Chinese Insurer Making A Bunch Of Banks Run Its Practice IPO, Will Pick The Best One To Run Its Real IPO

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You can, if you're interested, read a debate about bankers' ethical obligations in IPOs here and here and here, because Facebook. The gist of the debate is: should we be congratulating Facebook's bankers for being super ethical, because they helped their issuer client top tick the stock, which was what the client wanted, even though investors kind of got screwed? Or should we be pissed at them for failing to price the stock for a big pop, helping their investing clients and screwing the issuer a bit by leaving money on the table?

The answer I suppose is "you're not really supposed to screw anyone more than they can stand to be screwed," which is a good moral for life and the selling professions in particular, but there's kind of an important institutional reason for it here. The main job of an underwriting bank is not just to price a deal more or less right, but to price lots of deals more or less right. This follows from the bank's role not as just a sales force but as an "underwriter," that is, as some sort of gatekeeper to the capital markets that in the loooooooooooosest possible sense lends its name and relationships to issuers, vouching for whoever it brings to market.

If you do lots of deals that all pop too much, no issuer should use your services; if you do lots of deals that all crater, no investor should want to buy your deals. But those incentives should wrap back around: if your IPOs all crater, then no investor will buy from you, so no issuer should want to issue with you, because you can't actually market the deal to investors who might buy it. The bank's job is to balance each side against the other not only because they're all clients and should be treated nicely, but also because both sets of clients are profiting from the relationships and reputation that the bank has built up. If you don't like doing an IPO with a bulge bracket bank because they charge too much and underprice their deals, do your IPO with Joe Blow IPOs Inc. and see how interested Fidelity is.

I found this Deal Journal article funny, but also terrifyingly like that dream where you realize that you forgot to hand in one assignment and so have to go back to high school, because it's probably less funny for the bankers involved. It starts like this:

A $6 billion listing of a giant Chinese state-owned insurer is taking on new twists and turns as bankers gear up for an increasingly taxing deal.

In addition to previous demands that already have raised eyebrows among bankers, People’s Insurance Co. (Group) of China Ltd. is now asking banks that want to be on the deal to seek so-called cornerstone investors, according to people familiar with the matter. ...

PICC hasn’t assigned the role of global coordinator, or the bank responsible for coordinating the share sale, or bookrunners, responsible for selling shares, people familiar with the situation said. Those roles will be given out based on the investor orders the banks can get from cornerstone investors. This is unusual; normally, companies hire their banks after hearing them pitch for the business. Only after that do they ask them to approach potential investors.

The story develops crazily from there; it is perhaps not too much to say that PICC is having every bank audition to run its IPO by by running its IPO in miniature, lining up big investors and getting them to agree to buy PICC stock, but in an artificially constrained way where the banks divide up the universe of investors so that each bank is basically proving its ability to run the IPO by running 1/17th of the IPO. Also all the buyers' indications are nonbinding. Also this is totally goofy:

Four people familiar with the matter said Goldman Sachs Group Inc. has agreed to bring in cornerstone investments of $2 billion, or around a third of the deal, considered an impressive amount for a single bank, especially given weak sentiment among investors as markets falter worldwide.

Other people familiar with the matter said bankers misunderstood Goldman’s commitment and the $2 billion referred to the total that Goldman thought all the banks together could pull in from cornerstone investors, and that each underwriter would fill an equal portion of the cornerstone tranche.

I feel like ... that misunderstanding could have been corrected? Or that I should bid $3bn of nonbinding estimated cornerstone investments to be solicited by all the banks, and win the mandate for myself, what could possibly go wrong etc.

Leaving aside random confusions like that - and the fact that this would be wildly illegal in the U.S. but whatever - PICC's approach makes lots of sense for PICC. Markets are, um, choppy, and hiring a bank with billions of dollars of (nonbinding) orders signed up to run your IPO probably makes you feel a lot better about its chances of getting done than hiring the bankers with the slickest hair and the thickest pitchbook. A pitch based on expertise, strategy, relationships and positioning is less compelling than "you're done at $X."

The problem with that approach is that, if seventeen banks are basically lining up orders before they've been picked to lead the deal, they are unlikely to be doing much in the way of underwriting: instead of a system of bankers vouching for clients they know well in their first foray into the public markets, you have a system of brokers matching buyers and sellers with little information, all of whom think they're taking advantage of each other. Neither side has much reason to listen to the bankers. (I know: probably they don't anyway.) But PICC is benefiting, at least a little, from the banks' relationships with the investors they're calling to take part in this deal, while also undermining, at least a little, those relationships for future issuers.

Where bankers don't serve any vetting function, someone else does - and as Deal Journal points out, that someone here is the cornerstone investors, who agree to buy a big chunk of the deal, let their name be used publicly, and hold on to their shares after pricing. As a random public investor you might like that - you might prefer your companies to be vouched for by someone who's buying their shares, rather than someone who's selling them. That's sometimes how U.S. capital markets deals work, too. But in the long run it can't be great for banks to have their role in IPOs reduced to one of pure price-maximizing salesmanship - even if deals like Facebook look pretty close to that already.

Confusion Surrounds Giant IPO for Insurer [Deal Journal]
Show me the money, PICC tells long list of banks [FinanceAsia]

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