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I really hope that Facebook is just faking us all out with this whole “we’re IPO’ing on Wednesday” thing that they haven’t said, in part because I have yet to park $100k of the Dealbreaker slush fund/Bloomberg budget in Facebook shares on SharesPost. But just in case they actually do something next week let’s analyze the hell out of everything so we can be proven wrong by the filings. Okay? Okay.
One thing to over-analyze is that presumptive lead-left bookrunner Morgan Stanley’s shares did or did not go up on the news that Facebook will or will not file next week and MS will or will not be the lead bookrunner. One reason for the market to shrug off this quasi-news is that Morgan Stanley won’t actually make any money on the deal since Faceook is planning to punch everyone in the face on fees:
Facebook’s initial public offering is likely to set a new standard for how low investment banks are willing to go on advisory fees to win big business.
The world’s largest online social network is expected to tap public markets for $10 billion (6 billion pounds) in the coming months in an offering that will value the company at up to $100 billion, according to sources familiar with the planned IPO. It will be one of the biggest U.S. market debuts ever, and a prized trophy for the investment bankers seeking to win lead advisory roles.
That has set up a fierce competition on Wall Street, particularly between the presumed front-runners Morgan Stanley and Goldman Sachs Group Inc, which may offer their underwriting services for as little as 1 percent of gross proceeds, bankers and industry observers said.
So let’s say MS ends up with 25% of the economics – low for a lead underwriter – of a 1% gross spread $10bn deal. That’s a paltry $25mm for their efforts. Practically nothing.
Just for fun, Morgan Stanley did $1,132mm of equity underwriting revenues in 2011. By my count (Bloomberg LEAG, global equity & equity-linked & rights) that’s for 273 equity deals, meaning it got about four bucks a pop for those deals. It did 127 US equity deals with an average size of around $133mm and an average fee ticket of around $5mm, if you believe Bloomberg numbers.*
By that measure Facebook is 5x better. By other measures – like, say, the fact that Facebook is only paying 1% vs. market-standard 7% for small deals – it’s I guess 7x worse. Which is right?
Well, call me crazy, but I’m a big fan of money. And a sad fact about investment banking is that big deals tend to be easier than little ones. Not always, lots of caveats, but the sheer execution pain involved in a merger of among two huge public companies always seems to be dwarfed by that of a $50mm asset sale. Similarly a little IPO requires a team of bankers to learn about a little company, diligence the hell out of it to avoid selling fake trees or whatever, and then convince investors to learn about and buy it. Nobody needs to learn about Facebook. It’s Facebook! It learns about you!
In any case, IPO difficulty/work/risk/expense certainly doesn’t scale up linearly with size – it’s more likely flat or even declining. So if you’re not working any harder to get Facebook done than you are to get anything else done, then your $25mm Facebook ticket looks like about $5mm of regular IPO pay and $20mm of delightful profit. Much of that delightful profit is, of course, frittered away on miserable pitching, since rents call out rent-seekers. You can bet that Facebook pitch books were longer and prettier and less typo-ridden than the average $100mm IPO pitch, and were delivered by bank CEOs rather than midlevel VPs. Also people probably did stupid stunts like wearing band t-shirts and throwing sheep at each other and otherwise whoring themselves out depressingly to a bunch of fleecey 20-somethings. Still, no bookrunners will have much cause to be sad about the economics of their Facebook ticket from the perspective of, um, economics.
The reason to be sad about a 1% fee is not that it’s bad for the bottom line on that deal. It’s that it sets a bad precedent. The investment banking industry to a large extent revolves around “fee discipline,” which is basically the notion that the fee for an IPO is 7% and if you don’t like it you can suck it. This is important precisely because there’s no earthly reason for that number, and it’s also fragile for the same reason. You do a couple of deals for 6% fees and suddenly your fees are 6%. Morgan Stanley does a couple of deals for 6% and suddenly everyone’s fees have to be 6%. The world ends.
But this is Facebook! It’s fine. It’s the gigantic-est deal ever since, um, 2010, and it’s much sexier than bankrupt car companies. Also they’re dicks. No other company would dare ask for an 85%-off discount on IPO fees just because Facebook got one, right?
In some ways the 1% gross spread here works out better for the banks than a higher fee would. I mean, they’d take an extra hundred bucks or so, but a fee that looks microscopic – as opposed to just a little below market – is easier to justify as a one-off and exclude from future fee runs. And, just to be sure, a little whining to the press about how this is an unprecedented, uneconomic, puts-us-out-of-business, never-to-be-repeated lowering of fee standards can’t hurt.
* This is all equity deals and includes lower-paying and often smaller follow-ons. So sue me.