Bookbuilding on the 14th floor: the poor quality of the catering was the least of their problems
For Ronaldo Schmitz, the highlight of the deal came right at the start. Just after German unification, the board member for corporate finance at Deutsche Bank was summoned to Bonn to meet Christian Schwarz-Schilling, then federal post and telecommunications minister.
The minister came straight to the point. How much money could be raised by floating the telephone service on the stock exchange?
Even, asked Schmitz, if the government retained a capital stake? Yes, we want to privatize fully later, Schwarz-Schilling responded. How much?
It was an impossible question to answer. The telephone service was still a tax-exempt public monopoly, its true financial situation could only be guessed at and the German telecoms market would soon have to be opened up to competition. Difficult to imagine any serious investor buying stock. But Schmitz was determined to give a straightforward reply, and an optimistic one.
In that case, the banker estimated, around DM15 billion.
Elated, Schwarz-Schilling initiated plans for the initial public offering (IPO) of Germany’s telecoms monopoly as soon as possible. The Bundespost’s humble telephone division was renamed Deutsche Telekom.
A lot was at stake for the government and Telekom’s new chief executive, Ron Sommer, appointed in 1995. Raising so much capital could transform the financial prospects of a company which – as a BZW research report famously put it – is loaded with more debt than the Republic of Turkey. Furthermore an IPO on that scale might finally create an equity-owning culture in Germany.
For the banks, fee earnings of around DM500 million ($326.8 million), plus the prestige attached to Europe’s largest-ever equity offering, which in the end raised DM20 billion, were up for grabs. The lobbying of Telekom for underwriting roles reached a peak in 1994, when several European banks revealed ambitions to become leading players in international investment banking. The most ambitious and aggressive was Deutsche Morgan Grenfell (DMG) under Ronaldo Schmitz.
Schmitz knew from his years of negotiations with the government and his growing understanding of Sommer that the government and Telekom were determined to make this quasi-privatization a success, even if the banks lost a lot of money in the process.
Led by the nose?
Having established a rapport with the government and Telekom, Schmitz was determined to make the deal a financial and strategic success by defending the bank’s interests every step of the way. Some say that route led DMG to abuse its leading underwriting position to breach the rules on an unprecedented scale; others believe that all the banks involved were led by the nose by an autocratic issuer.
Whichever is true, the ultimate responsibility for what happened must lie with the management of Deutsche Telekom. Finance director Joachim Kröske, in the job since 1990, was regarded as capable but unremarkable. Bankers’ chief concern during the deal was that he would mix up the figures (which he never did); they also worried that his fragile health might suffer under the strain of the two-year marathon. The IPO project manager, Helmut Reuschenbach, recruited from the finance division at Daimler-Benz, was regarded as competent and trustworthy, but no great strategist.
So the real mastermind was Sommer himself, a German-Israeli with a background as head of Sony Europe. Described by admiring bankers as a marketing genius, Sommer persuaded investors to buy Telekom on its image and potential. It was Sommer who turned the Telekom share into a new brand name.
Sommer used the feel-good factor to create enthusiasm among retail investors, spending some DM100 million advertising the IPO. The next step was to persuade institutions to buy the share on the back of non-price-sensitive retail demand and in anticipation of its future performance, without looking too hard at the fundamentals.
The second marketing tactic was to guarantee a substantial dividend for 1996 and 1997. Third, Sommer managed to persuade the Stock Exchange committee to give Telekom a weighting of nearly 5% in the German 30-share Dax index, more than it strictly warrants on the basis of its subscribed capital.
As a result DM5 billion worth of Telekom’s total nominal capital of DM12.5 billion contributes to the Dax weighting even though less than two-thirds of that is actually subscribed – even after the 20% increase in the issue’s volume. Strictly speaking, it was illogical, but the Dax weighting obliged index investors to buy the stock.
Even the grey market (unofficial pre-market) in Telekom shares that opened as soon as the bookbuilding range was announced was depicted as an advantage for the issuer. Some of Telekom’s bankers argued that grey-market prices averaging around DM35 a share showed that investors valued Telekom far above the bookbuilding range of between DM25 and DM30.
But not all the banks were happy with these tactics. Many would have preferred Telekom to focus on the fundamentals, even though these were not as favourable. Not a single banker or analyst believed, for instance, that the price range was justified by the fundamentals alone. After all, Telekom still has debts of DM100 billion, 37,000 staff too many and charges that are among the highest in the world. What’s more, the company has scarcely been exposed to competition in a telecoms market that is still only partly deregulated. To stay in control, Telekom needed as much authority as possible over the syndicate.
Schmitz, Sommer and Hofmann: bankers and issuer had very different ideas about the price range.
Throughout the deal, all the syndicate banks felt Telekom’s heavy hand. The regional bookrunners – Dresdner Bank in Germany, SBC Warburg in the uk, Paribas in continental Europe, Goldman Sachs in North America and Daiwa for Asia and the rest of the world – were given the task of disciplining other banks in their tranche, judging them and making allocations on that basis.
Performance was one criterion: how pre-marketing was conducted, and what quality of orders were generated. But equally important was the banks’ conduct, which meant not breaking the myriad rules on publicity, research and contacting investors.
Firm dates were set for pre-marketing to start and for the bookbuilding period, which coincided with roadshows in 30 cities worldwide.
No syndicate bank was allowed to speak to journalists or analysts except on those exceptional occasions when they had an agreed message to transmit. Analysts from all syndicate banks were obliged to submit their research reports to the company before publication. Syndicate analysts remain gagged until the end of 1996, even though trading in Telekom stock has begun.
Syndicate banks were told that the rules had not been invented by Telekom, or by the global coordinators. It was merely normal procedure for the us securities watchdog, the Securities & Exchange Commission (sec), because the Telekom share was also being floated on the New York Stock Exchange. In practice, it seems the sec’s guidelines were interpreted as strictly as possible, while lawyers from Telekom and the global coordinators re-stated those rules every week to emphasize their importance. For Telekom, it was a highly effective way to control the syndicate banks and restrict the flow of information about the company.
Even if the rules came from the sec, the penalties were invented by Telekom. According to the detailed rulebooks sent to the entire syndicate, any bank found breaking the rules would be ejected from the syndicate and also put at a disadvantage in its attempts to win future government mandates.
Telekom also took an active interest in the global coordinators’ staff. Bernd von Maltzan lost his job as head of German investment banking at DMG early in 1996, but was kept on the Telekom deal at the client’s request. By autumn he was working in an entirely deferent business, as head of international private banking, but his presence at the roadshows was nevertheless required.
The more banks that were involved, the more effectively Telekom’s rules could be applied to the banking community as a whole. Thus Telekom was keen to invite as many banks as possible into the syndicate. German merchant banks Schröder Münchmeyer Hengst and Trinkaus & Burkhardt had not solicited places but found it impossible to say no after being approached by Telekom.
Even the advisers – nm Rothschild for the company and Credit Suisse First Boston (CSFB) for the government – were given bit-parts in the syndicate. Thus Telekom achieved not only the broadest coverage of the investor market but also won the right to impose discipline on practically the entire international banking community.
The only two notable institutions left out were BZW and Rabobank; both later played a significant role in the grey market.
The three global coordinators had special obligations. Deutsche and Dresdner were obliged to reveal the orders they received from captive accounts, such as the fund providers and insurance companies they own. All orders received by the three global coordinators were scrutinized for evidence of exaggeration, or attempts to win additional allocations. Non-lead banks were assured that Telekom would play an active role in the final allocation to prevent the global coordinators claiming any special influence.
Furthermore, Telekom insisted that a cap was placed on the allocations to the global coordinators, with the surplus distributed to all syndicate banks in each tranche. The cap was supposed to counterbalance the inherent power of the global coordinators, which complained that the structure of the syndicate was too democratic and grumbled that the regional bookrunners had far more authority than usual.
Right at the start, Telekom showed its dominance in the manner the global coordinators were selected.
At first, Deutsche had looked certain to be the sole global coordinator, thanks to Schmitz’s meeting with Schwarz-Schilling and subsequent consultations in Bonn. After years of sharing the top slot with Dresdner in all the main German privatizations from Volkswagen onwards, Deutsche believed it had finally established its supremacy as the leading German IPO bank.
But then came the partial privatization of Lufthansa in 1994 and the first beauty contest held by the German finance ministry. Under Hansgeorg Hofmann, newly arrived as board member responsible for syndicate business, Dresdner won the Lufthansa deal, and put itself back in the running for Telekom.
While other German banks, including strong contenders such as DG Bank, Commerzbank and WestLB, were still fighting for a senior place in the German syndicate, Deutsche and Dresdner had their places as lead managers assured.
At one point, Dresdner was named lead manager for the German tranche. But Deutsche fought back, persuading Telekom to divide the responsibility. Dresdner was now responsible for the domestic retail part of the issue, while Deutsche claimed chief responsibility for approaching German institutions. That division was partly cosmetic, however, since there was only one German book, and it was in Dresdner’s hands.
Deutsche then played the international card. Dresdner had gained its original mandate as head of the German tranche by claiming that the bulk of the issue could and should be placed in the home market. It praised the government’s view that Telekom is a Volksaktie (people’s share), which has always been owned by the German people and should remain in their hands. Thus Dresdner tried to persuade Telekom and the government to allocate three-quarters or even more of the stock in Germany, with a majority for retail investors.
But during the lobbying stage Deutsche cleverly undermined the case for a domestic focus by arguing that prestige and necessity required Europe’s largest-ever IPO be placed globally. Deutsche argued that it had greater experience and sales reach in international markets than any other German bank. The implication was clear: Dresdner was relying on the German market because it did not have sufficient international clout.
Unwittingly, Deutsche may thus have opened the door to Goldman Sachs, which was unexpectedly appointed as the third global coordinator, reportedly at the wish of chancellor Helmut Kohl himself. Goldman’s main argument was that Telekom should be placed via a full public offering in the us market, and neither Deutsche nor Dresdner had the experience to do that. Goldman also brought greater experience of the global investor market.
Although Deutsche was a global coordinator – and had the intangible but real advantage of seeing its name at the top left of the syndicate list as spokesman of the global coordinators – it was at a serious disadvantage to the other two.
As late as six weeks before the flotation, just before bookbuilding began, Deutsche Bank suddenly realized the implications of not having its own tranche, unlike Dresdner in Germany and Goldman in the us. DMG’s sales force would have to distribute its time and energy equally among investors throughout the world and would have no special status with any one group.
In the us, however, DMG had made substantial progress since being appointed a global coordinator two years earlier. DMG therefore persuaded Goldman to push for a larger us tranche than originally intended in the hope that both would get more allocations in that market. Goldman was only too happy to agree. Dresdner, which is relatively weak in the us market, found itself outvoted.
Under pressure to perform
The scheme backfired later, when 30% of the stock sold to us investors was returned to the market during the first two days of trading. The suspicion was that DMG had exaggerated orders in the us – where it was unlikely to reach the cap set on its earnings – even though it knew some of those investors were flippers.
German syndicate banks complained that if German institutions had been allocated that stock instead, they would not have had to buy in the after-market, pushing the price up alarmingly to DM33.90 at the close of trading on the first day, November 18. Others suspect that a flood of after-market buying was exactly what Telekom intended.
Deutsche’s next objective was to increase its allocation in all the other tranches. An agreement dating back two years stipulated that Dresdner and Deutsche should get roughly equal quotas of the whole deal. As bookrunner of the German tranche, Dresdner could reasonably have expected to win a greater proportion of the allocation. So it turned out: Dresdner won 25.5% of the German tranche, with Deutsche one percentage point behind.
To compensate for this expected defeat, Deutsche reserved the theoretical right to place more internationally. But, in practice, it was by no means certain that DMG would win more of the deal than Dresdner. And by marketing the share worldwide instead of having its own home tranche, and by bearing the expense of coordinating all the books, Deutsche incurred far greater costs. Year-end bonuses for DMG staff are expected to be higher too.
That – plus its well-known ambition to become a global investment bank – put DMG under pressure to perform.
About a week before the pre-marketing began, DMG began to call itself sole global bookrunner – a title it had never offcially been given, although it was responsible for pooling the five regional books. DMG points out that it is named in the prospectus as “the global bookrunner” and argues that there is no difference between the two labels.
But DMG salesmen were instructed to stress their bank’s status as “sole global bookrunner” when approaching investors. When pressed about the title’s exact meaning, DMG salesmen are vague, merely pointing out that the bookbuilding and the final allocation were being carried out at Deutsche’s Frankfurt headquarters.
But everyone in the market knew its significance. Many international investors are required by charter to subscribe only through the sole global bookrunner, if one exists.
Rival banks in the syndicate were infuriated when DMG produced a transparent paperweight bearing the legend “sole global bookrunner” as a gift for institutional investors.
Moreover, other banks say Deutsche also promised that its status as sole global bookrunner would give its clients a better chance in the allocation process. Schmitz is said to have spoken of a private meeting between Telekom and Deutsche Bank for this purpose during the allocation weekend.
Initially Telekom did not protest. After all, the paperweights had already been produced and were on their way to investors when the issuer found out about the scheme. But senior figures at Telekom now accuse DMG of having abused its position.
The other more serious charge levied at DMG is that it broke the very rules it had helped to write by jumping the gun to reach investors before the pre-marketing phase offcially began on October 9. This is reported to have happened almost everywhere, but appears to have been particularly effective in the uk and Asia.
Although DMG does not deny having approached investors first, it claims it was forced to do so as a result of a notorious meeting in Bonn on September 30.
Schmitz, Hofmann and Eric Dobkin, head of equity capital markets at Goldman Sachs, had all been at the IMF/World Bank meeting in Washington when they were summoned to Telekom’s headquarters at short notice. The meeting on that Monday morning was a gloomy affair. Having heard so many sceptical opinions in Washington, the bankers were fearful that neither institutional nor retail demand for the Telekom share would materialize.
According to the bankers, all parties had originally agreed not to propose any price range for the share until after the pre-marketing had given them a better indication of investor demand.
But Telekom had its own ideas about a price range, and having just received the reports from the syndicate banks’ analysts, was shocked to find that they did not tally. Angry Telekom managers demanded that the bankers should agree immediately to a range of DM25 to DM30 and use that as a basis for their talks to investors.
Dobkin chose this moment – which the others saw as too late – to open a debate about the valuation of the stock. us investors would value Telekom on fundamentals, not on technical grounds, Dobkin argued. That was later borne out at the us roadshows, when German bankers found us institutions unimpressed by their technical arguments about a ground swell of demand among German retail investors.
While Goldman’s analyst had proposed a price range of DM20 to DM25, Telekom clung to DM30, the figure first proposed by Kröske two years earlier and still taken seriously by the government, despite the analysts’ view that it was too high on fundamentals alone.
Dobkin fought for a deferent view on valuing Telekom as if “it was his own money”, as one participant said. He appeared willing to stake Goldman’s entire mandate on getting his philosophy across.
The German bankers present were troubled because a price of only DM20 or even less would be regarded as a serious failure by the government and Deutsche Telekom’s management – not to mention the banks advising them. Telekom needed to raise substantially more than DM10 billion. And even though Goldman Sachs had equal billing as global coordinator, Deutsche and Dresdner knew it was their joint responsibility to make the flotation succeed and to create an equity culture in Germany.
So Telekom succeeded in persuading the banks to accept a range of DM25 to DM30 after all. But this landed DMG in a particularly sticky position. Its research report, recommending a range of DM20 to DM30, had been sent out to investors that morning – it is a moot point whether this early dispatch was legitimate – whereas Goldman and Dresdner had not yet released their reports.
In Deutsche’s version of the story, this unexpected change of policy at Telekom forced DMG to contact investors immediately on October 1 to explain the discrepancy. Other banks – and now Telekom – counter that DMG exploited that opportunity to sell its Telekom story before the official start of pre-marketing. The evidence, they say, was the tell-tale presence of the DMG paperweight on investors’ desks.
Placed under pressure from other banks to act even-handedly, Telekom later punished DMG by reducing its underwriting and management fees in the uk and Asia. So while DMG had started out with an underwriting allocation of between 9% and 12% of the uk tranche, it ended up with only 9%. Of the 2.5% overall fee, 60% was selling commission, 20% for underwriting and 20% for management.
Responding to demand
DMG was forced to acknowledge the anger of uk banks in particular: it gave up several priority accounts in the uk and offered to give NatWest Securities a greater role in the syndicate. Furthermore, Telekom penalized DMG by reducing its participation in one-on-one meetings with important investors. DMG disputes this latter point, saying it gave up only one such meeting (Dresdner did likewise) because it agreed Merrill Lynch should have two more.
Dobkin had made his point on the valuation issue, but had changed nothing. Moreover Goldman’s fight was not over.
Even before bookbuilding, the issue was already oversubscribed by retail demand, creating a solid basis for marketing to institutions. More than 3 million retail investors had signed up for the Share Information Forum to get preferential allocation rights and the retail discount of 50 pfennigs per share.
Soon the issue was several times oversubscribed. On Saturday November 9, immediately after the us roadshows, the global coordinators proposed to increase the issue to allow orders to be allocated more generously and to enable Telekom to pay off its debt more quickly.
Telekom’s senior officers joined the Frankfurt meeting by video conference and, according to the banks, the only real question was whether Telekom could afford to honour its dividend pledges on the higher amount. Telekom had evidently done its homework on that point because the decision to go ahead was quickly taken.
The issue was increased by 20% to 600 million shares. Even that was not enough to dampen institutional demand. Kröske, who had suggested a price of DM30 a share in the first place, began to talk about going even higher.
The global coordinators were now nervous because Sommer’s technical arguments had succeeded brilliantly with investors. Even after the increase the issue was more than six times oversubscribed. Thus the demand in the five regional books would have supported any price, even in excess of DM30. Goldman had more cause for concern than ever, but this time Dobkin had the support of Hofmann and Schmitz.
Placing the responsibility squarely with Telekom, the global coordinators then refused to recommend an issue price. Any recommendation they made might have amounted to an obligation to support the after-market at that price. All three were surprised and relieved when the issuer opted for DM28.50, a compromise between retail and institutional demand. They almost forgot that the price was far higher than any analyst thought prudent.
On October 25, Deutsche broke another of its own rules by issuing a warrant on Telekom stock. That evening, just as the annual Bankers’ Ball in Frankfurt got under way, members of the German syndicate received an unsigned memo from Dresdner. They were warned not to attempt to issue a warrant and were told that Deutsche’s warrants had already been withdrawn. Apparently the sec had warned Deutsche that its derivatives might scupper the whole deal.
It seems to have been a risky attempt to test the boundaries. Immediately after the event, DMG said the warrant had been a regrettable mistake, hinting at a lack of communication between the syndicate and the equity derivatives desk. Then DMG changed its story and now explains that it decided to launch the warrant after realizing that several other German syndicate banks were about to do the same (which has since been confirmed by several members). Rabobank, a non-syndicate bank, became the first issuer of a Telekom warrant on October 28.
Trouble on the 14th floor
Deutsche claims its own warrant was necessary to control this new market, and was therefore not strictly against the rules. But it was a strange move from the leader of a syndicate which later tried and failed to suppress the sale of Rabobank’s warrant and had frowned on the development of the grey market, which was run by BZW.
As bookbuilding began in late October, Deutsche Bank set up what it called the “war room” on the 14th floor of its Frankfurt headquarters. Here staff from all three global coordinators took in data from each of the five regional books to create a global book.
Relations between the three became tenser than ever. Goldman and Dresdner complained that the rooms provided for them were dark and poky. DMG’s Rudolf Rhein came to work on October 29 to discover that the combination to his office adjoining the war room had been changed overnight; Dresdner Bank had somehow discovered the secret number. Nobody praised the round-the-clock catering service.
By the final weekend, tempers were frayed and all the main syndicate staff were tired of each other. Some declared that it had become impossible to work together. DMG was blamed for slapdash organization of the final few syndicate meetings; many smaller meetings that were scheduled never took place.
To the relief of all concerned, the decision to set the issue price at DM28.50 was taken in a few minutes on Friday, November 15. But the final allocation meeting – where the government, Telekom, the three global coordinators and the regional bookrunners met for the last time – took 12 hours the following day.
That was when many syndicate banks finally vented their anger at DMG’s gun-jumping. Lucinda Riches, an executive director in equity capital markets at SBC Warburg, regional bookrunner in the uk tranche, complained at length to the whole meeting that DMG had done enormous damage to SBC Warburg in its home market.
After that outburst the suggestion was floated to a smaller but influential group that DMG be ordered by Telekom to pay a fine for jumping the gun and calling itself sole global bookrunner. Schmitz was apoplectic.
At the time DMG’s rivals were probably unaware of the penalties already handed out by Telekom; that might have modified their calls for sanctions against that global coordinator.
But applying these relatively mild strictures hasn’t laid the issue to rest. Many syndicate banks are still mulling over DMG’s apparent immunity, worrying that it might encourage others to behave in the same way. Schmitz is unmoved. What matters, in his view, is that the client was pleased and the issue placed successfully.
Telekom seems unlikely to respond. A penalty would be unprecedented; there is an influential view that DMG is not in the dock and that the issuer does not have the right to act as judge and jury by sanctioning a breach of the rules or handing down penalties.
Nevertheless strong feelings were expressed to Euromoney about a global coordinator that apparently could not be trusted to keep its own rules. The rule that performance and conduct counted at allocation time obviously did not apply to the global coordinators. Other banks resent that. Rivals naturally interpret DMG’s action as part of a desperate quest for success and earnings following the large-scale recruitment of sales and syndicate staff around the world.
The only sanction seems to be publicity. Bankers say that DMG’s reputation will be coloured by views of its professional conduct in this deal. Some houses say that next time they will try to insist on fixed penalties for any syndicate bank, including any global coordinator, that breaks the rules. But no sanctions are possible to restrain an issuer that goes too far in having its own way.
For the syndicate teams, the IPO appears to have been completed successfully. After a week of trading, the price had settled comfortably above DM30.
The issue was a landmark for German finance: the first truly global equity offering from a German issuer. Telekom stock was marketed by dozens of banks to 3,700 institutional investors worldwide. More than 60 roadshows and presentations were held in 30 cities. (Ironically, given the earlier debate about the distribution of the shares, German investors did gain more than a two-thirds share of the deal. Germany’s 67% allocation, 60% of that for retail investors, was at the top of the range set before bookbuilding, while the other four regional tranches ended up with allocations near the bottom of their ranges: 14% for the Americas, 8% for the uk, 6% for continental Europe and 5% for Asia and the rest of the world.)
Corporate finance in Germany has moved on a couple of years as a result of the issue. Although 30 German banks handled bookbuilding for the first time in the Telekom deal, the technique is now firmly established as standard, just two years after it was first used in the Lufthansa privatization. The Federal Audit Office is said to have ordered the use of bookbuilding for all future privatizations because it oVers more transparency to investors. For the first time, German institutional investors could split their orders among underwriters without fear of a lower allocation or retribution from the coordinators.
Each of the global coordinators has reason to be satisfied with its performance. DMG ended up with an allocation of 20% – just 0.75 percentage points ahead of Dresdner Bank, while Goldman Sachs gained about 6%.
After its success with the Telekom share in the uk market, DMG is planning to expand its sales capacity there.
Now for the next one
At Dresdner Kleinwort Benson, Hofmann has decided to shift control of equities and corporate finance business out of Frankfurt and into the hands of Alan Yarrow, head of equities, and Tim Shacklock, head of corporate finance, at Kleinwort Benson in London. Telekom insisted that all three global coordinators manage the Telekom issue from Germany, so it is likely Hofmann had been planning this move for some time but waited until Telekom was out of the way.
Goldman Sachs, meanwhile, has served notice on all European banks that it is no longer content to play the junior role in any European equity deal, no matter how political or how large, having persuaded the issuer that expertise can compensate for lower placing power.
It is still debatable whether the flotation has created an equity culture in Germany. But the government clearly plans more privatizations, particularly at the regional and city level. Lufthansa’s second tranche is expected in 1997. But no large German flotation is expected until Deutsche Telekom brings its second tranche of shares to market, probably in 1999.
Bankers are not yet daring to make optimistic pronouncements about that deal, but Sommer has beaten them to it. Even these cynical professionals were shocked to hear he is already suggesting a range of DM40-DM50 a share for the second tranche.