Just Who Brought Those Duds to Market?
By ANDREW ROSS SORKIN
When the stock market closed on Nov. 12, 1998, the corridors of the Bear, Stearns offices on Park Avenue rang out with triumphant cheers and applause. The investment bank had made a big score: the initial public offering of theglobe.com, which it had underwritten after several rival investment banks refused the deal, had just achieved a record-breaking 606 percent gain on its first day of trading.
"I was getting a lot of applause for getting us into the game," recalled Scott Ehrens, who at the time was an Internet analyst at Bear, Stearns.
Two and a half years later, the clapping has turned into stunned silence.
Shares of theglobe.com, a youth-oriented Web site, trade for less than a quarter. At times, they have dipped below a nickel, down from a high of nearly $40 in 1999.
And the overall record of Bear, Stearns in initial public offerings looks little better. Of the 49 companies it has taken public since 1998, 13 — more than one-fourth of them — now trade for under $1 or have been delisted by Nasdaq, according to an analysis by Thomson Financial, which tracks securities data. Some are close to bankruptcy.
Less than two years ago, in the heyday of initial public offerings, Scott Scharfman, a senior managing director at Bear, Stearns, proudly beamed in Fortune magazine: "I've heard clients tell me, `You guys are cowboys. You do deals other people won't do.' "
Maybe it shouldn't have, either. Dot-com-pushing analysts have long taken the brunt of criticism for overhyping the market, but what about the investment banks and the bankers who took those companies public? Did they know they were selling damaged goods with no refund policy? Did they do it anyway?
It would be one thing if such poor performance were confined to Bear, Stearns. But many Wall Street investment banks, from top-tier firms like Goldman, Sachs, which have brought companies to the public markets for years, to newer entrants like Thomas Weisel Partners of San Francisco, have reason to blush. In one blindingly fast riches-to-rags story, Pets.com filed for bankruptcy just nine months after Merrill Lynch took it public.
Of course, investment banks that took these underperforming companies public may not care. They bagged enormous fees, a total of more than $600 million directly related to initial offerings involving just the companies whose stocks are now under $1.
"This raises a big question of quality control," said Roy Smith, a professor of finance at New York University and a former partner at Goldman, Sachs. "The net result is they made a lot of mistakes, and there's a price to be paid for that. A lot of folks look awfully stupid."
Of the 1,262 companies that went public from 1998 though the end of last year, the shares of 152, or 12 percent, can now be bought for less than a dollar, Thomson Financial said, and only a small fraction of the companies Wall Street took public over the last four years have been successes. The I.P.O. trash bin is so overflowing with companies whose stocks sell for pennies that Frank Quattrone, the legendary head of the technology group at Credit Suisse First Boston, jokingly likes to call them "our friends who no longer have a digit next to the fraction."
How did investment banks, paid for their expert advice, pick such lemons?
"It seems to me the underwriters got carried away with the exuberance of the market," said Alan R. Bromberg, a professor of corporate law at Southern Methodist University in Dallas. "But they are very much responsible. They took advantage of their own prestige."
On Wall Street, that prestige is often measured by quantity. Investment banks pride themselves on their place in "league tables," the tally of deals each quarter and each year that let one bank or another claim a place in the top tier of deal makers. Mr. Scharfman received credit for putting Bear, Stearns in the game. (He left Bear, Stearns shortly after making his bravado statement to join Mercata, an Internet purchasing service financed by Paul Allen, Microsoft's co-founder, which went belly-up in January.)
But that prestige looks different when quality is considered. Thomson's analysis illustrates how badly many banks have marred their track records. Matching the top 30 underwriters with initial offerings that have fallen below $1 or have been delisted, Thomson found the worst record at Thomas Weisel, which focused completely on technology companies and where a third of the companies taken public have gone sour. Of the biggest Wall Street firms, Bear, Stearns performed the worst — with a quarter of its I.P.O.'s now ailing — about the same as at a smaller firm, W. R. Hambrecht.
ING Barings and Deutsche Bank were only slightly better: about 16 percent of their initial offerings met the same fate. Even the most prestigious names, like Morgan Stanley, fell into the trap; 9 percent of its deals have fallen under $1.
Looking solely at performance in the years after the offerings, the records now are not much better. For example, the stock prices of J. P. Morgan's offerings since 1998 were down an average of 46 percent from their initial prices. (Its average includes initial offerings from Chase and its technology-focused unit, Hambrecht & Quist.)
No one is suggesting intentional evil, of course. "It doesn't mean they were out there trying to run over their grandmothers," Mr. Smith said. "The demand was so strong."
Still, not all investors felt equal pain. Some of the banks' best customers were allowed to buy in early — and often got out while the going was still good. But many small investors, enticed by the promise of quick riches, could not buy until too late — and big chunks of their nest eggs have been wiped out.
Now, of course, the market for initial offerings is all but dead — a situation that could ripple through the economy by preventing innovative companies from raising money to grow. Even many established companies are having a hard time raising cash. Agere Systems, the optical components business that was spun off from Lucent Technologies, ended up being taken public by Morgan Stanley last month at the very bottom of its target price. It raised $3.6 billion, instead of the $7.2 billion for which it had hoped. Only 21 initial offerings, valued at $7.97 billion, have been completed so far this year, compared with 143, valued at $27.3 billion, in the 2000 period.
And no one expects that market to rebound anytime soon.
"There's been a bit of a backlash so far this year — the pendulum seems to be swinging further back the other way as investors nurse upsets from late last year," said Dhiren Shah, managing director and head of Morgan Stanley's global technology group, which was responsible for most of the bank's worst- performing initial offerings.
TODD J. CARTER, director of investment banking at Robertson Stephens, a unit of FleetBoston Financial, offers a humbling explanation. "Investment banks had to be responsible and it was hard to be responsible," he said recently, sitting in his office overlooking a very foggy San Francisco Bay, with a small television tuned to CNBC. "The greed factor was at biblical proportions."
"Janus was telling us: `Bring more companies public. We want more product,' " he added. "I used to think that some of these companies were a joke. In the beginning, we were doubting Thomases. But that cynicism faded away when I saw the reaction in the market." Janus, the Denver-based mutual fund company, declined to comment. Its funds are all down for the year, some far more than general market averages.
At the end of quiet Hanover Street in Palo Alto, Calif., just blocks from Stanford University, is an unassuming two-story brick building across from a row of suburban homes. The building is the home of the Credit Suisse First Boston technology group, which since 1998 has helped Credit Suisse take more companies public — 186 — than any other investment bank in the world. As a result, it also happened to underwrite more public offerings that now trade below $1 than any other bank — 25 different deals. Those deals alone accounted for $133.8 million in revenue for the bank. And those duds were 13 percent of its total I.P.O.'s, putting it squarely in the middle of the pack with its competitors.
Mr. Quattrone, the technology group's head, is an animated deal maker who made his name taking companies like Cisco Systems public. He acknowledges that the last couple of years may have become too heady. "I'd say quite a few of the companies that went public early, got out and got the cash have done themselves a disservice," Mr. Quattrone said, sitting at an oversized table in a polo shirt and slacks in the "Pebble Beach" conference room. (An avid golfer, he named each conference room after a golf course.)
But Mr. Quattrone defends the decision to take those companies public, articulating a point that the companies themselves often make: "It's hard to criticize them after the fact, because they were in a situation where if they didn't go public, a competitor would have and they would be lunch anyway."
He added: "It's the same for us. If we don't do Netscape, Goldman Sachs will do Netscape."
Indeed, the race among Wall Street firms to take companies public was fierce. And technology-related companies were especially keen to use a seemingly bottomless well of investor cash to finance their capital- intensive start-ups.
Still, even Mr. Quattrone said that there was "really no reason why the market was going up that fast and why it was accelerating." Pausing for a moment, he put some blame on analysts: "What we saw was that valuations were getting completely beyond the realm of any individual to explain them, other than these well- respected analysts saying, `Well, you just don't get it.' "
Over all, he remains proud of the firm's performance. "Given the advantage that we have in terms of market share and the number of deals we did," he said, he thought his firm did the best job possible in striking a balance — meeting clients' needs while not shortchanging investors. "In a market where the rules were changing," he said, "our strategy of trying to focus on the highest-quality companies within the new ground rules worked."
Historically, the ground rules were simple. Investment banks courted companies that had been around for several years, had proven management teams and looked likely to remain solid. And, yes, turned a profit.
Those gauges were thrown out in 1998. "The rules definitely changed," Mr. Shah of Morgan Stanley said. The public's demand to get in on the action, especially in technology, he said, rewrote the book. "What I think happened was that the public markets were prepared to do I.P.O.'s at an earlier stage."
Investment banks also changed the way they promoted their initial offerings. The Securities and Exchange Commission has rules intended to prevent analysts from commenting on — or touting — stocks that they take public, for 25 days from the offering date. Some banks and their analysts pushed the envelope, talking up offerings to just about anyone who would listen, and helping to push prices higher.
It's a transaction-based business; the banks are in this to make money," said Randall Roth, a research analyst at Renaissance Capital, which has an I.P.O. fund that is down 36 percent this year. "Forget about them saying this is a relationship business. Very few of the big underwriters are not public. They have to meet their numbers, too. The proof is in the pudding."
"Twelve percent is huge," he said, speaking about all the I.P.O.'s now in the gutter. "It's a credibility issue, and they had a fiduciary duty to do due diligence. Any idiot gets an E*Trade account and suddenly they think they're listening to the pros."
Morgan Stanley mainly stuck to its old-school formula, Mr. Shah said. That formula produced results a tad better than those of its rivals: just 9 of the 99 companies it took public since 1998 are now in the under-$1 category. "At times, though," he said, "you had to question whether we had the right strategy, considering the market."
Compared with historical industry averages, however, even that 9 percent share is still remarkably high. From the mid-1980's through the late 90's, only about 1 percent of initial offerings typically fell below $1 or were delisted in the next three years, according to Thomson.
From 1986 until 1995, only in one year — 1989 — did a crop of I.P.O.'s trading under $1 represent more than 2 percent of the deal volume. The average for the period was 1 percent. From 1995 through 1997, that figure jumped above 4 percent. In the latest three-year period, it soared to more than 12 percent.
"For many technology companies, going public was disproportionately important in the evolution of their corporate and business models," said Michael Evans, co-head of equity capital markets at Goldman, Sachs, which took 14 companies public that can now be bought with coins — and bagged $177.3 million from these duds. "These companies saw the need not just for capital but also for the perception of credibility afforded by being publicly held, which was a significant component of attracting enterprise clients."
For Mr. Ehrens, the former Bear, Stearns analyst, his genius was clearly short-lived. After aggressively courting companies like theglobe.com, Prodigy and Xoom.com — all of which the firm took public — he acknowledges that his risk threshold may have been too high. "Everyone was too aggressive," he said from his apartment in Manhattan, where he is now an artist. "We were fighting our way into deals. We weren't getting them on a silver platter like Goldman or Morgan Stanley. We didn't have longstanding relationships in Silicon Valley."
Asked to comment, Bear, Stearns issued a statement saying: "We believed strongly in each of the businesses we helped bring to the capital markets over the past few years. At the time each of our issues met with strong investor response and performed well in the initial aftermarket. Neither we nor our clients could have foreseen the rapid and dramatic change in investor sentiment towards the technology and telecom sectors and the recent severe decline in equity valuations."
Even Todd V. Krizelman, a co- founder of theglobe.com, said that despite the downturn in its stock, the company made the right move. "Certainly for us it was very important to go public, and I'm saying that with 20/20 hindsight," he said. "It gave us huge credibility overnight."
Many investment banks whose I.P.O.'s fared the worst took on deals that were passed over by banks like Goldman Sachs, Morgan Stanley and Credit Suisse. "It was hard to be picky," Mr. Ehrens said.
Among the smaller banks that did a relatively substantial number of deals, Thomas Weisel Partners finished at the bottom. That bank, formed in 1999 by the founder of Montgomery Securities, a well-regarded investment bank acquired by Bank of America in 1997, has dealt only with offerings of technology- related companies. It has taken nine of them public since 1998; three can now be bought with loose change, and the banks' offerings over all are down an average of 68 percent from the offering price, the worst of the group. Weisel did not return calls seeking comment.
Of the major banks that took a big number of companies public, UBS Warburg and Bank of America Securities appeared to do best. Neither took any companies public that now trade below $1. In comparison with their rivals, that seems quite an achievement, considering that they took 57 companies public between them. And UBS Warburg's initial offerings are down an average of just 1.1 percent, compared with 4.5 percent for the top 30 underwriters. Bank of America Securities' offerings since 1998 are down 25 percent.
So is the bloodbath over? And when will the banks be back with another crop of I.P.O.'s, hopefully of better quality? From a historical perspective, if the market has indeed hit bottom, the next offering bonanza is still at least a year off. After the Nasdaq plunge of 1983-84, new offerings did not appear with great regularity until the end of 1985.
Even the most blue chip of banks will probably be cautious about returning to the market with new offerings, if only to restore their credibility. "Look, underwriters have brand names and reputations, and clearly being attached to underwritings that performed badly is not good for business," said Joseph Grundfest, a Stanford law professor and former S.E.C. member. "But there are two ways to spin this. Can you blame the merchant for selling something to a paying customer? How many shirts do you have in your closet that you can't believe you bought?"
Copyright 2001 The New York Times Company |
