May

22

 Often times I wonder If I am the only sane person in the world. For most of my career I have never understood why a corporate seller or I-banker should be praised because an IPO zoomed in the first few days of trading. By and large we praise people who buy low and sell high, but with IPO's the conventional wisdom is that we should praise those (and their agents) who sell low.

Imagine you hired a real estate agent to sell your house. He/She advises you to sell it for 300K. You do. The next day after you sell it sells for 500K. Are you happy? Of course not. Yet, when I-bankers do that very thing, they are praised, and so are the seller who sold at a low price.

The two decades of my career have seen only the following dynamic:

Stock goes up after IPO: Seller and Seller Agent good Stock goes down after IPO: Seller and Seller Agent bad.

Now, good and bad are subjective terms. If I were a buyer of an asset, I would want it to go up in price afterward. Of course, If I were a seller, I would want it to go down.

Conventional wisdom would probably say that it is in the interest of sellers and their agents as a whole if IPO's perform well, as that makes sure that buyers are around in the long term. However, shouldn't the seller's agent have a fiduciary responsibility to the seller, and not to the market as a whole?

The simple fact is this: This is the most successful IPO ever, and if I am ever in a position to IPO my company, I would want the stock price to plummet the day after I sold. That is how I would know that the investment banker(s) on the deal did a good job.

Yishen Kuik comments: 

I am sure there are other people who have been in and around the equity capital markets, but let me take a stab at Gordon's question.

1. An investment bank needs to have a stable of happy buyers and happy sellers to stay in business. All issuers like FB (the sellers) want to sell their equity for as high as possible - greed is universal among issuers. What investment banks will say in rebuttal is that you want to give the buyers a pop to make them happy, this way when you want to do a secondary down the road, your chances of successfully building a book is enhanced. Every businessman understands this — you have to leave a little on the table for the other guy, so that when you really need their cooperation, you can cash in those goodwill chips. This is why most IPOs are priced to pop a little. It's a goldilocks game - not too high and not too low is where both sides are happy.

Sometimes like Google, they thumb their noses up at Wall St and go their own way. But from what I understand the Google IPO was a mess.

2. At an investment bank during an IPO, the institutional sales coverage is the buyer's advocate and the ECM desk is the banks advocate. No salesguy who wants to stay in business wants to burn his client on a bad deal (although they are not adverse to inserting fat fees into a deal that won't burn the client - cue the selling of rich vol in creative re:opaque ways). The ECM desk however sometimes needs the buyers to take one for the team and support a weak deal. This is then repaid by participation in a good deals. Keeping track of favours owed and granted is the job of the respective heads of sales and capital markets, and this is what keeps the circus going, and how IPO books are built. The ability of an investment banks to raise stupendous amounts of capital very quickly is a non-substuitable service, and why they can charge substantial fees. A ECM desk that does not have the investment banking deal flow, does not have access to a top sales force, does not have skilled market makers, does not have the marketing power of a good research team and does not know how to manage favours with institutional investors will see it's ability to raise capital for clients degraded. And that ability is the engine room of an investment bank.


3.
CFOs and CEOs usually have careers that span several companies, all of which will need to go to market now and then. Therefore it is in their long term interest to cultivate good relationships with investment bankers. They will give a little, not much though, in order to get a little when they really need it. So when the ECM guy says he wants to price in a 10% pop, they will acquiese.

4.
Buyers want to align themselves with a bank that will feed them IPOs that have a high probability of popping. It's a sure strategy to pad their annual returns. But there is a dance here as well - buyers need to know that the investment bank is able to do a good job in pricing so that between the competing interests of the seller and the buyer, it is resolved slightly in favour of the buyer so that the health of the long term game is preserved. Buyers also want to know that their favours in swallowing bad deals are at least fairly noted and repaid. A good ECM professional therefore gets paid 7 figures, and the head can clear 8 figures.

This is why an IPO that goes up a little on opening day is viewed as a success by all parties. If it goes up too much it is viewed as a success by buyers & a mixed bag by investment banks ( the seller is pissed off, but then the industry is excited so more paper comes to market). If it tanks, it is viewed as a failure by buyers and the investment bank. The sellers have a mixed reaction.

This is also why I think it is very difficult to create an investment bank — there are many very expensive moving parts (teams of highly paid professionals) that need to come together. The Europeans and the Japanese have been trying for decades with very mixed track records and most recently Ken Griffith tried and failed.


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