Bloomberg has a story today about how, while one side of Morgan Stanley made lots of money on the Facebook IPO in fees and greenshoe trading profits, another side of it did not do so well. So: how much of the subtext here is actually here?
Morgan Stanley, the underwriter that took Facebook Inc. public at a record high market value, said its own money-management unit bought more than 2 percent of the shares sold through the $16 billion offering.
Morgan Stanley Investment Management invested about $380 million in Facebook’s initial public offering, according to regulatory filings late last month, the first to show its IPO purchases. A dozen funds run by the advisory unit’s growth team, headed by Dennis Lynch, each allocated 6.8 percent of their net assets to buying Facebook stock at the IPO price of $38 a share.
Facebook has fallen 42 percent since its offering, increased in size and price at the 11th hour. The drop erased $39 billion in market capitalization, ranking the stock as the worst-performing large technology IPO ever based on the early loss in value, according to data compiled by Bloomberg. The decline crimped the performance of Lynch’s growth team, described as a “crown jewel” of Morgan Stanley Investment Management, and left the bank’s fund investors behind on the investment.
This is a form of story that is not uncommon and a lot of the accompanying eyebrow-raising is usually unjustified. Still, we've got eyebrows, let's use them. Like:
- Facebook was a hot IPO and by all accounts sort-of oversubscribed, at least before the last-minute upsizing/repricing/estimate-crappifying. Had it looked hot to the underwriters, would they have given a better allocation to their own crown jewel asset managers than to outside investors?
- Facebook actually turned into a dog. Did the bankers doing the allocations have an inkling of that, and give their own crown jewellers a better window into the book than they gave to outsiders?
- Facebook actually turned into a dog, part II. Did the bankers doing the allocations have an inkling of that, and stuff their own asset managers because better to piss off an in-house client than an outside client who can decide whether or not to do future business with them?1
- Facebook actually turned into a dog, part III. Did the MS asset managers know that and volunteer to take down a big slug to help out the home team?
- Further back, MSIM invested in Facebook pre-IPO; did this help Morgan Stanley's bankers land the IPO?
I dunno, you can have other theories. On the ones above I go something like "maybe, no, maybe, no, yes," but have no confidence in those answers. Bloomberg talks to a guy who rejects the fourth theory - that Morgan Stanley's asset managers took one for the team, at the expense of their mutual fund investor clients - and I think he's right:
Morgan Stanley’s money managers had no incentive to help the firm’s investment-banking affiliate unload Facebook shares because their pay is based on generating high returns for investors rather than underwriting fees, said Jay Ritter, a finance professor at the University of Florida, in Gainesville, who does research on IPOs. “Most of the portfolio managers at mutual funds are focused on, ‘I want to generate alpha for my fund,’” Ritter said in an interview. “‘My salary isn’t going to be boosted if I help out the investment bankers.’”
But Chinese walls do get more porous when people get mad or desperate, and your year-end comp can sometimes be of less interest than your prospects for immediate unemployment. Is Dennis Lynch a bit pissed at Michael Grimes for the underwriting and pricing of this IPO?2 If so - I mean, he's a crown jewel, you'd think his annoyance could be manifested as "fire this incompetent."3
Any IPO, of course, involves balancing between investors who want low prices that then go up and companies who want high prices that then, um, go up. And if you piss off either issuers or investors, they can always call your boss and try to get you fired. The stakes do perhaps get a little higher when they can just walk over to your boss and try to get you fired, but the concept is the same.
It gets more interesting, though, as one side of the firm gets more powerful than the other. Remember how Goldman's investment bankers sort-of advised El Paso on its sale to Kinder Morgan, while Goldman's private equity arm owned a big stake in Kinder Morgan, and then Goldman got all sorts of sued for those conflicts of interest and ended up giving up its $20mm M&A fee? I am more sympathetic to Goldman's El Paso banking team than are some commentators, but I enjoyed Ronald Barusch's column a while back basically saying "boo hoo, Goldman lost its $20 million dollar fee over its conflicts of interest, but it made like $200mm on the private equity investment that created those conflicts."
Regardless of what actually happened, you can sympathize with those who saw a conflict, no? Imagine the next deal, where Lloyd and Harvey sit down with the target's M&A banker and the guy with the massive prop investment in the buyer and say "okay, what are we doing here? Giving objective advice or getting this sucker sold as quickly and cheaply as possible?" And you can imagine how the guy looking to make a $200mm prop profit talks a bit louder than the guy looking to make a $20mm M&A fee.
Especially if he's always out-earning the M&A guy. Morgan Stanley's not directly losing money on Facebook because its mutual funds lost value - they're mutual funds, they don't pay performance fees - but of course performance -> assets -> revenues. In Morgan Stanley's case, half of the revenues. We talked the other day about how Morgan Stanley is now half asset manager, with sales and trading accounting for 39% of revenues (down from 48% in 2007) and investment banking a piddly 11%.
If Fidelity ever underwrites an IPO you can bet it gets done at a price that Fidelity's mutual funds are 100% comfortable with, no matter how miserable that makes the issuer. It won't, of course - Fidelity has no investment banking operation - but, hey, neither does 89% of Morgan Stanley.
Many clients really believe - possibly beyond what the evidence supports - that different banks have different characters in underwriting deals, based on what class of clients they really care about in their heart of hearts. One reason these beliefs are non-evidence-based is that you can easily spin the argument either way: JPMorgan, which makes so much of its revenue off corporate clients, might push hard to get the best possible market terms for those corporate clients - or alternatively it might know that those corporate clients are sort of captive to its lending businesses, and so get pretty lazy when marketing their securities to investors. Morgan Stanley, having so much of its identity bound up with a retail franchise, might advocate its those retail investors and try to get them the best price - or alternatively it might think that retail investors are suckers and so market its banking services to corporates with the pitch of "we can stuff a lot of shares into price-insensitive retail hands."
One way to imagine an old-school investment bank is that it should sit exactly on the knife's edge of that dilemma, needing to please corporate clients so it can source deals and investing clients so it can sell them. As the modern world moves ever further from that pure investment banking model, though, and as investment banking revenue accounts for a smaller share of the pie at a lot of the big banks, there's less reason to expect them to strike that balance impartially. Which means that smart clients might want to get to work on figuring out where their underwriters' hearts really lie.
1. Related, perhaps, is the fact that there are actually legal restrictions on MSIM's ability to buy from affiliated sellers. So Fidelity can credibly promise never to pay MS a commission again, but MSIM can't, because it can't really pay them in the first place. So, screw 'em, right?
2. Though the fault in this case is mitigated by the fact that (1) everyone (especially MSIM, which already was invested) knew the company so it's hard to blame the IPO underwriting for your loss and (2) the price drop has been so catastrophic that it's hard to blame the IPO pricing for your losses.
3. Though I guess Grimes is kind of a crown jewel too, or was pre-Facebook.
4. It's not totally clear which theory the Facebook IPO supports; pure hindsight would suggest the latter - PRICE WENT DOWN! - but of course this isn't a story of dumb retail, it's a story of smart but internal mutual fund money.