Notes of Note from John F. Ince

Archive for the ‘Investment Banking’ Category

Sheared by the Shorts: How Short Sellers Fleece Investors: Ellen Brown

“Unrestrained financial exploitations have been one of the great causes of our present tragic condition.” — President Franklin D. Roosevelt, 1933

Why did gold and silver stocks just get hammered, at a time when commodities are considered a safe haven against widespread global uncertainty? The answer, according to Bill Murphy’s newsletter, is that the sector has been the target of massive short selling. For some popular precious metal stocks, close to half the trades have been “phantom” sales by short sellers who did not actually own the stock.

A bear raid is the practice of targeting a stock or other asset for take-down, either for quick profits or for corporate takeover. Today the target is commodities, but tomorrow it could be something else. When Lehman Brothers went bankrupt in September 2008, some analysts thought the investment firm’s condition was no worse than its competitors. What brought it down was a massive bear raid on 9-11 of that year, when its stock price dropped by 41 percent.

The stock market has been plagued by these speculative attacks ever since the four-year industry-wide bear raid called the Great Depression, when the Dow Jones Industrial Average was reduced to 10 percent of its former value. Whenever the market decline slowed, speculators would step in to sell millions of dollars worth of stock they did not own but had ostensibly borrowed just for purposes of sale, using the device known as the short sale. When done on a large enough scale, short selling can force prices down, allowing assets to be picked up very cheaply.

Another Great Depression is the short seller’s dream, as a trader recently admitted on a BBC interview. His candor was unusual, but his attitude is characteristic of a business that is all about making money, regardless of the damage done to real companies contributing real goods and services to the economy.

Here is how the short-selling game is played: stock prices are set by traders whose job is to match buyers with sellers. Short sellers willing to sell at any price are matched with the low-ball buy orders. When sell orders overwhelm buy orders, the price drops. The short sellers then buy the stocks back at the lower price and pocket the difference. Today, speculators have to drop the price only enough to trigger the automatic stop loss orders and margin calls of the big mutual funds and hedge funds. A cascade of sell orders follows, and the price plummets.

via Ellen Brown: Sheared by the Shorts: How Short Sellers Fleece Investors.

Goldman Deal Helps Facebook Remain Private –

In Silicon Valley, going public used to be the ultimate rite of passage for a start-up — a sign it had arrived.No more.With its $500 million infusion from Goldman Sachs and other investors, Facebook is now flush with cash, and a market value of about $50 billion, giving it the financial muscle it needs to compete with better-heeled rivals like Google.And Facebook hopes for an even bigger advantage from the deal, the ability to delay an initial public offering. That would allow it to remain free of government regulation and from the volatility of Wall Street. It would also allow Mark Zuckerberg, the company’s chief executive, to retain near absolute control over the company he co-founded in a Harvard dorm room in 2004.This strategy was unthinkable in Silicon Valley just a few years ago, when hundreds of start-ups with scant revenue and no profits, like and Webvan, raced to go public, and investors eagerly lined up to buy their shares.Lots of people would stand in line to buy shares in Facebook, but for now, only an exclusive few — wealthy clients of Goldman Sachs — will be able to. On Monday, Goldman sent e-mail to certain clients, offering them the chance to invest in the company.Article ToolsE-mail This PrintShare45 CommentsThat offer is the latest sign of the emergence of active markets in the shares of closely held companies. Those markets are helping successful start-ups like Facebook develop the financial wherewithal to compete in the big leagues of business. They have also become an avenue for venture capitalists and start-up employees to cash in their stock, turning many overworked engineers into instant millionaires.And so a young mogul like Mr. Zuckerberg, the world’s youngest billionaire at age 26, can enjoy many of the benefits of going public without having to tie the knot with Wall Street.

via Goldman Deal Helps Facebook Remain Private –

Goldman Sachs Pays Huge Bonuses And Gives Junior Bankers A 50% Salary Raise

Goldman Sachs delivered this years bonus news on Tuesday to partners, directors, vice presidents and analysts. Our reporting reveals that it was very welcome news to almost everyone. Partners this week were old that their 2009 bonus will be paid 60% in stock that will vest over 3 years. Several partners we spoke to seemed happy to get Goldman stock instead of cash.”Cash loses value over time, while Goldman stock gains,” one partner said.Junior employees at the investment bank also saw their pay change. Many vice presidents got bonuses that matched or beat the numbers paid in the record year of 2007, people familiar with the matter said. Whats more, some saw their base pay increase by as much as 50%, reflecting a shift away from bonuses toward salary. The huge payday seems to be having its desired effect.”Its made me rethink everything,” a Goldman Sachs employee said last night. She was sipping champagne. “I like the new structure even better. My monthly take home just went way up.”

via Bonus Watch 2010: Goldman Sachs Pays Huge Bonuses And Gives Junior Bankers A 50% Salary Raise.

Grim numbers point to the end of the venture capital era –

Excellent analysis of the current state of Venture Capital Investing in Silicon Valley …

How gloomy is this picture for venture capital firms? According to an NVCA survey, 90 percent of venture capitalists who responded expect their industry to contract through 2015.

That trend is well under way. While firms have not started collapsing en masse, they have been quietly shrinking. The number of principals at U.S. venture firms fell from 8,892 in 2007 to 6,828 in 2008. As firms raise smaller funds, they need fewer people to invest.

Some will argue that at least in the area of Web startups, companies can be launched on the cheap, and growing numbers of angel investors — those wealthy individuals who invest at the earliest stages — are stepping in to give these companies a boost. True, but that kind of funding doesn’t work as well for biotechnology, medical devices or cleantech. And these angel-backed companies are small and lean, and don’t create large numbers of jobs.

It’s not just fewer startups, though. When companies don’t go public, they don’t generate the same number of jobs in their later stages. Heesen said the cash raised from an IPO usually triggers an explosion in hiring.

“The real job creation starts far down the road, after they go public,” Heesen said.

Instead of going public, the companies that do show potential now get gobbled up by the Googles and Facebooks of the world. At the same time, valley giants like Hewlett-Packard, Oracle, Intel and Cisco Systems continue their acquisitions of larger tech companies, a consolidation trend that more often than not is accompanied by big job cuts.

So we’re seeing fewer startups and sweeping consolidation. Tie those trends together, and you’ve got a drag on job creation that could weigh down the valley for years to come.

With venture capital in retreat, we must look elsewhere for a new model for startup funding to kick-start the valley’s next era of innovation and the kind of job creation we desperately need.

via O’Brien: Grim numbers point to the end of the venture capital era –

How nonprofits could access needed capital. – By Douglas K. Smith – Slate Magazine

Private-sector companies have ready access to a gargantuan capital market of tens of trillions of dollars globally. Nonprofit organizations, by contrast, are crippled by capital-raising efforts that are minuscule, inefficient, and badly organized. As a result, nonprofits that have developed solutions for critical and growing challenges—in fields like education, health care, housing, economic development, and environmental sustainability—often struggle to grow.

This is a problem with a solution that is entirely within the power of our legislatures. Like the private sector, nonprofits need investors who take risks in pursuit of financial return.

We might call this approach “dynamic deductibility.” Here’s how it would work.

via How nonprofits could access needed capital. – By Douglas K. Smith – Slate Magazine.

Hedge-Fund Lending Draws Scrutiny –

Very very interesting …. Companies that borrow money from hedge funds often see a sharp rise in bets against their shares before the loans or loan amendments are announced, new research shows, suggesting that fund managers or others privy to these deals may be illegally trading ahead of the announcements.

The sharp spike contrasts with little change in the short selling of companies that borrow money from banks, according to the research.

“Hedge fund lenders, like banks, are ‘quasi-insiders’ and thus privy to private information about the performance of borrowing firms,” the authors write. “However, hedge funds are not subject to the same degree of oversight and regulation as banks.”

The paper, by four academics and accepted for coming publication in the Journal of Financial Economics, tracks the trading of 105 U.S. companies that borrowed money from hedge funds between January 2005 and July 2007—a period when regulators began demanding more information about short selling.

The academics found that the average company receiving a new loan from hedge funds saw a 74.8% spike in the volume of short sales during the five days preceding announcement of the new loan, as compared with the volume of short selling 60 days before the deal.

By contrast, 255 similar companies turning to banks for loans saw little change in the volume of short selling during the five days prior to the announcement of new loans.

Short selling also jumped 28.4% before the announcements of amendments to existing loans from hedge funds, compared with a drop of 17.4% in short selling before the announcements of amendments for bank loans.

Short selling after a loan is announced might be expected, as investors and lenders hedge their exposure or bet against a company taking on debt at a high rate. But when it jumps before the announcement of a loan, the activity raises questions about whether the very firms lending money are using nonpublic information to trade against their borrowers, or whether information is leaking out to others.

via Hedge-Fund Lending Draws Scrutiny –

John Ince Interviews Bill Hambrecht, Founder of WR Hambrecht and Hambrecht and Quist

John Ince Interviews Bill Hambrecht, Founder of WR Hambrecht and Hambrecht and Quist

Bill Hambrecht, 64, is Chairman and CEO of WR Hambrecht + Co, a financial services firm headquartered in San Francisco that he founded in January 1998.   Bill resigned as Chairman of Hambrecht & Quist in December 1997, the investment banking firm he co-founded with the late George Quist in 1968.   WR Hambrecht + Co leverages the internet and the auction process to bring transparency to capital formation and securities exchange processes.  The firm’s earliest and best-known innovation is OpenIPO, an auction-based model for initial public offerings.  WRH+Co is expanding the use of the auction to high-grade corporate debt offerings and other capital markets. He currently serves as a director for numerous private and public companies including KQED, Inc., San Francisco’s public radio and television station and Beacon Education Management, which manages charter schools.  Mr. Hambrecht graduated from Princeton University.

Ince: What was your original business model?

Hambrecht: The original business model was to see if we could put together the breadth and power of the web with an auction process.  The reason I thought we needed both was that the web was obviously a very efficient, cheap and quick way to communicate with a large group of people.  It was obvious that this could be a great mechanism for distributing securities to affinity groups or retail customers.   But I also felt that there was no way this would happen unless you had another pricing mechanism that took away preferential distribution.   As long as there was preferential distribution, the IPOs or any attractive new issue merchandise would flow to the best brokerage customers.  That’s the way the business is driven. So I felt that we had to do both.  I knew that the really difficult thing would be to get a different pricing mechanism in a market that was used to negotiated pricing.

Ince: How has that business model stacked up against reality?  Do you still feel it’s a valid model?

Hambrecht: Oh yes.  Definitely.  As a matter of fact, I think it’s almost a classic destructive technology in Clay Christensen’s (Harvard Business School Professor and WR Hambrecht Board Member)  model.  Effectively what’s happened is that we’ve done four IPOs and one debt auction and we have a number coming along.  It been greeted with skepticism and a lot of competitive heat against it, because it’s clearly going to change the economics that accrue to the managing underwriter in a traditional deal.  It seems to me that the competition has reacted just as Clay Christensen’s model suggest they would.  They added more services, more analysts and more functionality in an effort to stave off what is inherently a more efficient and cheaper process.

Ince: How will it change the underlying economics?

Hambrecht: In two ways.  First of all, there is really no justification today for the traditional 7% spread for an IPO.  It was a historical spread that used to be paid when you really needed salesman to sell a new issue.   But in the last 10 years new issues are priced so much below the market that they get allocated, not sold.  And they get allocated to the best commission clients.  So the second form of profitability, which not obvious to everybody, but is very much there, is the tremendous reciprocal flow of commission business to the underwriter, who delivers a guaranteed profit to the institutions.

Ince: How does that work?

Hambrecht: No one will admit to it, but effectively at some point or another an underwriter, salesmen or somebody will count up how much guaranteed profit they’ve given to an institution and will want a certain flow of commission business back.  My own gut tells me that the commission kickback to the investment bank is about 20%.

Ince: Can you give an example of this?

Hambrecht: If you take a 1999 average IPO.  It was a $50 million deal. The underwriter’s commission was 7%.  The stock price doubled and it basically created $50 million in guaranteed profit for the institutional investor that was in on the initial stock allocation.  The managing underwriter, who determines where about 90% of that stock goes into the institutional pie, will probably get about $10 of commission flow back.

Ince: The skeptics that you refer to suggest that your Dutch auction process is insufficiently sensitive to the aftermarket for the stock.  Do you agree?

Hambrecht: It depends what you want out of the aftermarket.  If you are distributing an offering where you are implying to the buyer that it going to have a big premium over the offering price, then yeah you want to set it up to create as much irrational demand in the marketplace as you can.  And you do that by creating this image of great demand and very little supply.  You do it subtly, but you do it.  It goes out and jumps dramatically on the first day.  This gets in all the newspapers and everybody says, “Gee this is a great deal.” To maintain that price, it has to bring in a lot of interest from  day traders and aggressive trading accounts, because they think this is something very hot.  The problem with that is that it doesn’t last.  This is what gives the big institutions an opportunity to flip the stock and have a guaranteed profit.

Ince: How will the Dutch auction change all that?

Hambrecht: What we try to do is have an aftermarket that first of all, the foundation is set by a group of buyers that bid for the stock they own.  In other words, this group of people in effect have helped set the price.  There is no expectation of a big runup on the first day.  So instead of this huge of amount of trading that you get on the first, second or third day, there is very little trading.  Because there is really very little need to turn it over.  We think that our system finds people that really want to own the stock as an investment rather than a trading vehicle.

Ince: So which system has a better pricing mechanism.

Hambrecht: An auction delivers a price that is a lot closer to the real market demand, than an artificially negotiated price that is really negotiated to create this big runoff and this big emotional frothy aftermarket.

Ince: In doing this, are you alienating some of the “loyal” institutional investors?

Hambrecht: Maybe, but that should have nothing to do with the placement of the underwriting stock.  The company pays you a spread to place the stock with long term shareholders.   Whether the underwriter gets a kickback of commissions or not, should have nothing to do with where that stock goes.  If you’re doing the job that you get paid to do, you should place it with the best possible long term buyer.  What has happened, because of the guaranteed profit in this business,  95% of the stock gets turned over the first day.  So the company isn’t getting what it’s paying for.  The underwriter is getting a lot more profit than even the company realizes, because it’s done in this reciprocity rather than in an open spread.

Ince: But the underwriters suggest that their financial incentive is to price the stock as high as possible.  Is that true?

Hambrecht: No, the underwriter’s real incentive is to price it as low as they can, because the indirect payment comes from the big premium that is placed on the stock in the aftermarket.  Our system does get them the highest possible price commensurate with the market level.  In other words, it should be true demand, not emotional demand.

Ince: So what is the ultimate potential of the Dutch auction?  Others suggest that it at best will be a niche market?  Do you think it has larger potential than that?

Hambrecht: On August 15, we our first debt offering using the Dutch Auction.  It was a $300 million debt offering for Dow.  It went extraordinarily well.  We think that Dow ended up with a price that was about as close to the true market level as you could come.  It’s trading now about one basis point away from where it came out.  It also got a much bigger mix if buyers than you normally get in a debt offering.  We think it will spread very rapidly in that market.

Ince: Do you see the other investment banks picking up on this?

Hambrecht: Well, they’re going to have to respond in some way.  It’s created a lot of interest.

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

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.

John Ince Interviews Thomas Weisel, Founder of Montgomery Securities and Thomas Weisel Partners

John Ince Interviews with Thomas Weisel, Founder of Montgomery Securities and Thomas Weisel Partners

Introduction: Tom Weisel, graduated from Stanford University in 1963 Harvard Business School in 1966,  has now been in the investment banking industry for 35 years.  He was the founder of Montgomery Securities and guided the firm to national stature, particularly in the high tech area.  Twelve months after Montgomery was acquired by Bank of America in 1997, Weisel left to start Thomas Weisel Partners.  Barely two years later, the Thomas Weisel Partners website boasts that they are the are the fastest financial services startup in history.

Ince: So you’ve managed to to get off to a fast start.  Can you compete with the big boys in an industry where many of them are getting even bigger and starting to offer a one stop shop for financial services?

Weisel: By the way, we could have made that statement even bolder and said we are the fastest startup in history, not just the fastest financial services startup.  To my knowledge no other startup has attained revenues of $186 million the first year and $500 million in the second, as we have done. Obviously I think we can compete with the big boys.  Yes, you’ve got some of the finest financial institutions in the world merging and clearly their strategy is to build global institutions, with a breadth of products to retain and grow their client base.   But I personally think that many of these mergers are not going to work.    The more thoughtful growing corporations in America aren’t interested in a one stop shop.  Instead they’re interested in two things the big firms are not delivering.  They’re interest in quality ideas and bulge bracket execution capability?

Ince: What do you mean by bulge bracket?

Weisel: Bulge bracket means top six investment banking operations in the United States. This is not just my opinion. The world defines bulge bracket that way to include Morgan, Goldman, Merrill.  The next three kind of change but today it includes Solomon, First Boston, and then the sixth is open to question right now, because of all the mergers, the definition of who is in the bulge bracket is changing as we speak.

Ince: How is the trend toward mergers and acquisitions changing the underlying competitive dynamics of investment banking?

Weisel: Basically, it’s eliminating competitors.  It allows firms like ours to grow with less competition.  You look at who the top 10 or 20 competitors were ten years ago and you’ve just eliminated a lot of them.

Ince: Since the Netscape IPO companies have been going public at a much earlier stage in their lifecycle, and often investors know little about these companies at the time of their IPO.  What’s causing all this and are the public markets performing a venture capital function?

Weisel: In 1999 and the first quarter of 2000,  many companies with dubious business plans were able to raise venture capital money in the public marketplace.   It allowed companies to get capital way earlier than they should have.   There were a lot of things contributing to that.  During  that period,  online retail assets went from $300 billion to a trillion.  Then you had the trend towards momentum investing in the institutional world. This was exasperated this by the incredible of Tsunami of capital that flowed for the first time into the public markets from the online retail investor.  They bid up indiscriminately the values of anything in the retail world that was broadly defined in the Internet space whether that be commerce, bandwidth or infrastructure.   Many companies went public that should have stayed private, and it lead to the volatility in the stock market.  These were not real intelligent investors.  These were “mo” investors (Momentum investors).

Ince: Has this trend started to institutionalize volatility into the stock market?

Weisel: No,  All that came unwound in April and May of 2000.  Today companies have to have a lot more substance in terms of a verification of a business model and verification of products before they can go public now versus that 15 month window.

Ince: So has the March/April shakeout changed the investment tenor?

Weisel: I think so.  But  on the other hand when you have the kind of multiples on earnings and revenues that you have in some areas of the marketplace, that is going to create tremendous volatility.  A combination of the online retail investor going from a very small to a large part of the marketplace, and the ownership of these companies,  along with very high valuations of these companies–that is a cocktail for volatility–the likes of which the capital markets have never experienced.

Ince: How does one navigate through such volatility?

Weisel: Focus and deep domain expertise is a critical valued added component.  The marketplace is not one size fits all. The nuances between companies even in the same space have never been greater.  Corporations need to be very very smart about when and how they access capital markets to their advantage.  They’ve got to make volatility their friend and not their enemy.

Ince: Will we continue to see these high multiples?

Weisel: It depends on the industry and the company.  In the main companies, are valued on the basis of their potential in the marketplace, and many of these marketplaces are just so new that people just don’t know how big it is.  Is it $10 billion, $30 billion.  That’s the function of a firm like ourselves, to bring some context.

Ince: What do you think about the so called “new”  techniques of evaluating these companies?

Weisel: Many people are justifying ridiculously high prices, by using supposedly new metrics. But the marketplace is not really changing the method of valuation.   If an investor falls into that trap, he’s going to lose a lot of money.   This all about marketplace

Ince: Let’s talk for a moment about the pricing issue.  Do you think the Dutch auction has merit as a pricing technique?  Will it ever catch on in a major way?

Weisel: The Dutch auction has been used for decades in pricing secondary auctions.  It’s a smart way of raising money for a company that is already public.  It makes no sense for IPOs.  It was a failed concept from the very beginning.  What company wants to price their IPO at the maximum high they possible can get because of supply and demand?  That makes absolutely no sense, because you are doomed to failure from the very beginning.  The stock has no place but down to go.  You’ve got nothing but upset shareholders.  You’ve got future options and employees that are under water.  It’s a virtual cycle.

Ince: But doesn’t it maximize the amount of money a company raises in an IPO?

Weisel: It maximizes the price, but the capital raising function is a two way street.  Both the issuer and the buyer need to win.  You’ve got to leave something on the table–future profitability for the buyer as well as the seller.  By the way,  the owner of companies doing IPOs are not selling.  They need to maintain and increase the price over the next year or two so they can exit and realize their investment.  So if they’ve ???? top ticked??? the stock price in raising capital, all of which goes in the company and not to them, that’s a failed strategy.  So what you want to do is price things where it’s most probably going to sell given no change in the environment or comparable company’s stock prices.  If you’re going to sell something at 50% or 100% higher than it would be rationally compared to, just because of a supply – demand imbalance, then you created in the offering, that doesn’t make a lot of sense and it’s a disaster waiting to happen.

Ince: Why?

Weisel: Because rational investors will eventually become rational and the stock price ought to come down to where that company should be valued relative to other comparable companies.  That’s essentially what most investment banks do.  They look at what other comparable companies are valued at and make a judgement based on the differences between the market opportunities, the product the management team and then attempt to price the company relative to those ideas.

Note:  This interview was originally published in Upside Magazine in 2000

Investment Banking – The Art and the Science

Investment Banking – The Art and the Science

by  John F. Ince

For eons the business of investment banking has been considered equal parts art and science.  It is a relationship driven business where the feel for the market at a particular moment can be a key competitive advantage for a firm.  And yet all around the new economy, technology is taking much of the art and feel out of business transactions.  The question remains:  how much longer can investment banking remain a tradition-bound industry where personal relationships and long standing practices are the driving force in most deals?

For the moment investment banking is basking in the afterglow of rapidly increasing revenues and profitability?  What’s giving fuel to all that growth?  First there has been the astounding increase in the availability of venture capital.  The maturation of the venture capital industry has provided a steady flow of IPOs to the industry.  According to Thomas Weisel (See Sidebar) of Thomas Weisel Partners,, “80% of venture backed companies get sold and never go public.  20% go public.  You’ve gone from roughly 25% of the IPO market being venture backed companies to over 65%.  And obviously the result has been a tremendous acceleration of the dollar volume of the IPO market.”

With accelerated consolidation in all sectors of the economy, there has been a dramatic increase in size and flow of M & A activity,  and therefore a dramatic increase in fee income.  The rise in the stock market has generated an ever increasing trading volume.  Last year, according to Weisel, $180 billion of equity was raised in the public area compared to $100 billion the year before.

The net net has been a dramatic growth in the profitability and size of the investment banking industry.  According to Weisel,  if one include revenues from institutional brokerage, M & A and equity,  the industry has been growing at 35% compounded rate for the last decade.  Weisel estimates that that marketplace has grown from $17 billion in 1995 to $40 billion in 2000.

All this is taking place against the backdrop of regulatory changes.   Last year, Washington opened up the floodgates of change with the partial repeal of Glass Steagell, which since the Depression era has legislated the separation of commercial bank, investment banks and insurance companies.  Quickly cam wave after wave of merger and acquisition. Each commercial bank felt they needed a boutique house to fill out their offerings.  Fleet picked up Robertson Stephens, which had been was bought in  1997 by BankAmerica.  B of A sold it the next year to BankBoston, which dropped BancBoston from its name after its parent merged with the increasing voracious FleetBoston Financial. NationsBank then swallowed up Bank of America, which had previously swallowed Montgomery Securities.

Chase Manhattan, not quite satisfied with their acquisition of  Hambrecht and Quist, made the big splash in mid-September with a purchase of the venerable house of Morgan for $35.2 billion or $195 share.  That transaction united two to the most venerable banks each with  rich legacies, but the synergies remain unclear. Having already acquired Chemical Bank and Manufacturers Hanover, Chase is attempting to position, the newly christened, J.P. Morgan Chase as a one stop shop that can compete in both commercial and investment banking.  That deal comes on the heels of two other major acquisitions of investment banks by commercial banks.  UBS, the giant Swiss bank paid $12 billion to buy Paine Webber early in 2000, and in August 2000, Credit Suisse ponied up $12.8 billion to buy Donaldson, Lufkin & Jenrette.

Will all these strategic moves pay off?  Not everybody thinks so.  Says Thom Weisel, “With the JP Morgan – Chase deal and the DLJ deal, there’s a tremendous amount of overlap.  It represents a thought process that is, quite frankly, historical–the global footprint, one stop shop, broader product base, bigger balance sheet – compete on the basis of capital.  These larger firms have gotten so large that they suck the best quality people into management.  Then they Peter Principle them up, so that they’re not really dealing with clients any more, and the people under them are just kids.”

For the better part of the 1990’s, J.P. Morgan had been attempting to transform itself from a blue-chip commercial bank into a investment banking powerhouse.  The Chase-Morgan deal underscores the desire of the commercial banks to move into higher margin business.  Says Joe Schell (See Sidebar) head of the Global Technology Investment Banking Group at Merrill Lynch, “Commercial banks have wanted to get into high margin businesses like investment banking for years. They hadn’t been successful getting into those businesses on their own so now they’re doing it by acquisition.”

Then there are the pioneer firms like Wit Soundview and WR Hambrecht + Co, who are betting that the changes all around the new economy are so fundamental, that it is simply a matter of time until investment banking is also transformed.  The Internet has opened up the possibility of new and potentially revolutionary delivery mechanisms for stock in IPOs.    According to Chris Mulligan, Managing Director of Wit, “Our mandate is to revolutionize the capital raising process. What does that mean?  It means we facilitate the dissemination of critical information, aggregate all demand,  allocate securities in a smarter fashion and insure better price transparency.”

While the pioneer firms have gained a lot of publicity, their volume of offerings and allocations has been small.  Although Wit has participated in 130 offering in 1999 and 119 offerings as of September 2000, they have managed only a handful. So far only four companies have used WR Hambrecht’s Dutch Auction (See sidebar).  One possible explanation for reluctance of issuing companies to let startups like Wit and WR Hambrecht manage their offerings is due in large part to what Bill Hambrecht calls the “Cathedral Effect”.  Says Hambrecht, “Issuing stock is a major event in the history of a company, not unlike a marriage.  For economic reasons the father of the bride tries to convince everyone that the Justice of the Peace makes the most sense.  The bride however usually wants to be married in the cathedral.”

The Internet has also lowered the barriers to entry in the financial services marketplace. Both financial and nonfinancial firms have been able to role out products and participate in new marketplaces. The net result is that the financial landscapes has becoming much more competitive.  According to Adam Holt, analyst with Chase H & Q, “What you have is traditional financial institutions trying to find ways to maintain customer bases, and remain competitive in a rapidly changing environment.” Companies like e-loan,, NextCard are moving into lending spaces that had traditionally been the exclusive empire of the financial institutions.  Then you have companies like E-trade and Ameritrade moving into the brokerage industry,  distintermediating more traditional financial service firms.  At the same time you have new breed of ground up banks like Wingspan or Netbank.

The so called ‘bulge bracket” firms frequently use rhetoric that seems dismissive of potential threats to their hegemony from the upstarts, but their actions suggest that they take the larger threat posed by technological change quite seriously.  If technology is the dimension on which investment banks will compete, Goldman Sachs, for one, intends to be well positioned to maintain their leadership position. Goldman has earned it’s stripes over the years taking some of the largest technology companies public including Microsoft and Yahoo.   Says, Steven Mnuchin, Co-Head of the Technology Operating Committee and Global Head of e-Commerce at Goldman Sachs, “Technology is having a dramatic impact on all areas of the firm. Not only do we work with technology-focused clients in our banking and investment banking practices, but we have also made  a major internal commitment in this area as well.”

Indeed, Goldman now has over 3500 full time professionals dedicated to internal technology in areas like electronic trading, risk management systems, infrastructure, clearance businesses, operations and modeling.  In this fiscal year they will be spending $1.5 billion on internal technology.  On September 11 2000, Goldman further emphasized their commitment to technological leadership with their acquisition Spear, Leeds & Kellogg L.P. (SLK) for $6.5 billion.  This deal  positions Goldman firmly at the center of price discovery.  It also puts Goldman Sachs at the forefront of advanced technology, specifically in the development and application of sophisticated trading, execution and clearing technology.  The SLK deal comes on the heels of their 1999 purchase  of  Hull, the largest electronic trader of options in the United States,  for $500 million.  Hull had developed a sophisticated platform to find the best price for options. Goldman has also hedged its bets with 15% stake in Wit Soundview. Stating the obvious,  Mnuchin says,  “We see technology as critical to our future success.”

None of these strategic moves would have been possible without Goldman’s 1999 IPO with netted them in excess of $5 billion.  With investment banking operating on such high margins, can  others be far behind with their IPOs?  Fleet Boston Financial Corp is rumored to be considering spinning off it’s subsidiary investment banking house, Robertson Stephens, in an IPO.  These moves are but one more acknowledgement of the extraordinary values being created by investment banks today.

Merrill Lynch has also made a major commitment to global investment banking bringing in industry heavyweight, Joe Schell, formerly with Montgomery Securities, and Banc of America Securities to shore up their technology capabilities.  Schell wasted not time, more than doubling the size of the technology investment banking group, from 80-170 within his first 9 months on the job.  He expects to add another 70 people within the next year.

New ideas often take hold slowly, especially in industries as tradition bound as investment banking.  It may be a stretch to characterize investment banking today as an industry at the crossroads, but it clearly exhibits many of the symptoms of one entering the nascent stages of transformation.  And much of that transformation is due to technology. Given the fundamental nature of the transformation that is sweeping through other sectors of economy, we can soon expect investment banking to undergo a more radical transformation that it has seen in decades?