Tuesday, January 24, 2012

Done right, emergent private exchanges can strengthen the IPO marketplace. "Done right" is the key

Read another interesting article, describing a recent talk, that brings up some issues worth a second look. The speaker and subject of the posting is a very smart entrepreneur who knows a great deal about markets, both public and private.  The piece covers private share trading, growth businesses for the last couple of years, as investors have scrambled for early access to shares of high-profile companies like Groupon, Zynga and Facebook among others.

From the combination of early employees seeking pre-IPO liquidity and later stage investors wanting to own shares of a few particular companies at pre-IPO prices, emerged an opportunity for a couple of savvy entities that built sophisticated eBay like mechanisms for trading private stock.  The strong IPO pricing and aftermarket performance LinkedIn were all it took to convince plenty of qualified investors to line up for a chance to participate in the private company markets; investors ranging from well to do individuals to some of the country's largest mutual and hedge funds.

The good news is that the success of these emergent trading platforms demonstrates that investors are clearly willing to try new markets, even ones that come with the disadvantage of much less transparency.  Investors in public stocks at least have quarterly financial releases to help them determine if the investment thesis is on track.  They also have a liquid market in which to sell their stock if they perceive that things aren't going as hoped.  Conversely, investors in private securities generally have significantly less information and the rather important disadvantage, at least for now, of tremendously reduced liquidity versus public markets.  If something goes wrong, selling a block of private stock can be on par with selling a house in central Florida in 2009, except that with real estate, (assuming one covered the mortgage payments) the seller with an unwanted property still has the house. With private equity, if the investment company hits a serious speed bump, the seller can be left with a worthless piece of paper. Period.

Recently, seeking the potential extra reward, investors have shown a willingness to absorb that incremental risk.  Or at least they did last year.  2012 could be a different story.  Plenty of private investors did well in early 2011. Their success stories proved to be a siren call, attracting new private investors in search of similar success.  But as with all markets, the private market news was all good until it wasn't.  "Wasn't" became tangible with Groupon and Zynga. These well-known companies with hotly anticipated public offerings, sold shares in the private market  at prices higher than their subsequent IPO value.  In the aftermarket, at least as of January 2012, these companies continue to trade below some of their former private market prices. The late-stage, private market bets on these "high fliers" failed to pay off.  Too many more of these and the private markets will likely have a very difficult time attracting new investors.  While both Zynga and Groupon may pay off splendidly in the coming years, there was no reward for those who jumped in on the late side of early.

Astonishingly, the recently posted article about these markets suggests that when companies trade at higher prices in the information-limited private markets and then perform poorly in the transparent, public market, it is an indication, at least according to our high-profile speaker, that "the IPO market is dying".  Really?  That a large pool of investors pays less for a company when they have data to analyze when compared to what a small contingent paid when they were trading on blind faith and betting on a greater fool theory, indicates that the educated market doesn't work?  In what alternative universe? 

There is definitely a place in the world for emerging private market trading mechanisms done right, and they can be a very useful mezzanine step while companies mature toward prime time readiness.  However, it is nonsensical to suggest that the existence of a new private market has dire consequences for the public marketplace. The IPO market is alive, well, healthy and thankfully much more selective than it was during the drunken era 12-15 years ago.   While that's rough on the relative performance of today's private investors, such rationality bodes well for all investors, public and private over the long run.  Darwin's commentary on survival applies far beyond the animal kingdom. 

Sunday, January 8, 2012

Off and Running

Now that blogs are rather out of fashion, I feel compelled to launch one.  In part this is because sorting through my in box at year end, I found so much mis-information on a topic near and dear to my heart, that I won't sleep well without throwing some experienced-based observations into the conversation.  For instance, I recently saw a blog post about picking bankers for an IPO, that made several assertions with which I beg to differ.

This blog argued that by the time a pre-IPO company is ready to actually hire investment bankers, it's too late to meet new candidates; according to this blog, the competitors should have been fully vetted already.  This is really bad advice. It may have been true 30 years ago when banking was "a relationship business" but it is a poor strategy today. Here's why:  One of the best ways to realize a salary or title gain on Wall Street is to move firms.  In fact every year after bonuses are paid, there is a street wide game of musical chairs.  While some firms (Morgan Stanley among others) have seen less turnover than others in recent years, to settle on a bank before it really is time to begin the process is to pack for a vacation by looking at last month's weather forecast.  I have yet to attend a bakeoff, even those that were conducted as mere formalities to sanctify pre-existing decisions, where some bank didn't surprise on the upside while another meaningfully underperformed expectations. 

Secondly, bankers that have the most time to visit early and often in the period before a deal are sometimes bankers who may have excess time on their hands - never a good sign.  Certainly, it helps to have met with banks at least once before a transaction is in sight, just to understand the differences in style, but to have come to any sort of conclusion ahead of the game is almost always a mistake.

If they wanted to, the CEO and CFO of a hot IPO prospect could spend endless time meeting with bankers happy to drop in, but what a massive time sink. Meet the contenders once if you like but spend the bulk of your time building the business. Allocate the time to banks and bankers when there is a decision at hand. That way,  you'll know you are evaluating the actual team that will be there in the trenches with you.

A second suggestion this blog made for those picking a team "is be sure to understand the reach of the banks under consideration" and then, it listed a favorite.  Well, yes, reach is important, but understand that ALL of the major bulge bracket firms talk everyday to the very same clients.  Some of the smaller boutique firms focus their efforts more specifically, by region or by fund description, but there isn't a successful fund manager anywhere who doesn't keep a dialog going with the whole lot of investment banks out there as after all, when investing, more information is always better.

A third point made in this piece was "pick the banker who had a hot hand last year".  That is as clever as the old "pick the investment manager who had the hot hand last year".  For those who haven't followed the industry, rarely is there a fund that repeats at the top of it's sector. On those rare occasions when a fund did put two back to back winners together, year 3 was generally a clunker.  Success rarely translates from year to year.  Serious investors evaluate the issue coming to market, not the logo of the bank on the cover, beyond the "tier one", "tier two", and "tier who?” designation.  It's the quality of the work, not the color of the logo that matter.  The key is not figuring out who had the hot hand last year, it's figuring out who will field the very best team for you this year, on an individual-by-individual basis.

I've passed my self-imposed 600 word limit, so enough. The point is, beware of generalizations, as there is nothing static about investors or investment banks.  Nothing beats solid homework on the various banking teams at the time you are ready to hire them to work for you.