Let’s disclose some conflicts of interest. I want to be all “go read this post from the NY Fed’s Liberty Street blog about the Facebook IPO greenshoe, it’s good, you’ll like it,” but I have this nagging sense that I’m mostly saying that because the New York Fed cited Dealbreaker, and what are the odds of that, so I want you to see it with your own eyes. But the post is fun, if you like this sort of thing, so, now you’ve got the recommendation and the disclosure, make your own call.1
Anyway the Fed researchers look at the Facebook IPO and the underwriters’ price stabilizing activity on its first trading day, Friday May 18. And they note, as I did, that there was a whole lot of buying at the IPO price of $38, which was probably largely due to the underwriters and which kept the stock above $38 going into the weekend before it cratered Monday morning. But they also note that there was a whole lot of buying at $40, which kept the stock above $40 for … 15 minutes.
Based on this they deduce:
Based on our identification assumption, the evidence we produced suggests that not only did the underwriters forfeit the profits they could have made by covering their short position with shares bought in the marketplace below the offering price had they let the price fall, they also incurred costs through the stabilization attempt at $40. Assuming that they purchased all shares traded at the $40 price (about 34 million shares), we calculate that underwriters spent about $66 million supporting the stock, or almost 40 percent of their underwriting fees. If this estimate is correct, underwriters’ reputational concerns and obligations to the firm may have outweighed their short-run profit motive.
There is much to be fascinated by here. Like, one: is it true? My roooooough guess at the time was that the underwriters bought in about half the (63 million share) greenshoe at $38 on the Friday of the Facebook IPO, leaving them short 30-ish million shares at $38 that they bought in at Monday’s $34-$35 prices, making them a ~$100 million profit. This accords with media reports citing people familiar with the matter who said that the underwriters made $100 million on the stabilization.
The New York Fed comes out slightly differently; they think that the syndicate bought ~half of the greenshoe at $38 (for no profit) and ~half at $40, losing two bucks a share2 for a total expense of $66 million. That’s a $166 million swing on a deal with $176 million in total underwriting fees.3
What do you make of this? Its based basically on the fact that, while supply of shares for sales was sort of smooth and normally distributed around ~$41, there were outsized clusters of bids at two exact integer prices, $38 and $40, which certainly seem suspicious and as though they came from underwriters rather than independent buyers. This is not slam dunk evidence – as they say “since our data do not identify individual investors, this identification is based only on indirect inference” – but it’s plausible.
I have some doubts, though, because, um, if Morgan Stanley et al. actually spent $66 million helping its investing and issuing clients by stabilizing the stock at above the IPO price, why would all those people familiar with the matter tell the press that instead Morgan Stanley et al. made $100 million by neglecting their stabilizing obligations and hosing their clients, at the exact time that Morgan Stanley was pitching for more tech IPO business on the back of Facebook? One obvious answer is “because those people worked at competitors and wanted to screw Morgan Stanley” but this is not a thrilling answer; Morgan Stanley by all accounts has telephones so could correct the record if things were as the Fed thinks they were.4
Still it’s sort of appealing. As the Fed researchers write:
Underwriters have conflicting objectives on the day of the IPO when the stock price appears at risk of falling below the issuing price. Their obligation to the firm — and their reputation — pushes them to support the stock, especially around the IPO price. However, this does not serve their short-run profit interests. Indeed, notice that because of the greenshoe option, which is equivalent to a short position on the stock and a call option at $38, the underwriters are effectively long a put option with a strike price of $38. … Such an option would become valuable were the price to drop below $38 and should therefore never be exercised above the strike price.
The underwriters’ “obligation to the firm” – i.e. Facebook – are more customary than binding; the underwriting agreement gives them the greenshoe option but doesn’t say how they have to use it. Morgan Stanley could have done nothing to support the stock, bought back the whole 63mm shares at $34, and made $250 million, without Facebook having any legal claim against them. They gave up at least $150 million of that profit, and maybe threw away all of it and $66 million besides, because that way they get to keep having greenshoes. Which are sometimes profitable – as Facebook’s probably was? – and sometimes not – as Facebook’s maybe was? – in themselves, but which are more important because they let you keep having IPOs: the greenshoe and accompanying stabilization definitely makes investors more willing to buy in unproven IPOs. And that means fees, and, like, having an underwriting business and stocks to trade and all that good stuff.
The greenshoe is a classic case of long-term greedy: when an IPO is looking like it will break the deal price, you can either make lots of money at your clients’ expense with no immediate repercussions, or you can spend lots of money to help your clients with no immediate benefit, just for the long-term good of your franchise. I suspect Morgan Stanley ended up somewhere in the middle, making a good-faith but not foolhardy effort to prop up the price and giving up millions of potential profits while still ending up with some windfall. But in these dark days, with everybody and their muppet accusing banks of turning their backs on their long-term-greedy roots and seeking out the quick buck, it’s nice to see that some people believe in the old model of banking.
In a Relationship: Evidence of Underwriters’ Efforts to Stabilize the Share Price in the Facebook IPO [FRBNY / Liberty Street Economics]
1. Though I cannot fully endorse the punning headline. To be fair! This is like five months after the IPO, all the good Facebook puns were taken. I should call this post, like, “Create Event” or something.
2. The annoying noodge / former capital markets banker in me cannot resist adding “PLUS THE GROSS SPREAD.” So $2.418 per share.
3. Being less aggressive than the Fed you could assume the syndicate:
- Sold 63mm shares (the greenshoe) at $38,
- Bought 17mm shares (half the Fed’s assumption) at $40 = $34mm loss,
- Bought 32mm shares (~3/4 of the trades at the bid at $38 on Friday) at $38 = $0 P&L,
- Bought remaining 14mm shares on Monday at $34 = $56mm gain,
- For a net $22mm gain on the greenshoe.
Assuming that the covering on Monday was at around $34 – could be more, could be less, but the VWAP was $34.48 for the day and $34.60 for 9:30 to noon – and they bought half the shoe at $38, the breakeven would be buying about 20 million shares at $40, or a little under 2/3 of the amount traded there. More than 20mm at $40 is a loss, less is a gain.
4. Here is another, more convoluted, reason to question the NY Fed’s conclusion. If you are the underwriters, you buy stock at $38 to soak up supply and try to keep the deal at or above the IPO price; if you fail you’ve done your best and lost nothing but some gross spread. But why buy stock at $40 – above the IPO price? The answer has to be something like “because you think that support at that price will be more effective than support at $38″ – that is, that the market will view support at $40 as indicating strength and so a defense of $40 might cause the stock to turn around and shoot back up, while a defense at $38 will look weak and will quickly be breached.4a I dunno, this sort of psychologizing-and-anthromorphizing-and-technical stuff is not my bag, maybe there’s a head and shoulders or something in there somewhere.
But if that’s true – and something like it has to be true; if the underwriters tried to stabilize by buying at $40 they had some reason for thinking that was a worthwhile endeavor – then it’s a statement about trading rather than stabilizing: “if there’s enough buying at $40, the stock will probably rally above $40,” as opposed to “we might as well buy at $38 because it’s free for us to do so and that’s what we’re supposed to do.” But if that’s right then it’s a profit opportunity for non-syndicate buyers: if you put in a limit bid at $40 and buy alongside the underwriters, then if they (and/or you) are right that that will push the stock price up, then you can sell at $42 or whatever and make money. So someone should have done that.
Basically: if there was any reason for the syndicate to be buying at $40, there was almost-equal reason for non-syndicate buyers to be buying at $40. So it’s unlikely that all of the $40 buying was done by the syndicate – whereas it’s quite plausible that all or almost all of the $38 buying was.
4a. Footnote in footnote! You can fake-math this out a bit. You make 41.8 cents for each share of the greenshoe that you exercise; you lose $2 for each share that you instead buy at $40. If you buy 63mm shares at $38 – so no greenshoe exercise – you make zero, that’s your baseline. If buying 10mm shares at a $2 cost keeps the stock above $40, then you lose $20mm on those shares but make $22.15mm ([63mm - 10mm] x $0.418) on exercising the greenshoe on the remainder. So that – really 10.89mm shares – is roughly the breakeven; you’d buy up to 10.89mm shares at $40 if (1) you were sure that would keep the stock above $40, or at least above $38 and (2) you were purely motivated by near-term profit and loss. Neither assumption is likely to be true, thus the fakery of this math, but you’d probably keep something like this in mind.