Monday, February 6, 2012

Facebook IPO: The Lucky Underwriters

Ready for public scrutiny?
Who will be the fortunate few--the lucky underwriters who take
Facebook public this spring, who will earn millions in fees for arranging the most watched IPO perhaps since Google went public (Aug., 2004) or the most interesting banking deal since, say, the breakup of AT&T (1983)?

Sure, the Goldmans, Morgan Stanleys, and JPMorgans will be at the top of the syndicate list--the lead underwriters, the dealmakers who negotiate the fees, arrange the syndicate group, and ensure there is an orderly process when the stock finally goes to market.

Facebook is being valued in the range of $75-100 billion, an unusually wide range, but such range is not a surprise. Facebook has only just begun to share details of revenues, profits and business strategies.  Prospective investors and regulators will now pore through vast amounts of information it filed with the SEC last week and will ask questions about what the company will look like five or 10 years from now. 

They wonder how Facebook will achieve steady revenue growth and high investment returns once the number of users reaches a plateau (at 1 billion?) or when another new thing comes along to distract those same users.  They must determine whether Google+ will be a threat.  And they will assess whether Facebook will be able to handle the strain of being a public company:  shareholders pressing for rapid growth, analysts expecting the company to beat quarterly earnings estimates, or a stock price fluctuating frequently without reason.

While the company will be valued at $75 billion or more, the actual public offering is expected to be $5-10 billion of new shares. Market behavior this spring and investors' response to Facebook's long-term storyline will determine the total valuation (closer to $100 billion than $75 billion?) and the total value of shares offered to the public (closer to $10 billion than $5 billion?).  Of course,  corporate-finance models, the instincts of experienced bankers, negotiations between bankers and company management, and supply-demand dynamics in the marketplace will also influence valuations.

Assume the underwriting will be $5 billion.  Underwriters will line up to share a gargantuan amount in fees, recalling the glory years when IPO activity sparked and soared regularly.  (Remember the gushing over dot-com IPOs in the late 1990s and early 2000s?)  If the conventional negotiated fee for an equity offering is about 4%, Facebook could dangle as much as $200 million in fees for capture by the syndicate group.

But Facebook has leverage--because the offering will be large and closely watched and because investment banks will want to secure other banking business going forward.  With that leverage and with hints that it will use it in the way many Silicon Vally firms have tried in the past, Facebook will negotiate the fees down to levels below 4%, or even 2%.  Still, it's likely underwriters will be paid fees at least in the $75-100 million range.

Morgan Stanley, JPMorgan and Goldman Sachs will be the lead underwriters.  Goldman lost the lead it had for much of the last year. Some say bad publicity that seems to follow Goldman often these days hampered its efforts to be the leader among the leaders.  Morgan Stanley touts its highly regarded technology banking team, and JPMorgan has a leading corporate-lending business that recently arranged a loan facility for Facebook.  Those factors helped thrust them into lead roles with Goldman.

All three will also want a more permanent advisory role with the company in future deals:  other credit facilities, future debt offerings, mergers and acquisitions, another round of equity financing, or an advisory role when Facebook is finally able to penetrate China, if ever.  Don't forget, too, all three have substantial private-banking businesses and will hustle to try to manage the portfolios of newly minted millionaire employees.

For the IPO, banks will, therefore, settle for lower fee rates now to ensure long-term relationships later, but only so much, as investment banks squirm when they set precedents in allowing underwriting fees to fall below traditional levels.

But now comes an interesting question:  Who else will be in the syndicate?

Who else will get to share the exposure, visibility and fees from the Deal of 2012?  Will Facebook ensure the selection of the syndicate is fair and includes regional broker/dealers, small boutiques, and firms majority-owned by those from under-represented groups (women and minorities)?

Sometimes the company issuing shares doesn't rely on investment banks to fill out the lower rungs of the syndicate. Sometimes they request that the syndicate leaders respond to specified wishes. (One frequent wish is to allocate shares to investors who say they will hold the stock, instead of "flip it" shortly after the offering.)

Before it's time to go to market and sell the new shares, the arranging banks are responsible to ensure the offering has been successfully pre-sold at the offering price and under the terms negotiated. They use market intelligence, previous relationships, and industry prowess to get the deal done. Often from experience and habit, they allocate new shares to a club that includes other big names and to others based on expansive retail networks, high-net-worth clients, and large funds that have close ties to the banks. 
They won't necessarily step back to try to be "inclusive"--unless they are reminded to be so or, in some cases, instructed to be so. The company going public will then ask lead underwriters to honor its requests.

Facebook is still young.  Early signals, however, suggest Facebook will have special requests for its syndication.  Founder and CEO Mark Zuckerberg will likely want to folow Silicon Valley patterns of breaking the mold when it comes to relationships with banks (new ways of doing the old kinds of deals). (Google certainly did so when it went public and tested new ways of allocating and pricing shares.)  Zuckerberg and Facebook will not want to be seen as strong-armed by banks.

COO Sheryl Sandberg, from her days at Google to the present, has been an effective advocate for women in business.  She is known to devote extracurricular time as a leader in women's initiatives.  She regularly hosts gatherings to discuss strategies for women to advance to senior management, balance work-life pressures, and have an impact on others in entry-level positions.

Sandberg and Zuckerberg also have binders of statistics that show women comprise the majority of Facebook's 845 million users and drive most of the daily activity.  While the top rungs of banks still have diversity challenges, Facebook users are as diverse as the world is. All groups, many countries, many religious backgrounds, many ethnic groups, and many races log on.

So why shouldn't the prospective list of new shareholders, investors, and underwriters be similarly diverse?  Why shouldn't such firms as M.R. Beal, Sibert Brandford Shank, Guzman and Williams Capital be included in the syndicate list and share in the lucrative fees?

Let's watch and see what happens.

Tracy Williams

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