Notes of Note from John F. Ince

John Ince Interviews Joe Shell, Head of Merrill Lynch Investment Banking in 2000

Note:  This interview was conducted in 2000 while Ince was with Upside Magazine

Interviewed by  John F. Ince

Joe Schell joined Merrill Lynch in February of this year as head of global technology investment banking. Prior to that, Schell headed investment banking at Montgomery Securities for approximately 15 years. Subsequently, he was head of investment banking at Bank of America after its merger with Montgomery in 1998. At Merrill Lynch he has expanded the global investment banking group from 80 to 175 professionals with a goal of making Merrill Lynch “the premier technology investment bank.”

Upside: What do you make of the recent trend towards commercial banks acquiring investment banks and how does this change the underlying competitive dynamics of investment banking?

Schell: Global reach is very important in today’s world. Everybody is getting bigger.  This makes for fewer, but stronger competitors.  Small firms can appear to be more facile and able to react more quickly, but, particularly in the technology sector, companies need firms with global capabilities almost immediately.  They’re picking firms to do their first financings whether they be private financings, IPOs or M&A transactions earlier in their lifecycle,  firms that they can stay with in the long term.  The underlying message to take from DLJ-First Boston and Morgan-Chase and all the recent mergers is that scale, and having capability in all relevant areas, particularly the high margin areas like investment banking is extremely important. They’re trying to match the global scale that we already have.

Upside: How much of this is the result of regulatory changes and how much is other factors.

Regulatory changes allowed it, but it was not the catalyst.  The market was the catalyst.

Upside:  How is technology changing investment banking.  The conventional wisdom of investment banking is that it is a relationship driven business.  Are the potential efficiencies that grow out of the Internet as applicable to investment banking as they are to some of these other industries that are being transformed?

Schell: I agree that investment banking continues to be a relationship driven business as opposed to a transaction driven business.  All of us invest a lot of time and energy in building relationships. Technology is affecting some parts of the underwriting and distribution process, but I don’t believe it will displace the relationship advisory side of investment banking.  On the brokerage side, I just don’t see that all of a sudden, because of the power of the Internet, a brokerage client is going to be perfectly happy in a relationship where he never meets a broker or talks to or sees the research from a broker.   There is certainly a place in our economy for online brokerage, but I just don’t see it overwhelming the full service side of the business.   It’s not black or white.  It’s not one replacing the other. The online brokerage business is expanding rapidly, and in fact we have one of the best offering available.  But at the same time there are still a lot of smart  people who are willing to pay for the extra services you get from a full service firm. They will co-exist happily.  Depending on marketplace at any give time one will seem to have momentum versus the other.

Upside: So what are firms like Merrill doing to compete in this new economy?

Schell: Most all the older firms that have done business the full service way, now have online initiatives that have become part of their offerings.  I don’t think there is any credence to the thought that we’re going to be marginalized.  We will be more and more competitive thanks to some of the smaller younger companies that are showing new ways of doing things.

Upside: What are the key success factors in investment banking today?

Schell: Brand will always  be important given that it continues to represent what a firm stands for.  In the case of Merrill Lynch, our brand is a global firm, the symbol of our brand is the bull and that represents our positive outlook.  We do our best job when the markets are difficult and when there is the need to market more broadly.  Also important is the ability to market broadly.  In a service oriented business like this, a firms’ ability to prove themselves in volatile times like this is critical.  That means having the resources, the capital, the research, and good people and being able coordinate those resources.

Upside:  Since Netscape went public, we’ve had firms going public at a much earlier stage in their lifecycle.  Has the volatility of the marketplace become institutionalized by this trend toward earlier stage IPOs?

Schell: To some extent yes.  The public markets in the last couple of years have been accommodating to companies that were not as mature or well tested as they used to be.  You’re like likely to have issues that come in out in first couple of quarters as public companies that are disquieting to the market.  We sell public stock, particularly in the tech world, on the basis of promises or expectations of future performance,  more than on past performance.  So if there’s any hiccup or wrinkle in that performance, it gets magnified greatly because of the dependency the market had in the first place on buying these companies on the basis of expected performance.  Sometimes valuations got ahead of where the fundamentals were.  All of sudden the individual investor has awakened to the fact that this is not a no risk business.

Upside: Let’s focus on pricing for a moment. Do the open IPO and Dutch auction being tried by WR Hambrecht make sense, and do you think it will ever catch on in a major way?

Schell: The Dutch auction approach has utility and merit when there is a very sophisticated market and you’re trying to find the buyers who are willing to pay the greatest price.  But, I don’t think it has applicability in most technology IPOs.  I don’t think that the individual investors or the more aggressive hedge funds that are willing to be the highest priced buyers in IPOs, create a very stable aftermarket.

Upside: Can you expand on that?

Schell: When we do a transaction, we’re not only trying to accomplish the best price for our client.  Many times the best firms know that they could sell the issue at a higher price, but they feel that the lower price would accomplish the firms objectives of a fair price for the stock, but also accomplishes the other side of having investor purchase the stock and know that it’s a good investment not just for a day or two, but for a longer term.  That creates the stable aftermarket, hopefully a gradually rising aftermarket.  The company then has access to the public markets again, and it has served the best interests of all parties.   In a Dutch auction, you sell securities to the highest bidder and that is totally inconsistent with a good aftermarket because you wipe out all the upside potential. The Dutch auction process doesn’t have the sensitivity to the aftermarket dynamics that we have when we do it the regular way.  You’re making a long term mistake for the company and it will be born out pretty quickly.

Upside:  But what 1999 where we saw the huge jumps in stock price, and the issuing firm lost out on the fundraising potential when the price was priced so low. What do you say to the firms that feel that because the initial price was price too low, money was left on the table?

Schell: I’m not aware of very many companies who feel betrayed by their underwriter.  There is so much input to a company during the course of selecting investment bankers.  They’re face to face with the investment bankers during the roadshow.  They are given a very thorough education about how stocks are valued in public markets.  For the most part, all the people who are involved with making pricing judgements,  own significant portions of the stock and they love to see the stock jump from 20 to 80.  Most people understand that underwriters make more money if we sell it higher.  But we have to find the highest price consistent with the job we set out to do: having a successful public launch and strong aftermarket.  We have audiences on both ends of the process and we’re trying to find that perfect price which maximize values to the sellers of the stock and also creates the best opportunity for investors down the road.

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