Monday, May 13, 2013

Straight from the Buy Side - Part 1

Sometimes, its good to go straight to the source.....

With the addition of Leslie Pfrang the enormously talented Leslie Pfrang to open the NY office and head up Class V East, over the past few months, we have been meeting with investors and private company management teams both to discuss our expanded products and services and to listen to their thoughts and concerns about the IPO market in 2013.

What we learned should keep this blog going for  - well, at the rate of recent posts - decades.  Hopefully, we will shrink that down to months.

In future posts, we'll share investors' quotes about bookrunner structures, share allocations, preferred lock-up release strategies and how to recover if something runs amuck during the first year as a public company.  For the first "reveal"of what investors are thinking, we're focused on what, if anything, from the syndicate side has any impact on the decisions by those actually making the buy or pass decision on IPOs.  

Perhaps because it was the question that received the most consistent answer from the country's largest IPO buyers,  we're starting with these investors' almost universal belief that in IPOs, the smaller, full-service or boutique banks are under-compensated relative to value provided.  The comments that follow may be our writing, but they are wholly reflective, and in several cases verbatim quotes, from the country's biggest long-only buyers of IPOs.   We addressed our questions specifically to those firms and portfolio mangers that investment bankers call out when building "ideal ownership" target lists for new issues.

By way of background for those who haven't been through the process, when picking bankers "for the cover" of an IPO, the goal is to build a syndicate of banking teams with different skill sets, serving different investor market segments, hoping that when the time comes for the roadshow, issuers can maximize the number and variety of accounts that will hear the story.  That's the theory.  In reality what happens, particularly as the market has come back from the adventure that was the 2008/2009 debacle, is that issuers will choose as bookrunners several big banks that look very much alike in terms of skills and client focus.  Once those two or more big guys have been promised the majority of the total deal fees, the issuer-to-be will parse out what remains to the smaller banking organizations. 

Issuers are acting pragmatically when they choose this structure.  With compressed bonus structures, there is a great deal of movement by bankers and analysts between firms and therefore, many issuers wisely want to have a big cheese and an "insurance big cheese" firm to work actively on the deal, just in case a banker or the key analyst opts out in the middle of the process.  Furthermore, as no one firm has anything close to a monopoly on good ideas, having more smart minds fully engaged in the process improves the output.  The problem is that by the time two or more big banks have been enticed into the deal, the funds left to compensate the rest of the syndicate are sparse.

During the actual IPO process, at least for "hot" companies, this isn't much of a problem. The simple truth is that for the sought-after companies, those offering a compelling investment thesis, a solid financial plan as well as a credible and skilled management team, most any bank with a balance sheet can place an IPO.  For those that are more complicated or speculative, or for those where something goes wrong after trading begins, the importance of a fully committed syndicate, including several high-quality, engaged co-managers, grows rapidly as investors are likely to seek a cross-section of opinions.

However, once the IPO is in the rearview mirror, the image blurs.  Analysts at the large "bulge bracket" banks, are compelled to spend the bulk of their time and effort following the largest market cap companies. Why? Because coverage of large cap stocks drives a research analyst's Institutional Investor (or II) ranking.  Bankers feature these rankings when pitching new IPO business, to demonstrate the superiority of their research team.  Perhaps even more importantly from an analyst's perspective, research directors use this ranking to determine compensation and allocate the bonus pool.   Perversely, according the investors with whom we spoke, high-ranking in II correlates negatively with strength in on-going coverage of smaller market cap, recent IPOs.  This means that if you, the newly issued IPO, have a market cap much below $2.0 billion or a float much below $.75 - $1.0 billion, you just aren't all that important to those analysts.  You are the talented singer at the Bluebird Cafe and their careers are made supporting the acts at the Grand Olde Opry.

However, the smaller firms earn their stripes by discovering and/or promoting those names everyone doesn't already know. As talented as some of the analysts at these firms are, they are unlikely to have an edge on Google or Apple.  However, they do have the flexibility to spend more time on the "up and comers".  It is for that work that the buyside will pay them.  Long after the IPO fireworks have faded, these are the analysts that are more likely to stay with your company, promoting your story when appropriate - if for no other reason than that they have to do so to  differentiate and stay relevant.

But don't take our word for it.  Here is the specific question we asked the major IPO buyers, followed by the verbatim answers from the investors (in no particular order).

Q. On a scale of 1 to 10 how important are some of the smaller (non bulge bracket) investment banks to the health of the technology IPO and on-going research process.

Investor 1. Boutiques add all the value for companies < $ 3 bln. They do all the real research and can give a more balanced view. I think economics should be paid 60 bulge/40 boutiques on the IPO, maybe more to boutiques on the follow on. Bookrunners on the top line get the quality deals because of who they are. The four guys on the bottom line are what make the stock work over time.


Investor 2: Co-managers do all the ongoing research, they are not all busy with II like the bulge bracket.  II focus for bulge bracket firms means they have to spend most of their time on large cap names, pushing the small cap stocks off to their juniors. Bulge will do non-deal roadshow and call management. Boutiques will do real proprietary research and have a differentiated view. We think 25 to 35% should go to the boutiques on IPO and more on follow on.


Investor 3Boutiques are very important to my decision to invest. Economics for boutiques should be much higher than currently, perhaps 30 to 35%.

These are NOT culled responses from a group of diverse answers, and in case anyone is suspect, note the names on the cover have no impact on the work Class V does.  The truth is that 90% of the companies in our survey answered the questions similarly to those quoted above.  Institutional investors definitely value the big banks but also clearly rely on the aftermarket research provided by the relatively smaller firms.  Quite to the contrary of those bemoaning the demise of the famous Four Horsemen (Alex Brown, H&Q, Montgomery Securities and Robertson Stephens), an entire stampede of somewhat smaller full service, regional and boutique firms are very much alive.  However, it is up to management teams and the boards of companies headed down the IPO track, those thinking beyond the bell-ringing ceremony and on to the quarters and years that follow, to make sure those non-bulge bracket organizations are able to fund the costs of on-going proprietary research. The health of the IPO market depends on it.

Next up: - the buyside's thoughts on the age old - How many bookrunners? question.