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.