Friday, August 31, 2012

Knocking Down Doors in Venture Capital

Jenn Wei, a Stanford MBA who once worked in investment banking, is now researching, chasing and negotiating deals in technology as a venture capitalist at Bloomberg Capital.  Last week, in postings that appeared widely in business media, including, she wrote about the startling, but not surprising lack of women in venture capital--in Silicon Valley (California), in Silicon Alley (New York) and at other pivotal venture spots around the country.

She reminded us of the glaring scarcity of females at negotiating tables, within network huddles when ideas are bantered about, and in closed-door meetings where entrepreneurs, deal-doers and investors decide the right amounts for an early-round investment to support the next new thing.

She offered a few reasons why women are not prominent in the industry and dared to propose solutions. She said women desperately need role models in the industry and industry participants need to take time to understand the likes, interests, and proclivities of women.

Her observations won't knock down doors, nor will they force those who run the best-known venture-capital firms to change the look, face and appeal of the industry overnight.  As much they should be, they aren't focused on demographics of who's who and who's where as much as they desperately chase the next "disruptive" technology enterprise.

But gosh, she makes a point that is obvious to anybody who takes a moment to survey who is in the industry--from those at entry levels to those who sign off on the big angel investments. Who's exactly roaming the corridors at top venture-capital firms? What did they do to prepare to be in the right place and the right time? Whom did they know?

CFN examined the statistics of the industry last year. See CFN-Venture Capital and Diversity.  Women comprise about 11% of the venture-capital professionals (based on industry surveys last year), while blacks and Latinos are virtually invisible at the major firms (firms such as Accel, Greylock, Sequoia, and Kleiner Perkins).  (Asians and Asian-American comprise about 9%.)

Wei pointed to the Midas List, a Forbes-magazine list of the top 100 in venture capital, those responsible for making the most lucrative investments in technology, those who have had successful track records in sniffing out the next Facebook or Zynga and getting in early, while accumulating board seats and significant numbers of pre-IPO shares. She had trouble finding women on the list. And she wondered why.

In the list's top 20, there are no women. Women have had modest success in leading technology firms (e.g., at eBay, H&P, Facebook, Yahoo, etc.). So why haven't they been leaders in venture capital? (Or why, for that matter, are blacks and Latinos still invisible in the industry?)

The top 20 on Forbes' list includes familiar names, including those who would likely be in a Venture Capital Hall of Fame, if such existed. It includes Marc Andreessen, Jim Breyer, John Doerr, Reid Hoffman, and Peter Thiel--not necessarily household names, but wealthy investors (a billionaire here and there) and legendary leaders of venture funds.

What typifies this top 20 among the top 100, beyond the fact that a little luck here and there certainly counted for some of their success and wealth?

1.  While some like Thiel and Andreessen became venture investors after their blockbuster successes from a start-up they founded (PayPal, Netscape, etc.), most of the others started out working in investor funds and worked their way up because of investment-related experiences, contacts, opportunities they took advantage of, and solid track records. Many of the same--without a doubt--joined the right venture firms and fell into the arms of sympathetic mentors willing to help someone follow their paths.

2. Many of them, plugged into technology updates and gifted with insight about technology trends or market behavior, hit more than a few home runs by getting in early in recent years with investments in Groupon, Facebook, Twitter, Linkedin, NetFlix, Pandora and Zynga.  One or two home runs helped build a reputation, which helped establish more contacts, funding, or entrees into whatever niche of the industry they needed or wanted to be in.

3.  Many have science, math, and engineering undergraduate degrees, permitting them to exist comfortably among professional engineers, computer scientists, or 22-year-old coding geeks.

4.  But most of this group are financiers at their core, competent in evaluating investments over 3-, 5- 7-year horizons, able to comprehend balance sheets and funding needs of start-up companies, expert at assessing growth prospects of a new company, sensitive to the tweaked structures of the capital structure of a young company, and experienced in deciphering board-room behavior.

So it's not a surprise that most in this group of 20 and a substantial number in the top 100 have MBAs in finance from top schools (Harvard, Stanford, and Wharton, being prominent in the top 20, and Consortium schools Berkeley and Michigan also being prominent in the top 100).

Basically qualities, characteristics and experiences many women (and others from under-represented groups) possess.  The doors are slightly ajar, and they might have to be knocked down in order for everybody to get in.

Tracy Williams

Wednesday, August 15, 2012

On Campus: Getting Back to School

Yale SOM's new campus: One year away
In late August, there's always a vibrancy on the campuses at business schools (including the Consortium 17) across the country as they prepare for the fall sessions.  New MBA students arrive on campus--wide-eyed, anxious, and excited about new experiences, new classmates and the challenges of in-depth study of finance, accounting, marketing, policy and recruiting.  Second-year students arrive after the intensity of summer internships (and with full-time offers for the fortunate ones), ready to resume studies in cherished, more interesting electives after the core courses are done. 

Professors and deans get excited, too, as they are buoyed by the interests, eagerness and dreams of students. Always there is electricity during the early days of school in the fall, until students drift into an October grind, when it's time to ward off the pressures of upcoming midterms and recruiting chores.

But for now, it's August, and there are new faces and bundles of energy. New MBA Consortium students at Cornell have already touched down on campus and begun orientation.  Its MBA Class of 2014 comprises 40 Consortium students; 17 have expressed an interest in finance or financial services.

During its first week, all Cornell first-year students were treated to a riveting keynote address from management consultant Frans Johansson, who spoke on "The Intersection."  Johansson told the MBA first-years that business careers, ideas or projects accelerate or take off when they reach a certain "intersection," where "unexpected ideas," diverse people, and "cross-thinking" merge.

He encouraged students to recognize those "intersections," leverage them and take advantage of them--as if to say students should recognize when they are in that right place at that right time or at least should capitalize on the influx of diverse ideas, diverse people and special situations when they are in the right moment.

Last week the New York Times reviewed Yale's efforts to stand out from the business-school pack. Yale's new dean Edward Snyder comes armed with ideas, a plan and a new building. Dean Snyder  left Chicago's Booth School to venture into New Haven, likely enticed by the odd-ball heritage of Yale and its experimental approaches to business-school education.  Since its mid-1970s founding, Yale SOM has always been a business-school maverick or has always been perceived that way, even after it changed its degree from an MPPM (master's in public and private management) to an MBA years ago.

If other top schools are careful and methodical about education overhaul, Yale SOM has traditionally taken risks and tried new approaches.  Most recently, it instituted a novel "integrated curriculum" for first-year students. It wanted to destroy the pillared approach, where finance types keep to themselves and operations and marketing types remain in their own domain.  Hence, all courses attempt to address concepts or issues, for example, in finance, marketing, operations, employees, shareholders, management, social responsibility and global impact. The new approach is apparently working, as it launches its seventh year this fall.

Yale SOM also counts down the days when everybody in the school can move into its brand-new campus (Evans Hall) next year.

NYU-Stern recently announced a new degree--not to replace the MBA, but to recognize the crucial importance of data mining and data management in business.  This fall it introduces the MS in business analytics within the Stern business school.  Some MBAs will contemplate supplementing their degrees with this new one-year program, although Stern didn't announce such a joint-degree program.  The program recognized the mammoth amount of data available to business managers and helps business managers learn how to use it to an advantage. It also helps students and managers use statistics and quantitative analysis to form business strategy, make decisions, and manage revenues, profits, costs and balance sheets.

The new degree will take a four-prong approach to analytics:  (a) mining data, (b) interpreting it, (c) modeling and (d) visualization.

The arrival of fall also brings on a flood of media-related business-school rankings.  The rankings are widely dreaded, often criticized, usually questionable, always controversial, wildly varied, and sometimes puzzling.  But everybody takes a peek at them--from first-year students, applicants, professors, recruiters, and, yes, deans.  With so many lists and rankings, there may no longer be one authoritative list. 

If readers don't take them too seriously, some rankings can be amusing or at least can highlight special strengths of certain schools.  Advanced Trading, a website and publication focused on sophisticated and complex trading (including high-frequency trading and global markets), provided its list (not a ranking) of the top 10 "Quant Schools," the top business schools for quantitative research and trading analytics.  Four Consortium schools made the list: Carnegie Mellon, Cornell, UC-Berkeley, and NYU.  The list was based on a survey of senior Wall Street managers and traders, hedge-fund managers and others.

DiversityComm, Inc. regularly provides lists of companies, organizations and schools that emphasize or promote diversity. This summer, it offers a list of the top MBA schools for African-American students. Its criteria revolved around each school's outreach and accessibility to black applicants, students and graduates. It's no surprise 15 of the 17 Consortium schools made the list (all the Consortium schools, except Emory and Wisconsin).

Tracy Williams

See also:

 CFN:  Composing the Class of 2014
CFN:  Rankings: Take a Peek, but Be Cautious--2009
CFN:  Yet Another Ranking of Business Schools--2010 
CFN:  Gearing up for the Fall, 2009 

Friday, August 10, 2012

Morgan Stanley: Can It Please Analysts?

A financial institution strives hard to get it right--stay out of the headlines, focus on core businesses, hire talented people, manage risks, oversee diverse sources of revenue, rationalize costs and allocate capital properly. And despite all efforts, the institution is not a darling among equity analysts, investors, and market watchers.  Analysts and the markets sense something is amiss. They recognize  the organization is fine-tuned and structured appropriately. They reason the right managers are at the top managing a complex, global business. But they sense an undetected vulnerability. The bank experiences a periodic, surprising earnings stumble, and the market declares degrees of doom. The company is admired, its history revered, but analysts are biased toward a high probability that losses will occur from nowhere.

Sounds like Morgan Stanley. While some financial institutions have been whipped soundly in business headlines the past few years (Goldman Sachs, Bank of America, Citi, and JPMorgan Chase), Morgan Stanley has managed to hover in the media background, yet it hasn't managed to generate sterling results and win the respect of those who study every move, step and dollar earned of major banks.

The bank, in some ways, is still recovering from spirited in-house battles from over a decade ago, when the leadership then, under CEO Philip Purcell, tried to reshape it from an upper-crust investment bank to a financial super market. Those were the days of a new strategy when the firm, after affiliating itself with retail giant Dean Witter, sprouted a national network of brokers, while trying to maintain its entrenched standing as a top investment bank for the top half of the Fortune 500.

Morgan Stanley, too, is recovering from the debacles that led to the financial crisis in 2008-09. Complex, exotic mortgage securities caused debilitating setbacks at Lehman, Bear Stearns, Citi and Merrill Lynch.  Morgan Stanley was also pummeled by piles of CDOs on its balance sheet. 

Some old-time Morgan bankers (and partners) wished Morgan had long ago retreated to its days of pure investment banking, without regard to or worry for an expansive retail network. Sales & trading would exist as a complement to corporate-advisory work. And retail brokerage would be done, well, in another hemisphere. Old-timers preferred deep relationships with corporate behemoths, rather than moms and pops. After the in-house strife years ago, Morgan Stanley has been on a consistent, steadfast path seeking to become bankers and brokers for moms, pops, uncles, aunts, General Motors and Facebook.

Its mission is clearer, and its ambitions known. Yet somehow it occasionally trips up and reports earnings that would embarrass its peers. When others report modest declines in trading revenues, for example, it reports unseemly, unexpected losses in trading. When others have blockbuster quarters in earnings, it slips in with mediocre profts.

As a result, there are always ongoing rumblings about its stock price and its prospects for being able to compete with the creme de la creme of banks. (Its stock had climbed above $20/share in early spring, but has since plummeted to less than $14/share.) Ratings agencies, just as they did with other large banks a month ago, have battered the bank, too, placing it on "negative" watch lists and assigning it near-junk ratings (as Moody's did recently).

To its credit, Morgan Stanley, under the leadership of current CEO James Gorman, tells its story with much more confidence. While earnings are not emitting shining rays, it has done all things possible to reduce leverage, build up capital, avoid embarrassing front-page lawsuits, and do what is popularly known as "de-risking" its balance sheet. Its balance sheet is now about 10% smaller than it had been two years and is now supported by an equity capital base of over $60 billion. It has taken aggressive steps to reduce the likelihood of "a run on the bank" (by reducing reliance on short-term funding).

In recent weeks, it has reaffirmed its desires to take greater control over its joint venture with Citi running the branch network Smith Barney. It has also re-engineered, just like its peers at Goldman Sachs and JPMorgan, to prepare for Dodd-Frank and Basel III regulation. It unloaded without fuss its enormously successful hedge-fund-like, black-box trading group.

Furthermore, somehow the institution, in whatever current state of being it is in, seems to have survived in the way Bear Stearns, Lehman and Merrill didn't. In 2008, the other three fell like dominoes; trading floors everywhere whispered, wondering if Morgan Stanley were next.  It wasn't. 

Hence, it fumes that it gets little credit. Investors and analysts applaud the restructuring moves, but it's all about the earnings, they counter. In the most recent quarter (second quarter, 2012), Morgan Stanley blamed a 48% drop in trading revenues (mostly from fixed-income activity) on its nearly 50% decline in earnings and its paltry 2% return on equity--yet another quarter where analysts insist they were caught off guard.

Morgan Stanley managed to win an enviable role in the Facebook IPO during the quarter. The coup was a tribute to its highly regarded technology-banking team in Silicon Valley. Many thought Goldman Sachs and JPMorgan had inside routes to the top role. But even this most anticipated IPO in years had slip-ups. Now regulators, market pundits and investors are playing a Facebook blame-game of figuring out whether Nasdaq incurred real systems mishaps or whether Morgan Stanley led in mis-pricing the shares on day one.

What can Gorman and lieutenants do to win favorable sentiments from analysts, investors, and ratings agencies?

First of all, it will need to get the ROE to rise above 10% and stay there. There is inevitable volatility in this industry, so earnings won't grow quarter after quarter. But the market wants to see some semblance of stability, even among investment banks where fees from M&A and equity underwriting can evaporate overnight.

Second, the market wants to see if Morgan Stanley, like its peers, has real solutions for the oncoming onslaught of regulation.  Will the bank be able to generate revenues and returns with reduced risks, reduced leverage, stiff capital requirements, more transparency, and no longer the opportunities to ride the momentum of "prop trading"?

Third (and arguably most important in the eyes of some), the market wants to see if the firm can control costs, control risks, and reduce the likelihood of the unexpected, huge loss.

Some analysts have called for more aggressive steps. Break up the firm into separate units: the retail brokerage, the investment bank, international banking, and hedge-fund trading, says prominent bank analyst Michael Mayo, who last week reasoned that doing so could double the stock price. 

Seize more of Smith Barney and pour more resources (people, brokers, and capital) into the brokerage and wealth-management businesses, say others.

Become a large-scale version of a boutique like Lazard? That means selling off other parts and maintaining the Morgan Stanley brand for a niche investment-banking business, compete with Lazard, Greenhill, Evercore, and other boutiques and beat them with more capital, an international presence and a corporate-loan unit. More easily said than done.

Continue to pare down businesses into the few where it is a market leader or what it sees as the best potential for growth? That seems to be the likely strategy or the one Morgan senior management is running with at the moment.

Go behind closed doors, and you can bet that senior management is frustrated that with all the tweaking, it continues to hustle to try to get it right. However, it is smugly satisfied that it won't bow out in a Lehman- or Bear Stearns-like way.

Tracy Williams

See also:

CFN:  How Does Goldman Do It? Feb-2010 

Friday, August 3, 2012

Dark Days at Knight Capital

Despite all efforts to corral Wall Street to avert a crisis, avoid market collapse, and instill confidence in the system, guess what happens. Yet another major misstep in the marketplace by one of its big participants.  And not just the rare market mistake that occurs once every year or two.  Missteps, hiccups, and strange collapses seem to be occurring these days just about every other week.

This week, it's Knight Capital, the equities market-making firm that announced losses of over $400 million after it launched new software in its trading systems.  Software errors and technology glitches led the firm's black boxes to spew large orders of errant trades. By the time the firm's humans (not machines) could discover what was happening, it was too late. The losses had piled up on trades the firm had no idea it had booked and would have never wanted to make in the first place.  The losses wiped out about half of its book-value equity, and now it struggles to survive intact. Until this week, Knight existed quietly in a niche role in stock trading (institutional equity brokerage, trading and market-making) and had been successful and well regarded in equity markets.

The trading mistakes resulted after Knight implemented new code to capitalize on a new form of retail-related trading with the New York Stock Exchange. They follow a series of embarrassments and other blatant mistakes all around the financial system the past two years.  Knight's loss reminds us of the 2010 "flash crash," when computerized trading involving futures and equities led to a sudden, shocking, unexplained nose-dive in stock markets.  Regulators afterward implemented safe-guard measures to reduce the probability of another flash crash. Or they thought they did. This week, regulators observed the unusual activity at Knight. The overall market corrected itself, but it was too late to save Knight from itself.

Beyond flash crashes and trading losses from bad computer code or faulty systems, there have been steady occurrences of bad events--almost enough to scare retail investors away from markets for the rest of the decade.  In just the past several months, MF Global, the large futures brokerage, collapsed after taking on large trading positions in Europe markets and losing hundreds of millions in customer funds. The upstart trading system BATS, specializing in stock match-making and high-frequency trading, planned its own IPO, but canceled it because of technology problems in its own infrastructure.

JPMorgan Chase this spring announced over $5 billion in trading losses from trading credit-default swaps in what was supposed to have been a safe hedge on its balance sheet.  The Nasdaq Exchange and Morgan Stanley are being blamed for the problems Facebook had on opening day in its IPO. Facebook and others say Nasdaq's systems mishandled orders and trading  in the first moments of trading in Facebook stock.  Nasdaq has acknowledged some errors, but claims those errors have little to do with underwriters' pricing the IPO too highly and with the precipitous decline in Facebook share prices since Day 1 of the IPO.

Last month another futures brokerage Peregrine Financial, less well known in futures markets, collapsed, and customers and regulators are panicking to locate their own funds.  And now Knight Capital.

Knight Capital is being described as a high-frequency, algorithmic-trading firm, although its evolution is more conventional.  The firm was launched in the 1990s to act as a market-maker of Nasdaq-traded stocks.  Retail brokerage firms from every corner of the U.S. send their brokerage orders to Knight or similar firms that always stand ready to make markets (buy or sell), based on order flow from investors.

As equities markets advanced, became more deregulated, dispersed and decentralized and trading volumes grew and trading became more computerized, Knight advanced, too.  It retained its market-making roots, but transformed into a sophisticated institutional trading organization with a prowess for high-frequency trading and black boxes humming all over its offices.

It traded on behalf of clients, counter-parties, institutions and itself. Clients routed their trades to Knight because Knight promised them fast execution and best prices (when they bought or sold stock).  If mom or pop or a Vanguard mutual fund bought or sold stock, chances are the trade was routed toward Knight Capital for execution, or at least Knight had a chance to see it and make a rationale bid or offer. Or let's say, Knight's computers.

All major institutional players engage in some form of high-frequency trading today, if only to survive and have a chance to squeeze tiny profits from the system--whether they are Knight, Goldman Sachs, hedge funds like Citadel or one of the many "algorithmic traders" with names like Getco, Jump Trading, Sun Trading, Peak 6, Quantlab or Susquehanna.  Some firms like Getco trade for their own accounts, jump into and jump out of markets in nanoseconds to make minuscule profits based on market tendencies and discrepancies.  Market-making firms like Knight promise clients they offer technology advantages to get them into and out of markets with fast execution, best prices, and handsome profits.

JPMorgan is so large and so well-capitalized (and some argue, so important to the global system) that its billions in losses in the second quarter caused an unsightly black eye, but nothing more than a financial sprained ankle. Knight's losses wiped out half the firm's capital base, and it now struggles for survival.  It may not exist a week from now.

What will likely happen?

The firm's CEO Thomas Joyce says the firm has sufficient "excess capital" based on SEC requirements. That means the firm meets SEC minimums for capital and the SEC can't force the firm to shut down immediately. It doesn't mean the SEC can't swarm the firm with regulators and investigators to see what happened, decide whether there should be penalties, or urge the firm to wind down or sell itself immediately.

At Knight, losses over $400 million imply the firm needs new funding immediately--new capital, new long- and short-term funding. Funding is necessary for ongoing, everyday operations--to support trading and market-making positions, to fund deposits at exchanges and clearing organizations, to pay down worried short-term lenders, or to pledge more collateral for other lenders. The longer it takes to replace the $400 million, the less likely Knight will survive in any form.

Already brokerage firms, trading counter-parties, institutional traders and hedge funds have stopped funneling trades its way, reducing revenue flow. They stand on the side lines to see how this story will unfurl. Perhaps they will resume trading once they see an outcome comfortable to them. Few outcomes, however, will be comfortable for Knight shareholders and employees.

The likely outcome?  With lenders, creditors, clients and counter-parties retreating and not willing to engage with Knight until after figuring out what happened--and with regulators and the public crying "mismanagement" or lashing out at technology-based trading, Knight Capital will likely have to sell itself in entirety or in bulk pieces.

Once it is confirmed that the firm's loss was due to technology or programming errors and not fraud or an attempt to do something illegitimate, larger financial institutions funds will see value in its parts or whole.  There is value in its order flow from hundreds of broker/dealers and hedge funds with long-term relationships with the firm (if they all choose to return when the madness dims). There is value in its existing memberships, tie-ins, and plug-ins to equity and futures exchanges. And there may be value in the existing black boxes that have worked well in normal markets (if we assume that the problem this week was all due solely to the firm's lack of patience in testing new trading code).

Bankruptcy is always a route to get to the best possible result for shareholders, who will no doubt suffer. CEO Joyce's acclaimed career in equity markets may end and his successful efforts to turn Knight into an important market participant could be forgotten.

Have we come to expect mammoth market mistakes to be the new normal, despite the good intentions of new regulation and oversight? What else could possibly occur this month, when we usually think Wall Street slows down for vacation?

And just think, all the turmoil and chaos this week because of a 15-minute, computer mistake in Jersey City.

Tracy Williams

For more, see also:

CFN:  JPMorgan and Trading Losses, 2012
CFN:  MF Global and Its Demise, 2011
CFN:  Facebook and Its Rough IPO, 2012