Mitch Feierstein: Morals go pop as greedy banks make millions from the great IPO rip-off
Friday 03 January 2014
At a select committee towards the end of last year Vince Cable was grilled about the huge leap in the Royal Mail’s stock market value. As you’ll remember, the company was floated at 330p a share and traded as high as 600p in November, a rise of 82 per cent in a few months.
Mr Cable defended the launch price, saying he considered adding 20p to the IPO price but decided against it because of worries that threatened pre-Christmas industrial action might scare investors away. I’ve no doubt Mr Cable was doing his honest best. That he took the best available advice. That he thought long and hard about the right thing to do.
I’m also in no doubt that he was stolen from. That you were. That companies and company owners are stolen from as a matter of routine.
The reason? Alas, it’s yet another grubby secret to do with the way the finance industry – and investment banking in particular – is keen to rip off everyone they come into contact with. In particular, Wall Street and their buddies in the City of London have successfully perpetuated a myth about what constitutes a successful IPO: the myth of the “pop”.
A “pop” is the slang name for the traditional increase in a company’s share price in the day or so post-IPO. So, for example, LinkedIn was launched on to the markets at $45, and the first shares started trading at $83, a massive 84 per cent above the launch price. That might be a fairly extreme example, but pops of 20-30 per cent are common and are widely viewed as the signs of a successful launch.
Wall Street argues that you need to reward your launch investors and you need to get positive stories about the company circulating from the off. A positive market sentiment is born and, if the company lives up to expectations, you have a stock market success story.
Those are the arguments, and they’re self-serving lies. Sure, it’s probably true that a launch investor is taking a little more risk than an investor who is purchasing a company with a stock market history. So offering those launch investors a little kicker makes sense, like the first airline to take a new type of airliner normally gets fat discounts to compensate for that bet on the unknown.
But with most IPOs, any added risk isn’t that huge. A company like Royal Mail is hardly an unknown quantity. The company’s sheer size means that pretty much every large institutional investor will have to end up owning a piece of it. So an IPO pop of about 5 per cent would be ample – that’s one heck of an overnight return on your money.
So what’s the justification for a pop bigger than 5-10 per cent? The Wall Street story is about positive sentiment, selling a great PR story. And that PR is, I suppose, worth something. If you could simply go out and buy that kind of news coverage, I guess you’d find corporate CFOs willing to splurge maybe half a million dollars, that kind of money.
But the actual cost is eye-watering. Take the Royal Mail. If the shares had been launched at 540p (about 10 per cent from its actual high), the taxpayer – you – would have collected £2bn more than you actually did.
What’s more, the long-term value of that pop is essentially nil. A few years back, a company came to market, valued at about $500m. The price set in early trading fell below the offer price and the company was slated for the failure of its introduction to the market.
But what a failure it was. The company in question was Amazon, whose stock market value is now around $175bn. Company values are set by the strength of their business and the effectiveness of their management. Anything else, in the long run, is just hooey.
Wall Street will want to interject at this point and remind you that their job as middleman is to strike a balance between the interests of the buyers and the sellers.
And that’s also nonsense. The banks paid to manage an IPO are paid hefty fees by the company and its pre-IPO owners. The banks should have no other interests in mind. What’s more, the owners of the company pre-IPO are the ones who have built the business and deserve to reap the value. The IPO-buyers are financial investors for whom stock price rises and falls are an ordinary and unremarkable part of their business. Sure, they’d prefer a pop to a fall in price, but either way it’s just part of what they do.
So what the heck is going on?
The answer, of course, is that banks are ripping their clients off, as usual. The big investment banks will handle a major equity issue for a particular company perhaps once in a generation, and often just once in a corporation’s lifespan. On the other hand, they do business with the big institutional investors all the time: investors on whose good favour those banks absolutely rely.
And given that banks can choose who to reward with a sweetly under-priced IPO deal, the opportunity for undisclosed conflicts and kickbacks is simply extraordinary.
Nor is it just the equity market where these things happen. The percentage pops in the corporate bond issuance market are similar, but still rip off corporates to the benefit of banks, by screwing the very customers whom it is their duty to protect.
Given that investigators have found collusion and corruption in pretty much every corner of the banking industry isn’t it time to explore the issuance markets too? They’d find a grubby cartel of banks and lead investors handing buckets of cash to each other in some back alley – cash stolen from the companies on whom our economy depends.
The sight might be unedifying, but look on the bright side. The resulting fines would go a good way to paying back Vince Cable’s lost £2bn.
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