do the company a huge disservice here. IPOs that double or come close to doubling on an opening price and that close up higher imply that the underwriters did not know what they were doing. Sure, it gives Splunk a market value of twice what it was told, but it also means that the company raised only half of what it could have raised. Companies come public so that they can finance their growth and to create a liquidity in the company (and a liquidity event for the backers).

Almost all of the shares were sold by the company: 12,507,278 shares were sold by Splunk, and 992,722 came from selling shareholders. To make matters worse, Splunk had granted the underwriters a 30-day option to purchase up to an additional 2,025,000 shares to cover over-allotments. You can bet your assets that the greenshoe option was exercised.

The reason that the 100% premium to the premium pricing is a huge disservice is because it means that money managers, hedge funds and mutual funds who were allowed to buy shares on the IPO suddenly have a double in price on their hands. They took none of the venture stage risk, and they did none of the work to get the company public other than look at the growth rates and say, “Sure, I would like to buy 10,000 to 100,000 shares.” And they double their money overnight.

When you see moves like this, it should really point out that the OpenIPO process from W.R. Hambrecht & Co. might be at least one better way. If this does not give Facebook an even stronger leg to stand on to demand that the underwriters take huge discounts and offer a strong pricing, then nothing else does.

When Splunk first filed for an IPO it was for up to $125 million. The company sold $229.5 million in total gross proceeds (including insider shares) and that is before considering the 2.02 million shares in the overallotment option, which you know have already been exercised by the underwriters. The total implication is that Splunk probably could have raised up to $300 million to $400 million, if you discount the huge opening and closing premiums on the first day.

In 2011, Splunk had the following expenses: R&D $23.56 million; Sales and marketing $74.78 million; and G&A $19.69 million. Had the underwriters priced this one correctly, Splunk could have raised another full year’s worth of operating expenses.

Imagine if you were selling a rent house property and your real estate agent left a full year’s worth of living expenses on the table. At some point in the future, companies coming public should be able to have at least a bit more control over the IPO process.

JON C. OGG