Morningstar said in a recent regulatory filing it has chosen a ticker symbol for its initial public offering, suggesting that it might finally be ready to bring shares to market after months of delays.
In a Feb 3. S-1A filing with the Securities and Exchange Commission, the Chicago-based mutual fund research firm said shares of its common stock would be listed on Nasdaq under the ticker symbol MORN, but that the terms and date of the offering have yet to be determined. The number of shares that will be sold and the price range for the IPO also were not disclosed. Through the offering, the company hopes to raise $100 million in capital to fund new business initiatives.
Plans to bring the firm public were first announced last May, but since then, there had been no activity until the registration amendment was filed. During that time, the company has become the subject of two regulatory investigations, raising doubts about the timing of the IPO. In keeping with quiet-period restrictions, Morningstar spokeswoman Margaret Kirch Cohen declined to comment on the IPO process.
New York Attorney General Eliot Spitzer subpoenaed the company as part of an investigation into its consulting business, Morningstar Associates, which recommends funds for 401(k) plans and provides advice on asset allocation, and its brokerage subsidiary Morningstar Investment Services. Given Spitzer's track record for sniffing out impropriety, many industry observers caution that the probe may spill over to perceived conflicts of interests between the funds it recommends and the fees it accepts from its advisory clients.
A recent article in Fortune magazine reported that Spitzer's subpoena was related to a retirement product sold by two large insurance companies that are clients of Morningstar Associates. The report said that Spitzer is looking into "whether fund companies may have paid Morningstar to recommend their funds over other firms." Morningstar vehemently denied the suggestion that it accepts fees other than those paid by the plan provider.
On top of that, the SEC is mulling charges against the company for publishing erroneous fund data on the Rock Canyon Top Flight fund and subsequently failing to correct the miscue in a timely fashion. While the SEC does not have explicit jurisdiction over research providers, the agency told Morningstar that if it was reckless in its handling of the data, then a civil suit could be brought against the firm. The company has said it is fully cooperating with the Commission and the attorney general's office on those matters.
"You can't bring a company public with that sort of black cloud hanging over it," said Sal Morreale, a trader who tracks IPOs for Cantor Fitzgerald. He is skeptical that the shares will come to market anytime soon. "It's not even on anyone's radar screen," he said, as he flipped through his IPO calendar.
"It's been completely dead in the water," agreed John Fitzgibbon, an analyst for IPO Desktop, a provider of independent IPO research for professional money managers and individual investors.
Still, other industry experts are more optimistic about the offering. "While investors seem skittish of such things, the issues do seem small," said Tom Taulli, co-founder of IPO research firm CurrentOfferings.com. "And, with the amended S-1 filing, perhaps Morningstar is now confident that the issues will not be enough to scare investors." Taulli expects the IPO to be priced within the next few weeks, likely between $15 and $20.
"It's not that unusual for a company to have some fits and starts in the process of going public," said Jay Ritter, Cordell professor of finance at the University of Florida. "Changing market conditions could prompt them to put it on the back burner for a while."
In January, Morningstar said that Morgan Stanley would no longer serve as its lead underwriter for the IPO and that it decided to use a "Dutch" auction format, one widely used overseas but still a rarity in the U.S. IPO market. Instead, the company hired W.H. Hambrecht, a firm that specializes in the auction process, as its new lead underwriter. Historically, there have only been 10 IPOs in the U.S. that have used the Dutch auction format, nine of which were handled by Hambrecht. The only exception was Google, which Morgan Stanley begrudgingly engineered on an auction basis last August.
While bringing a company public is a rather nuanced process, the simplest explanation for the Dutch auction is that it's a sealed bid auction, in which both individuals and institutions have a level playing field, and investors can submit bids through their broker. Essentially, the company looks at the demand curve that has resulted from the auction and decides what price the offer price should be set. Anybody who had a bid at or above that price is allocated shares. "The equality resonated with us," said Joe Mansueto, Morningstar's chairman and chief executive officer, last month.
The advantage for Morningstar using the auction format, according to Ritter, is that it exerts greater control over the process rather than having the investment banker pulling the strings. That way, the company can potentially raise higher proceeds and leave less in the hands of investment bankers, he said. In that regard, between the shareholders and the company, they're going get more of the total pie and the investment bankers will get a smaller slice than it would in a typical IPO.
The downside, Fitzgibbon notes, is that the average run-up on a stock brought to market via the Dutch auction is about 0.3% on its first day of trading. Further, with the exception of Google, only two other IPOs that have used this process have been successful: Overstock.com and Peet's Coffee. Then why opt for the Dutch variety? "The logic behind the move is to get these deals done," he said, noting that the auction process cuts through a lot of the red tape. It says, "Here we are. What do you want to pay for us?'" he said. As for the level-playing field for retail investors, Fitzgibbon argues that only qualified investors can participate in the auction, which may exclude "Ma Kettle and Joe Sixpack."
Morningstar carries tremendous weight in the massive $7.9 trillion mutual fund industry and has enjoyed significant growth since its days as a startup back in 1984. But despite its high profile and solid reputation, the company generated only $130 million in revenue in the nine months ended Sept. 30. And while it did post a net profit for the period, it has lost $80 million in the previous five years.
In the short run, the infusion of cash from the IPO will certainly help the company cover losses and invest in ways to improve revenue streams, but over the long haul, it will have to give its business model a makeover in order to fatten margins. Expanding its institutional business is the key to its success, analysts say, because eventually the IPO cash will dry up and it will have to find a way to deliver for its shareholders. This could be a very dicey situation considering it has built its reputation as being a champion of individual investors.
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