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Goldman Sachs, Morgan Stanley and CSFB, the top technology investment banks, were the most prominent arrangers of technology and internet IPOs during the extraordinary bull run that has just come to its inevitable messy end. But the April crash has exposed these three banks to criticism for how they managed their deals. Too many turned sour, others quickly reached stellar valuations way above their IPO price, all rushed out in a frenzy to keep clamouring investors sated. No underwriter escaped this, but the top three fell into the trap more frequently, and more prominently. Each developed its own renown. Morgan Stanley went for biggest first-day gains, which for a time many considered a key measure of deal success. CSFB went for a super-fast deal turnround, and then became equally fast to pull deals, after the tech stock crash. Goldman just went flat out for market share.
In part because of this, Goldman's reputation has taken a bigger hit, as it underwrote more of the e-tailing companies than any other bank, although Morgan Stanley and CSFB both competed fiercely for many of the mandates. As the sector lost favour with investors, who began finally to question the sanity of inflated valuations on questionable business models such as Pets.com and drkoop.com simply because they sold on the internet, the aftermarket performance of many Goldman-led deals has plummeted. And just before the crash Goldman failed with the most promising deal of the year: Palm, makers of the Palm Pilot.
And while they leapt in, some other underwriters held back from the dot com frenzy. Merrill Lynch's reputation once suffered as it was considered the laggard in tech banking, especially after it lost one tech banking co-head in November last year, and another this February. Merrill must now be thankful that, following their departures, it resisted the temptation to build market share by underwriting dross.
Alex Brown, now subsumed into Deutsche Bank, appears to have stuck to the fundamentals. This old horseman had one of the best-performing deals of last year, Ditech Communications, despite its only gaining 0.9% on its first day of trading, which in those crazy days marked it as a failure. It was also one of the few to spot early the speculative nature of business-to-consumer (B2C) companies, and pull out of the chase to win their IPO mandates.
In their favour, however, Goldman, Morgan Stanley and CSFB have also been involved in some of the best tech and internet sector deals of the past two years. The average market performance of the IPOs they arranged from January 1999 to March 2000 is still strong. So what if there have been a few failures?
The failures, reflecting the volatility of the internet sector, raise the question whether underwriters have any responsibility to act as gate-keepers to the public markets. So far, it is Goldman whose reputation has been hit hardest. MSDW and CSFB insist that they only look for the best breed of companies, and point to some impressive aftermarket figures to support this. But they had pitched for the Goldman deals which tumbled, and many of the companies they did take public are still in their infancy. Perhaps the next crash could hit these. So is it the task of equity capital markets teams to restrain the enthusiasm of investors, or is their job simply to connect them to capital-hungry firms ?
Until very recently investors would jump into almost anything touted as a growth technology stock. So of course bankers fell over themselves, and each other, trying to win the 7% fees that come with IPO mandates.
In the US, which has been in the grip of the internet boom for the past three years, falling share prices over the past year at many companies involved in B2C websites, or e-tailing, offered evidence of investors slowly rejecting their business models. E-toys, drugstore.com, 1-800 Flowers.com (a B2C with a freephone number: how internet-enabled is that?) are just three. The crash of tech and internet stocks in mid-April, on the Nasdaq and worldwide, did more than highlight the volatile nature of these investments. It marked a fundamental re-assessment of new economy business models.
Five years ago such a shakeout among high-risk growth companies would hardly have warranted much attention. They would have been privately-owned, and the big investment banks would not have gone near them. But so many are public companies, marketed and sold by investment banks that claim that they only take the best companies public. Often, in the last couple of years, that has not been the case. And ironically, while new issue departments churned out risky new IPOs, other voices at the same firms warned of the dangers.
In an April 19 research report the Morgan Stanley Dean Witter US internet research team, led by Mary Meeker, came up with some revealing facts. First, there were 501 technology IPOs between 1980 and 1999, with a total market capitalization as of end-January this year of $4 trillion. A total of 123 had produced returns in excess of 1,000%, and just 5% had created 77% of the wealth.
Second, in the newer, more volatile internet space, there had been 371 IPOs, worth $834 billion by the day of the report. There were 27 with gains of more than 1,000%, and 5% of them had created 71% of the wealth.
Third, since the start of 1999 the Morgan Stanley internet basket has been through four bull markets and three bears.
Fourth, according to the authors, the "typical 'new paradigm' company is going public at what used to be the typical first round of financing for traditional venture-backed businesses". Stock investors had become venture capitalists by default. These were not the best companies; they might have had great business plans, but little history. And finally, most internet companies will fail: "30% of internet IPOs will be trading above issue price, 70% below issue price."
A flight to junk
"Five years ago," says Marty Whitman, who runs the Third Avenue Fund in New York, a purely value-driven fund that does not get involved in IPOs, "the big investment banks would never have brought these high-risk companies to market. It's a flight to junk." But the desire to become the king of tech banking has driven many firms to make risky decisions. The question now is: have the lead firms damaged themselves in the process? It's time to re-assess how the top underwriters behaved during the goofy times.
Merrill is for ever being told of its failure to conquer the tech space, and how it has cost the thundering herd its perch at the top of the IPO league table. It's aware of this, and came close to buying Hambrecht & Quist two years ago to plug the gap.
Yet it still brought to market last year four of the top 30 performing IPOs in the tech and internet sectors - Internet Capital Group, Netro, Aether Systems and Finisar. According to data from CommScan, Merrill's aftermarket performance for the 22 tech-related IPOs it underwrote between January last year and the end of March this year was an average increase of 122.94% up to May 18, better than all bar CSFB (155.12% for 52 deals) and Morgan Stanley, which managed 297.25% on 40 deals.
Those figures are fine for investors that took a piece of each deal those top firms led, in a portfolio approach. But they're cold comfort for investors that picked the wrong IPOs, and relied on the arrangers' tacit endorsement of each individual newly-floated company.
It is the bankers at Deutsche Banc Alex Brown who have surprised many with their record. Led by co-heads of equity capital markets David DiPietro and Doug Baird, Alex Brown has one of the most consistently successful records in bringing new issues to market. Overall, the bank ranks third for all IPOs launched from the start of January 1999 to end-March 2000, with an average gain on May 18 of 111.83%. In tech only, it is a bit further behind, sixth just after Goldman, with an average increase of 98.99%. But it has fewer deals underwater than any other bank.
Baird points to the firm's pricing and placement power as its real strength. "The problem we had in that goofy IPO market was that it was far too easy for bankers to get lazy when they saw a deal was 20 times oversubscribed, with numerous 10% orders, and no limit orders. You ran the risk of laying the stock to investors only looking for short-term gain. If that happens the company has done a three-week roadshow, paid a 7% gross spread and has no core shareholders to show for it." They are also, he says, more selective about the issuers they will work with, take time preparing companies and try to determine a sustainable offer price.
Elsewhere, the weird and goofy never seemed far away. It seemed as if the old economy market structure was being cast aside and new rules were being applied to equity capital markets.
Last year there were 539 IPOs in the US, more than any other year, at an average of 10 a week. In busy periods that could get up to 25 or 30 a week. Tech and internet stocks made up at least half. No investor can keep up to speed with that many, or understand fully all the new technology and applications.
Seals of approval
So what does he do? He looks, in part, to the underwriter for information and effectively for sponsorship of the newly listing stock. Confirm that with the statements from the two top equity underwriters, Goldman Sachs and Morgan Stanley Dean Witter. "Institutional investors screen prospectuses by looking at who is on the left side on the front page," says Stuart Bernstein, a managing director in Goldman's equity capital markets group, referring to the spot on the prospectus where the bookrunners are listed. "They look for two names there maybe 75% of the time, and want one of them to be Goldman Sachs."
In his office in Times Square, right next to the Nasdaq Board, co-head of Morgan Stanley Dean Witter's equity capital markets group John Anda says: "Our reputation is built upon our ability to create long-term value for our issuers. Undoubtedly our track record plays an important role in attracting new clients."
In other words, issuers rely on a lead-manager's brand to get a deal done, and investors look for a brand to assure them of a company's worth. The underwriter acts as a primary source for filtering deals.
Did bankers fail in that job? All now say that they were turning down many more deals than they were doing. Yet it's easy to see how standards slipped and bankers got caught up in the fever of the times. "We all had so many deals to do, with all the filings and the marketing and investor meetings which go with it," says one equity capital markets banker. "While the due diligence on these was still good, there were so many deals that there is simply no way that we could have devoted as much time to each of them as we'd have liked."
Something extraordinary was happening last year. The stock markets appeared to be soaring: the Dow Jones jumped past 10,000 and flirted with 11,000 in 1999, and the Nasdaq composite index rose 86%. It almost doubled in six months, from 2736.85 on September 30, to 5048.62 this March 10th.
But most stocks lost value last year: 52% on Nasdaq and 67% on NYSE ended the year lower than at the start. To hit their targets investors had to rely on picking a few big movers among those already listed, and, most crucially, getting in on IPOs. "Investors were looking for a big pop on their IPO investments to make up for lack of opportunity in the secondary market," says Jeff Edwards, co-head of equity capital markets at Merrill Lynch. So IPOs became an asset class of their own? "It's always been its own asset class," Edwards continues, "but never to such an extreme extent."
Churning investments
Issuers looked at IPOs as more than just a way to raise capital. Public flotation became for many the means to establish a brand and kick-start a business. "There were a lot of immature business models out there," says a senior equity capital markets banker, "but spending $50 million on advertising could change that. So at times the IPO was a question of branding, and not to have taken them public might have put their business plan in jeopardy."
Part of the reason for this lies with the tendency of venture capital firms to churn investments. "There's certainly an argument that the barrier for IPOs was getting lower and lower," says Tim Gould, a director in Lehman Brothers' equity capital markets group. "As that happened, venture capital firms reached further down, too, and looked to free up capital by turning over other holdings to the public market in a hot IPO environment."
And public market investors' behaviour changed, says Deutsche's Baird. "As investors become more ebullient, and willing to take on more risk, more companies at an earlier stage of development are able to go public."
The main culprits here are the B2C sites, the worst performing deals as a group. Goldman took 15 public last year, but in the past eight months they have fallen out of favour. And Goldman is suffering from this change in sentiment more than its competitors in part because it was so successful last year. "We won the mandates from all those businesses against stiff competition," says Lawrence Calcano, co-head of Goldman's technology investment banking division. "Morgan Stanley and CSFB, as well as others, competed vigorously for the business. And the market was eager to buy these issues."
There have been some disagreements over this. Morgan Stanley denies pitching for one B2C IPO eventually done by Goldman, even though bankers at the latter swear they saw their rival's pitch book (written by Meeker and her team) sitting on the CEO's desk. But essentially, Goldman's rivals confirm its line.
Should they have all competed so hard for these deals? Is a company that sells flowers on-line a growth company, or is a site selling toys? Two years ago they were perceived to be so. "Two years ago it became obvious that the internet would be a great business tool," says Baird at Deutsche. "But we didn't know the exact implications. The ability to do business on-line with individuals was a wonderful opportunity to avoid the costs of bricks and mortar. The development of varied consumer applications of the internet was of great interest to investment banks."
But many of these B2C companies are obviously not wonderful new business models. Goldman's excuse that others were going after the same business is not entirely true. Yes, Morgan Stanley and CSFB did, but Deutsche Banc Alex Brown, which has a much longer presence covering tech and growth companies, pulled out of competing for B2C a year ago.
After a while, new measures for judging the success of tech IPOs took hold and new primary market practices developed around the IPO boom. The most noticeable change between taking old-economy and new-economy stocks public is the size of first-day gains. The change was best summed up in late April by a comment from Jeff Hirschkorn, an analyst at on-line IPO tracking company, IPO.com, when discussing with a journalist from CNBC the then-imminent spin-off of AT&T's wireless division (essentially its mobile phone business). To be considered a success, he said, the AT&T deal had to show a 50% first-day gain. "I'd say a gain of less than 20% is a failure considering all the hype. Anything less than 20% and you can kiss the IPO market goodbye."
Two years ago, a 20% first-day increase was viewed as a runaway success. But that changed once TheGlobe.com, an on-line news and communities site, went public in November 1998. Lead-managed by Bear Stearns, it closed up 606% on its offer price. It was the largest ever first-day gain, making its two 20-something founders instant paper multi-millionaires. Over the next 15 months such deals were judged a success based on the size of what bankers came to call the first-day pop, and there were a slew of deals that registered 200% or more. In December, VA Linux made a new record - a first-day gain of 697%.
One prominent underwriter provided Euromoney with data for all technology and internet IPOs launched between the beginning of June last year and March 21 this year for seven of the lead underwriters: CSFB, Goldman Sachs, Morgan Stanley, Deutsche Banc Alex Brown, Robertson Stephens, Chase H&Q and DLJ. Of the 219 deals they underwrote, 88 rose 100% or more on the first day. That is 40% of all the deals. Many more increased by between 50% and 100%.
A ride for the biggest US IPO
Several things contributed to this: small floats attracting huge demand; retail investors and day traders trying to get in to a stock on the first day and not using limit orders; poor pricing; actively pricing the issue low to get a big increase as part of a publicity and branding exercise; and poor placement. But that this mentality was transferred to AT&T Wireless is astounding. It was a spin-off - and a tracking stock at that, not ownership - from an old-economy company. It was not a small-scale IPO of a new company with no profit history. Quite the opposite, for at over $10 billion this was the US's largest ever domestic IPO.
To the ears of seasoned bankers, Hirschkorn's was a brash statement. "We older bankers have been horrified at the first-day performance over the last couple of years," says one banker. "We need to get back to the way it was before this boom when a 15% to 20% gain was the norm."
At Merrill Lynch's downtown New York headquarters, head of equity capital markets Jeff Edwards is thinking along similar lines. "Throughout the 1990s, really until 1998, most IPOs were priced to leave enough upside to give a near-term gain of around 10%. It was virtually unheard of for a deal to trade up 100% or more on the first day." It was no good sign if a deal did. Back in 1993 Boston Chicken's IPO made headlines when it went up 200% on its first day. Experienced bankers took particular note of its fate: the company filed for bankruptcy in 1999.
Those deals that rise the most on the first day rarely figure as the best performers over the longer term. According to data provided by CommScan, of the 30 with the highest first-day gains last year, only five were among the top 30 over the longer term (to April 20). Often companies such as Foundry and Juniper turn out to be longer-term winners, even if they don't sustain large first-day gains.
The big movers on day one tend to fall into one of two camps. They may simply be a victim of uncontrollable market demand, whether rational or irrational. Of more concern are deals in the second camp, where the first-day pop is a sign that the underwriters have failed to manage the pricing and syndication properly.
Consider an institutional investor who has done all his homework on a new listing in last year's bull market, likes the company, and figures it has the potential to move from an offer price of $20 a share to $65 within two years. He wants 500,000 shares, can only get 100,000, and decides to buy the rest in the secondary market.
The deal is heavily oversubscribed, and he is just one of many institutional investors allocated a chunk. Retail loves the story too. It opens at $60, and keeps on rising, passing his estimate and closing at $90. He couldn't buy in the market. By his model the stock only has downside now, so he sells out within a day or two of the offering and takes his gains onto the next IPO. The stock is forgotten.
He was a potential core long-term holder of the stock, but in such a heady market the underwriter has got lazy, allowed the deal to be bought rather than actively selling it, and the aftermarket performance gets out of hand. Or the bank is searching for a big one-day gain to get the company - and its lead underwriter - fawning publicity on CNBC that evening.
It may also have been one of several deals the bank is working on that week. It's a good market, deals do well, so the bankers watch it to make sure it doesn't head south on the first day, and then move on to the next one.
At some point investors realize what underwriters are doing, and adopt a corresponding game plan. "We've had institutional investors tell us that they know what strategy our competitors follow, that it's one of an IPO bull market bucket-shop," says an equity capital markets banker. "So they buy IPOs and trade stocks with that in mind." And it suits the investors, as it makes for a sure-fire way to make great returns in a short space of time to compensate for the poor performance of their holdings of already listed stocks.
The result is a real danger that a company's stock may be left without any core shareholders. If that happens, the stock takes a nosedive, may well end up below the offer price and won't be touched for months. That could well damage the company's prospects for raising capital later. And that's a particularly bad outcome for those prone to burn cash, such as tech and internet companies that depend for their existence on continued access to financing. The very manner of their IPOs may have reduced many funding-hungry dot coms' chances of survival.
Some bankers were pondering this long before the Nasdaq crash.
"The lack of control over initial aftermarket performance has become a real problem," one banker was telling Euromoney last July. "We're the bankers bringing these deals so I suppose we're partly responsible for it."
Another banker at one of the top three tech underwriters privately admits culpability. "Too many companies went public last year," he says. "All of us share the guilt for that. And there was definitely a quality issue across the Street: as the market got hotter, the risk appetite increased, and companies at an earlier and earlier stage of development could do an IPO. And then the pressure mounts to do things more quickly, which might affect pricing." An example was the $1.8 billion global offering for Chartered Semiconductors, led by CSFB and Salomon Smith Barney. The IPO was launched on October 29 last year, less than three weeks after filing date and after just five days of marketing. It actually did well, finishing the day up 60%, and trading well afterwards, being up 300% by this May. But that's a time-table more normally associated with an a secondary offer of a large, liquid listed stock.
New economy at work
Other banks offer in their defence the fact that equity underwriting standards have not declined, rather the very nature of tech companies creates new requirements. "It's not the process that's changed," says Anda at Morgan Stanley Dean Witter, "it's the new economy. There's a lot of operating leverage at the company level, where so much more depends on being the first mover even if there is little or no capital. Why do they plummet? Because another company has taken first-mover advantage. And because stocks are options on a company's assets. Those with few assets are really volatile."
Lehman's Gould shrugs off the notion that underwriters should stand above the fray and pass judgement on which companies deserve to list and which don't. "So many of these tech and internet deals are concept stories, and everyone knows that. It was an emerging market, a land grab. We're now in the weeding-out process. It's not our job to act as portfolio managers or make investment decisions on behalf of our buy-side clients." And yet, Gould continues, the bankers need to be convinced that companies have a good business model. Didn't that question get overlooked in the great land grab?
Once the company has got past that hurdle of being declared fit for public ownership, how should its stock be priced? That soon became a farce with internet stocks. "Over the last two years the old revenue model was thrown out. Instead it went from P/E ratios to next year's revenue multiples, which were so often inflated, to 'it's on the internet'," says one banker. Then you look at what other companies price at, and bring it at a discount."
Some bankers dispute this. "It's all about value," says Anda at Morgan Stanley. "Otherwise it's supply and demand, and that makes for a frothy and volatile mix. So we adopt the former approach, which is why issuers come to us and come back to us." But Anda's institution has underwritten more big first-day pops than any other: 59% of the deals it brought to market between June 1999 and March 2000 rose over 100% on the first day. And of the 30 largest first-day gains last year, the bank was sole bookrunner on nine, and joint bookrunner on two more. CSFB and Goldman had five each (and Goldman was joint books on two more, strangely with Morgan Stanley - Expedia and FreeMarkets).
In the markets Morgan Stanley won a reputation for being the bank that offers a big first-day gain as part of its underwriting package. Rival bankers talk obliquely of deals Morgan Stanley was underwriting that were postponed because bankers could not be assured of such quick first-day gains.
That may in part explain why Morgan Stanley comes out so far on top of the aftermarket performance tables. On May 18, each of the 59 deals it acted as bookrunner on between January 1999 and the end of March this year had an average increase on share price of 206%, nearly double that of its nearest competitor, CSFB. In technology IPOs the gap is even bigger: the average offer to current increase for Morgan Stanley deals is 297.25%, compared with 155.16% for second place.
This is a rare league table: the ideal spot for a bank is probably in the middle, not the top. Buyers of Morgan Stanley deals have done well. But the issuers might be able to level some complaint.
Deutsche Banc Alex Brown's Baird takes a different tack. "We aim to blow through the fluff of it all and get down to those who want to own the stock and who understand the company. So we try to work with investors to get a sense of price levels at which they would accumulate stock and, more importantly, at which levels they would sell it. We're not interested in simply talking up the stock to get a book 20 times the supply. There is nothing more dangerous than an oversubscribed book without any real interest or understanding behind it."
So how does that happen? "There are maybe 400 to 500 institutions which are interested in a stock in the filing range," he continues. "There are 120 or so who will actually buy it at opening price, and three to five who will buy in at any price - that is, those who understand the company and want to own it".
Surprisingly, Anda says that aftermarket stock performance is not his primary criterion for success. "I define winning according to how much market capitalization we create." Goldman Sachs likes this measurement as well. But while market cap is important, it does not measure the success of a deal. Surely taking a company public is not just about creating huge market caps, but about getting a fair price for the issuer, a decent stock for the investor, and leaving a path open for the issuer to return to the market as and when is necessary?
Goldman Sachs' equity capital markets bankers have been under attack since March for underwriting deals, mainly in the B2C sector, whose performance in the aftermarket leaves Goldman's overall record trailing that of some of its major competitors. E-Loan, InsWeb, 1-800 Flowers.com, Barnesandnoble.com, TheStreet.com, Ashford.com, Planetrx.com, Webvan Group, Agency.com, Palm. All are trading below their offer price.
Pilot-less Palm
In defence Goldman's Calcano lists the top 20 internet deals ranked by market capitalization. Eight of these were Goldman-led IPOs. "The point is that we want to build quality market share by bringing sound companies to market," says Calcano. "This list shows that we do that very well." What differentiates the banks now is whether they did the right deals, and whether they did them properly. In many cases, Goldman did. It has an enviable franchise, and has worked on some excellently dispatched deals.
But on this list of biggest internet companies by market cap is one of the worst deals of the past two years: Palm. It's seventh with a market cap (on April 10) of $21.48 billion. That has since fallen to $13 billion.
It's not just aftermarket performance that Goldman's rivals have been gleefully pointing to. The listing of Dutch ISP World Online is potentially more damaging, as Goldman and joint bookrunner ABN Amro Rothschild are being accosted (along with the company and a host of auditors and lawyers) for not disclosing early enough and fully enough details of a pre-IPO sale by founder Nina Brink, at a much reduced price to the public offer, of a large chunk of shares to three strategic investors.
Goldman isn't the only underwriter under attack, it just has the highest-profile loss-making deals to its name. CSFB, for example, is regarded by its competitors as a deal shop. Cranking out IPOs regardless of whether a company is ready to go public. Having pulled more deals, 18, than any other bank since April, say its detractors, is proof. As is the fact that CSFB has more deals with a short interval between filing and launching than any other underwriter. An average period between filing for an IPO and launching is two or three months.
Between October last year and mid-March, eight of CSFB's 30 tech IPO deals were launched within about a month of filing, and that has helped earn the company a reputation as a bucket shop. "CSFB will promise to get your deal done in a week," says a competitor. "It's what I call the McDonald's school of IPOs - just flip them out the door." Yet CSFB-led deals have done well in the aftermarket - its 70 IPOs from January 1999 to March 2000 are still up an average of 118.67% at the end of trading on May 18. Even after the sector's apparent collapse, all of the top three tech equity houses have a multitude of successful deals to point to.
So, does the fall in B2C stocks herald the decline of Goldman Sachs? Unhappily for its competitors, no. Its equity capital markets franchise is incredibly powerful.
A decade ago, when emerging market stocks were all the rage and then suddenly fell from grace, Goldman shrugged off its association with the worst performers by pointing out that the firm with the biggest share inevitably has some of the worst deals as well as the best. It may have three of the worst performing deals of 1999 (InsWeb, Planetrx.com and Ashford.com) but also three of the best (Juniper Networks, Tibco Software and Portal Software). And judging by events since the crash, Goldman remains the golden banker. Since March 27, it has been involved in equity deals worth $25 billion (AT&T and MetLife have helped to skew that somewhat, making up over $15 billion), including tech stocks that have performed well despite the market correction, such as Saba Software and 360 Networks.
If tech stocks do shake off the correction and come back into vogue, no prizes for guessing who'll win the mandates.
When pricing and allocation mess up
To call Palm an internet company is stretching the imagination. It's more of a would-be wireless company. Palm makes the Palm Pilot, the most successful of the hand-held computers/personal organizers with a 70% market share.
On March 2, parent company 3Com, its own stock suffering in recent months, spun off a little under 5% of Palm. It should have been a banker's dream. For several months investors had been tired of all the dot coms and e-tailing companies with no profits but a flair for spending. Palm had real profits from a real business with a huge market share. The bankers use Palm Pilots, the investors use them, even the journalists use them. Morgan Stanley and Fidelity use the Palm VII, the first version to have in-built internet access, in adverts as a way to trade stocks on the go.
For weeks CNBC and TheStreet.com had been talking up Palm's merits. On the morning of the launch Jonathan Ross, an analyst at ABN Amro, took the unusual step of recommending the stock. Normally banks not involved in the deal wait for the bookrunner to begin coverage. The stock had been priced at $38 a share. Ross put out a price target of $90. Surely this deal was a winner.
In fact it was just the opposite, though it started well. It opened at $145 and reached a high of $165 during the first day, although it closed at $95. That gave it a market capitalization twice the size of parent 3Com, which still owns over 90% of Palm.
The price fell throughout March. Even its results, beating estimates, couldn't stop the slide. The deal, which was marketed "as if it were the second coming", according to one banker, now stands 50% below where it was priced.
Admittedly, the slide below the offer price did not happen until after the market crashed in mid-April, but even before then, says one competitor, "it was already clear from the appalling movement of the stock that the allocation and pricing had been screwed up".
Little else can explain the stock's terrible performance: the company is beating analysts' earnings estimates; the competitors, Microsoft and Handspring (the latter is run by former Palm employees and is due to go public with CSFB soon), were known about before the IPO and, says Bernstein, "it was one of the most oversubscribed deals we've ever done. We had investors telling us they'd be prepared to pay up to $104 a share in the open market, and many did just that".
It's not so much a question of whether Goldman Sachs priced the deal too high or whether the deal should have been brought in the first place. It's a question of execution, and on that Goldman would appear to have failed. Some blame must rest with 3Com - it took the decision to restrict the offering to 5% of shares, and the market's disappointment with 3Com was reflected in the fact that only in April, as Palm's shares dropped below issue price, did the company's market capitalization exceed that of the value of the remaining shares it owns in Palm.
Market conditions can't be discounted: this was the end of a bull run, and Palm was one of the last to come to market in it. But Goldman misjudged the investors, or did not allocate enough shares to those core investors who were really interested to buy and hold.
Game theory mixed with cat and mouse
Foundry Networks makes the gigabyte ethernet switches that help internet companies to avoid bottle-necks on their systems. Last year it decided to go public. Its bankers, Deutsche Banc Alex Brown, worked out a pricing range of $14 to $18, eventually priced above the range at $25, and by the end of the first day you could get hold of them for $156.25 apiece - a 525% first-day pop (these numbers are before a two-for-one stock split).
Huge first-day pops have often heralded poor longer-term performance. But not this time. Not that the bankers were happy with the first-day gain. "We'd rather not have seen such a huge increase," says Tony Meneghetti, managing director in Deutsche Banc Alex Brown's technology group. "But we were less concerned than we might have been - we knew they had the right infrastructure."
Alex Brown bankers don't like huge first-day gains. They run the risk of those you hope are going to be your core long-term investors selling out immediately. And cashing in a 525% gain must be pretty damn tempting. But this time they seem to have got away with it.
How? First, the management is well known, not least Bill Johnson. He had run a company in the early 1990s called Centillon Networks, which he sold to Bay Networks for $140 million in 1995. Second, it had developed a good relationship over three years with its bankers - Meneghetti and Johnson went even further back, as the bankers who had taken Centillon public, too. And third, it had resisted the temptation to list a year earlier.
Offers of selling out, and of strategic stakes and partnerships, were rejected by Johnson in favour of getting some more funding from its venture capital investors.
Playing hard to get helped investors develop a healthy interest in the company, and helped Deutsche judge which were merely interested in making a fast buck.
No easy task, as the allocation of an IPO is a wonderful mix between game theory and playing cat-and-mouse. By the time it came to market, more than 300 accounts had expressed an interest and got some part of the allocation. "But there were those who went further and asked more in-depth questions which showed they had a great interest in and understanding of the company," says Meneghetti. "We identified these accounts as core holders, of the stock." There were just a handful of them.
These investors were allocated a larger share of the IPO. If they do indeed understand the story and get a decent allocation, they will then, so the theory goes, be more inclined to buy in the secondary market. And the real test of this system, especially in this deal, came in the aftermarket: after such a big hike on the first day - the biggest of the year until VA Linux hit 697% later in the year - surely even these core holders would want to jump ship? Apparently not. "Those core holders are still there, many of the others have increased their stake in the secondary market, and the deal is still owned 65% to 70% by institutions," says Meneghetti.
Was Deutsche Bank Alex Brown's method that different from its competitors'? "We took Foundry public at a time when others were churning out deals within a month," says Meneghetti. "But we took our time to do our homework and find the right investors and so avoid any binge-purge mentality."
But no, his is not the only bank that can do it. "The core of the best stories are still owned mostly by institutions, such as Juniper and Sycamore," he says. That, at least, should give some comfort to Goldman Sachs and Morgan Stanley, the respective underwriters of those deals.
| Top 30 IPOs of 1999 for value creation |
| Rank |
Bookrunner |
Offer |
Closing |
Stock ticker |
Closing |
52-week |
52-week |
Issuer |
Pricing date |
| |
|
price |
price/day 1 |
symbol |
price Apr 25 |
high |
low |
|
|
| 1 |
Morgan Stanley Dean Witter |
19 |
45.25 |
BRCD |
110 3/4 |
185 |
4 3/4 |
Brocade Communications Systems, Inc. |
24/5/99 |
| 2 |
Goldman Sachs |
34 |
98.875 |
JNPR |
192 1/2 |
312 15/16 |
30 3/64 |
Juniper Networks, Inc |
24/6/99 |
| 3 |
Deutsche Banc Alex. Brown |
11 |
12.5 |
DITC |
81 7/8 |
140 3/16 |
5 1/2 |
Ditech Communications Corp |
9/6/99 |
| 4 |
Credit Suisse First Boston |
21 |
61 |
CMRC |
55 1/2 |
165 1/2 |
4 3/7 |
Commerce One, Inc. |
30/6/99 |
| 5 |
Goldman Sachs |
15 |
32.375 |
TIBX |
79 3/8 |
147 |
63 7/64 |
Tibco Software, Inc. |
13/7/99 |
| 6 |
Morgan Stanley Dean Witter |
19 |
42.688 |
VIGN |
45 13/16 |
100 43/64 |
7 |
Vignette Corporation |
18/2/99 |
| 7 |
Morgan Stanley Dean Witter |
23 |
90 |
ARBA |
66 15/16 |
183 11/32 |
6 1/5 |
Ariba, Inc. |
22/6/99 |
| 8 |
Lehman Brothers |
16 |
45.375 |
VERT |
45 1/8 |
148 3/8 |
8 11/16 |
VerticalNet, Inc. |
10/2/99 |
| 9 |
Credit Suisse First Boston |
16 |
48.25 |
VITR |
40 |
106 |
7 21/32 |
Vitria Technology, Inc. |
16/9/99 |
| 10 |
Morgan Stanley Dean Witter |
23 |
84.125 |
RBAK |
67 3/8 |
198 1/2 |
16 1/4 |
Redback Networks, Inc. |
17/5/99 |
| 11 |
Roth Capital Partners |
7 |
6.75 |
EDV |
64 5/16 |
74 1/8 |
5 3/4 |
Envision Development Corp |
28/9/99 |
| 12 |
Chase H&Q |
12 |
18.063 |
ARTG |
66 1/2 |
106 1/2 |
5 1/8 |
Art Technology Group, Inc. |
20/7/99 |
| 13 |
Credit Suisse First Boston |
16 |
40.125 |
PHCM |
66 5/16 |
208 |
16 1/8 |
Phone.com |
10/6/99 |
| 14 |
Merrill Lynch |
16 |
48.438 |
AETH |
126 15/64 |
345 |
41 1/8 |
Aether Systems, Inc. |
20/10/99 |
| 15 |
Morgan Stanley Dean Witter |
21 |
68.438 |
CMTN |
80 1/2 |
115 |
25 1/4 |
Copper Mountain Networks, Inc. |
12/5/99 |
| 16 |
Morgan Stanley Dean Witter |
12 |
19.688 |
NVDA |
85 |
150 |
20 3/8 |
Nvidia Corporation |
21/1/99 |
| 17 |
Merrill Lynch |
12 |
24.438 |
ICGE |
40 3/4 |
212 |
7 |
Internet Capital Group, Inc. |
4/8/99 |
| 18 |
Deutsche Banc Alex. Brown |
25 |
156.25 |
FDRY |
78 |
212 |
54 |
Foundry Networks, Inc. |
27/9/99 |
| 19 |
Robertson Stephens |
14 |
47 |
QSFT |
45 |
98 1/8 |
10 1/4 |
Quest Software, Inc. |
12/8/99 |
| 20 |
Goldman Sachs. |
14 |
37.375 |
PRSF |
39 1/8 |
86 |
13 7/8 |
Portal Software, Inc |
5/5/99 |
| 21 |
Merrill Lynch |
19 |
86.875 |
FNSR |
36 |
61 47/64 |
19 11/64 |
Finisar Corp |
11/11/99 |
| 22 |
Chase H&Q |
10 |
14.875 |
FFIV |
58 3/4 |
160 1/2 |
10 1/8 |
F5 Networks, Inc. |
3/6/99 |
| 23 |
Credit Suisse First Boston |
14 |
26.563 |
VRTA |
78 13/16 |
222 |
23 3/8 |
Virata Corp |
16/11/99 |
| 24 |
Merrill Lynch & Co. |
8 |
23.5 |
NTRO |
43 3/8 |
119 5/8 |
11 1/4 |
Netro Corp |
18/8/99 |
| 25 |
Morgan Stanley Dean Witter |
38 |
184.75 |
SCMR |
69 1/2 |
199 1/2 |
47 1/4 |
Sycamore Networks, Inc. |
21/10/99 |
| 26 |
Robertson Stephens |
14 |
34.625 |
NAVI |
37 9/16 |
164 15/16 |
19 1/4 |
NaviSite, Inc |
21/10/99 |
| 27 |
Roth Capital Partners |
5 |
5 |
AREM |
25 5/16 |
49 3/4 |
3 7/8 |
AremisSoft Corp |
21/4/99 |
| 28 |
Credit Suisse First Boston |
20 |
43.75 |
ALLR |
53 |
94 1/8 |
17 |
Allaire Corp |
22/1/99 |
| 29 |
Credit Suisse First Boston |
16 |
29.375 |
INFA |
37 5/16 |
110 7/8 |
9 1/2 |
Informatica Corporation |
28/4/99 |
| 30 |
Credit Suisse First Boston |
15 |
18.063 |
SWCM |
74 3/4 |
155 |
17 5/8 |
Software.com |
23/6/99 |
| Source: CommScan |
| Top 30 IPOs of 1999 for value destruction |
| Rank |
Bookrunner |
Offer |
Closing |
Closing |
52-week- |
52-week |
% change- |
Stock ticker |
Issuer |
Pricing date |
| |
|
price |
price/day 1 |
price Apr25 |
high |
low |
offer/curr price |
symbol |
|
|
| 1 |
Robertson Stephens |
23 |
55.188 |
1 15/16 |
40 7/8 |
1 9/16 |
-91.58 |
VUSA |
Value America, Inc. |
7/4/99 |
| 2 |
Raymond James & Associates. |
11 |
11 |
1 9/16 |
11 3/16 |
1 1/8 |
-85.8 |
INMG |
Ins Mgmt Solutions |
10/2/99 |
| 3 |
Allen & Company |
11 |
11.563 |
1 7/8 |
14 5/8 |
1 5/8 |
-82.95 |
WFHC |
Women's First Healthcare, Inc. |
28/6/99 |
| 4 |
Warburg Dillon Read |
16 |
16.438 |
2 7/8 |
41 |
2 7/8 |
-82.03 |
CYBA |
Cybear, Inc |
17/6/99 |
| 5 |
Ferris, Baker Watts |
14 |
23.938 |
2 5/8 |
28 1/8 |
1 15/16 |
-81.25 |
HITS |
Musicmaker.com |
6/7/99 |
| 6 |
Goldman Sachs |
17 |
27.875 |
3 5/16 |
44 |
2 3/32 |
-80.88 |
INSW |
InsWeb Corp |
22/7/99 |
| 7 |
Robertson Stephens |
17 |
43.625 |
3 3/8 |
37 3/8 |
2 9/32 |
-80.15 |
FLAS |
FlashNet Comms. Inc. |
15/3/99 |
| 8 |
CIBC World Markets |
10 |
9.344 |
2 |
10 |
1 1/2 |
-80 |
MCMC |
MCM Capital Group, Inc. |
8/7/99 |
| 9 |
Credit Suisse First Boston |
13 |
16 |
2 5/8 |
20 |
2 1/16 |
-79.81 |
CBDR |
CareerBuilder, Inc. |
11/5/99 |
| 10 |
Goldman Sachs |
16 |
26 |
3 1/8 |
36 1/2 |
2 3/4 |
-79.69 |
PLRX |
Planetrx.com |
6/10/99 |
| 11 |
Chase H&Q |
14 |
14 |
3 |
17 1/8 |
2 1/16 |
-79.46 |
SKDS |
SmarterKids.com |
22/11/99 |
| 12 |
Gruntal , L.L.C. |
13 |
13 |
2 11/16 |
15 7/8 |
2 1/32 |
-79.33 |
FASH |
Fashionmall.com |
20/5/99 |
| 13 |
Bear Stearns |
13 |
10.313 |
2 3/4 |
14 9/16 |
1 1/2 |
-78.85 |
MTHR |
Mothernature.com |
9/12/99 |
| 14 |
Donaldson, Lufkin & Jenrette |
17 |
22.375 |
3 11/16 |
44 7/8 |
3 |
-78.68 |
ESTM |
E-Stamp Corp |
8/10/99 |
| 15 |
Goldman Sachs |
13 |
13 |
2 7/8 |
35 |
2 19/32 |
-78.37 |
ASFD |
Ashford.com |
22/9/99 |
| 16 |
ING Barings |
13 |
13 |
2 7/8 |
15 |
1 1/2 |
-77.88 |
ILIF |
Ilife.com |
12/5/99 |
| 17 |
DB Alex. Brown/Chase H&Q |
22 |
57.438 |
5 5/16 |
43 1/8 |
4 5/16 |
-76.42 |
TURF |
iTurf Inc. |
8/4/99 |
| 18 |
Donaldson, Lufkin & Jenrette |
9.5 |
9.5 |
2 1/2 |
10 5/16 |
1 15/16 |
-75.33 |
JFAX |
Jfax.com |
22/7/99 |
| 19 |
Bear Stearns |
8 |
8.625 |
2 3/16 |
12 9/16 |
1 3/4 |
-75 |
EFTD |
Ftd.com |
28/9/99 |
| 20 |
EBI Securities Corporation |
10 |
9.531 |
2 1/2 |
12 15/16 |
2 1/4 |
-75 |
NTVN |
Netivation.com |
22/6/99 |
| 21 |
J.P. Morgan Securities |
16 |
20.125 |
4 7/32 |
30 3/4 |
3 1/2 |
-74.32 |
VMIX |
Valley Media, Inc. |
25/3/99 |
| 22 |
Bear Stearns |
9 |
16.438 |
4 3/16 |
45 3/4 |
1 15/16 |
-73.96 |
KOOP |
drkoop.com |
7/6/99 |
| 23 |
Deutsche Banc Alex. Brown |
23 |
40.25 |
6 1/8 |
35 3/4 |
4 |
-73.64 |
ABTL |
Autobytel.com |
25/3/99 |
| 24 |
Goldman Sachs |
21 |
18.188 |
6 5/8 |
23 3/16 |
4 1/4 |
-73.51 |
FLWS |
1-800-Flowers.com |
2/8/99 |
| 25 |
Lehman Brothers |
12 |
13.688 |
3 5/8 |
29 |
2 7/16 |
-73.44 |
TCTY |
Talk City, Inc. |
19/7/99 |
| 26 |
Credit Suisse First Boston |
14 |
40 |
3 15/16 |
31 |
3 3/16 |
-73.44 |
AWEB |
Autoweb.com |
22/3/99 |
| 27 |
Gerard Klauer Mattison ,Inc. |
11 |
10 |
3 |
14 |
2 1/2 |
-72.73 |
NETR |
Netradio Corporation |
14/10/99 |
| 28 |
Bear Stearns/MSDW |
20 |
18.375 |
5 27/32 |
18 1/2 |
4 3/4 |
-72.5 |
STNV |
Statia Terminals Group N.V. |
22/4/99 |
| 29 |
Deutsche Banc Alex. Brown |
22 |
39.563 |
6 1/8 |
18 1/2 |
4 3/4 |
-72.16 |
ONEM |
Onemain.com |
24/3/99 |
| 30 |
Chase H&Q |
11 |
9.688 |
3 1/8 |
13 5/8 |
2 15/16 |
-71.59 |
QUOT |
Quotesmith.com |
2/8/99 |
| Source: CommScan |
| Aftermarket performance of top 20 investment banks from |
| January 1 1999 to March 31 2000 – all US IPOs |
| Rank |
Manager |
% change-offer/current |
No. of deals |
| 1 |
Morgan Stanley Dean Witter |
206.29 |
59 |
| 2 |
Credit Suisse First Boston |
118.67 |
70 |
| 3 |
Deutsche Banc Alex. Brown |
111.83 |
35 |
| 4 |
Lehman Brothers |
95.99 |
35 |
| 5 |
Roth Capital Partners |
92.8 |
8 |
| 6 |
Goldman Sachs |
68.63 |
64 |
| 7 |
Chase H&Q |
65.48 |
30 |
| 8 |
SG Cowen Securities Corporation |
63.59 |
6 |
| 9 |
Merrill Lynch |
51.94 |
47 |
| 10 |
Robertson Stephens |
41.04 |
59 |
| 11 |
CIBC World Markets |
34.25 |
9 |
| 12 |
Banc of America Securities |
33.22 |
9 |
| 13 |
Bear St | |