Are IPOs good or bad?What are the incentives of an investment bank in pricing an initial public offering? There is one big obvious one. You are selling the IPO to your investor clients, the mutual funds and hedge funds and asset managers who buy the stock. You want them to be happy, because they are big repeat customers who pay you a lot of money (in trading commissions, prime brokerage, etc.) and whom you need to buy future IPOs. They want the price to be low, so that it goes up a lot, so that they can make money. So there is a big obvious incentive to price the stock low. If the banks know that the "true" value of the company—the price where it will settle after the first day of trading—is $25, they might want to price it at $15, so the people who buy it can make a lot of money. There is another big one but it is less obvious how it cuts. You want your issuer client—the company selling the stock—to be happy, because (1) it is paying your fees for the IPO, (2) you hope it will be a repeat customer for investment banking business (though it probably won't do another IPO), and (3) you hope that other issuers will want to do IPOs with you, so you want testimonials from happy customers. So you want the issuer to be happy. But what will make it happy? You might think that since the issuer is selling stock it will want a high price, and that is basically true; investment banks compete for IPO mandates in part by flattering companies that they will get a high valuation. Companies want to sell stock at high prices, and telling them that you can do that—and then doing it—is a way to have a good IPO business. But it's more complicated than that, and companies tend not to want the highest possible price. Investors want to make money on the IPO—they want an "IPO pop"—and the companies want the investors to be happy. Once you do an IPO, those investors are your investors; they own your company and elect your directors and go to your shareholder meetings and vote on your say-on-pay proposals and so forth. Happy investors make a happy CEO, so the CEO will want the investors to be happy, which means giving them an IPO pop. Also independent of any real effect of the IPO pop, having an IPO pop feels like a win; it feels like a validation of your company and all your hard work. It is nice to see that people like you and want to pay for your stock. So if the banks and the company knew that the "true" value of the company was $25, but there were enough orders in the book to price it at $30 (and then watch it trade down to $25), they wouldn't do that. The company wouldn't want that; it feels bad to watch your stock go down, and to have your shareholders be mad at you. So if the true value is $25, the company might want to price at $22, to give the investors a nice little present and to have the pleasant experience of watching its stock go up. (Also: Who is "the issuer," anyway? Often the banks will deal with the chief executive officer of the issuer. If she is selling all her shares in the IPO, then of course she will want a high price, but of course she isn't selling all her shares. Generally a CEO will keep most of her shares through the IPO; frequently she'll keep all of them. So she has only a limited economic reason to care about a high price; a higher price means less dilution but that is a small effect. She's more interested in the deal looking successful so that she can sell stock at a higher price later. The same will often be true, to some extent, for her venture-capital or private-equity backers; they might sell a big chunk of their shares but will keep some, and will want to maximize their expected overall sale price, not just the price they get in the IPO.) There are other incentives. Here is a small obvious one: Banks generally get paid a percentage of the deal, so the higher they price the shares the more money they make. Seven percent of 10 million shares at $25 is more than seven percent of 10 million shares at $18. There are less obvious ones. In theory, banks have a huge financial incentive to price IPOs way too high, because of the mechanics of the "greenshoe" included in the deal. In an IPO, banks will sell extra shares, generally an extra 15% of the deal. If the stock goes up and stays up, the bank will buy those extra shares back from the company (using the "greenshoe" option) and make a bit of extra money (just the IPO fee on another 15% of the deal). If the stock stays flat and threatens to go below the IPO price, the bank will buy those extra shares back in the market at the deal price, "stabilizing" the price to prevent investors from losing money; in this case the bank won't really make any extra money (it will buy the shares back at the same price it sold them). But if the stock plummets immediately—if it opens far below the deal price—and stays down, then there'll be no real stabilizing to do. The banks will just buy the shares back, in the market, at a price far below where they sold them. In that case they can make a fortune, potentially far more than their IPO fees. (Some version of this seems to have happened with the Facebook Inc. and Uber Inc. IPOs, both of which quickly broke their deal price.) If your plan was to maximize revenue from an IPO, you would price the deal as high as you possibly could and still allocate shares, hoping that investors would try to flip their shares, the price would crash, and you'd get rich on the greenshoe. If you knew the true value was $25 and you could allocate the book at $35, you'd do that, and make $10 per share on the greenshoe. So banks have incentives to price IPOs high (pleasing the issuer, maximizing their fees, greenshoe trading profits), and incentives to price IPOs low (pleasing investors), and their business is balancing those incentives. Banks are, precisely, the middlemen between issuers and investors; they play a role in IPOs not because they are free of conflicts of interest but because the conflicts are unavoidable and someone has to balance them. I want to propose one more incentive for the banks, though, which is kind of a new one. If you price an IPO too low, Bill Gurley will complain about it. Gurley, a venture capital partner at Benchmark, is the most notable current critic of IPO pricing, but he is far from alone; a lot of venture capitalists and some tech founders share his view that banks are too cozy with investors and not cozy enough with issuers, that they systematically underprice IPOs to make investors happy and leave money on the table for issuers. If a bank does an IPO and it has a huge pop, Gurley will notice, and will tweet about how the company left money on the table and the banks are conflicted and IPOs are bad. This is not just a matter of venting on Twitter. Investors like Gurley aren't just complaining about the IPO structure; they are also advocating for other structures, new ways for companies to go public without the conflicts involved in IPOs. The big ones are direct listings and SPACs, special purpose acquisition companies, both of which—in different ways—take the pricing decision away from banks. In a direct listing, a company just goes public via an opening auction on the stock exchange; effectively its initial price is set by "the market." In a SPAC, a company goes public via a merger with a shell company controlled by an investor or operator; its initial price is set by a one-on-one negotiation. Your model could be that every underpriced IPO makes it more likely that future private companies will go public by direct listing or SPAC. Is that an incentive for banks to price IPOs higher, to reduce the likelihood of an IPO pop? Maybe? One thing that I have said before about direct listings and SPACs is that they are actually quite lucrative for banks; they cut the banks out of the pricing decision but somehow pay them more in fees. Still, if your model—like Gurley's—is that banks underprice IPOs to please investors, because pleasing investors is more lucrative for the banks than pleasing issuers, then the banks will not want to lose IPO business, even for lucrative SPAC business. The complaints, and the threats from venture capitalists about disrupting the IPO and taking their business elsewhere, would lead to less underpricing; they would make IPO pops smaller and rarer. The more coverage SPACs and direct listings get, the more big private tech unicorns murmur that they are considering using them to go public, the more careful the banks would get about avoiding big IPO pops so as not to kill the golden goose. An alternative model of all this would be, yes, right, there are incentives, but the main thing going on in IPO pricing is that no one knows how much a private company is worth, and banks and issuers and investors all do their best to figure it out, but there is a wide range of uncertainty around the IPO number and sometimes it turns out to be wrong in either direction. Everyone's goal is for the IPO price to be a little bit too low, so that there's a 10% or 20% pop and investors and issuers and bankers are all happy. Sometimes they miss, though, and it's way too low and there's a 100% pop; other times they miss too high, and the stock drops. In volatile uncertain markets the range of outcomes is wider, so pricing will tend to be more conservative, so you'll tend to see more huge pops, though also some IPOs that trade below the deal price. And in volatile uncertain markets you'll also see more talk about SPACs, which are a way to reduce uncertainty. Anyway: Cloud-service provider Rackspace Technology Inc. suffered the worst U.S. trading debut of the year while BigCommerce Holdings Inc. scored the best as the once-rebounding IPO market turns decidedly mixed. Rackspace, which was taken private in 2016 by Apollo Global Management Inc., closed its first day back as a public company Wednesday down 22% after raising $704 million in an initial public offering that was already priced at the bottom of the marketed range. That was the worst first-day performance on a U.S. exchange this year for a company raising at least $100 million, according to data compiled by Bloomberg. BigCommerce, meanwhile, priced its IPO above a marketed range that had already been elevated earlier to raise $216 million. The e-commerce software company doubled from its offer price for the best debut of the year, the data show.
Gurley complained about BigCommerce on Twitter, but to me this outcome—the best and worst IPOs of the year coming on the same day—looks more like the uncertainty hypothesis. Knowing that they are under scrutiny, knowing that any big IPO pop might push private companies further into the arms of IPO critics and SPAC sponsors, the banks running the BigCommerce IPO priced it higher than the range they launched at, and it was still wildly underpriced. Meanwhile the banks running Rackspace priced it at the bottom of the range they launched at, and it was still overpriced. You can tell a nefarious story here, but the simpler story might be that no one knows what a private company is worth and it's expensive to find out. Nikola!At Alphaville, Jamie Powell points out an amazing 10-Q, the quarterly financial report that Nikola Corp. filed on Tuesday. Nikola is a $13 billion company, by market capitalization. Its net income in the second quarter was negative $86.6 million but that's no big deal, plenty of huge companies lose money. (For the second quarter of 2019, for instance Tesla—Nikola's, um, namesake—had a net income of negative $389.3 million, and it was about a $42 billion company at the time. That worked out well!) More impressive is that Nikola's revenue for the second quarter was very small ("immaterial," Nikola actually calls it), just $36,000. Most impressive, though, is how they earned that revenue: During the three months ended June 30, 2020 and 2019 the Company recorded solar revenues of $0.03 million and $0.04 million, respectively, for the provision of solar installation services to the Executive Chairman, which are billed on time and materials basis. During the six months ended June 30, 2020 and 2019 the Company recorded solar revenues of $0.08 million and $0.06 million, respectively, for the provision of solar installation services to the Executive Chairman. As of June 30, 2020 and December 31, 2019, the Company had $3 thousand and $51 thousand, respectively, outstanding in accounts receivable related to solar installation services. The outstanding balance was paid subsequent to period end.
"Solar installation projects are not related to our primary operations and are expected to be discontinued," says Nikola, but I guess they are doing one last job, specifically installing solar panels at founder and executive chairman Trevor Milton's house? It is a $13 billion company whose only business so far is doing odd jobs around its founder's house. Yesterday I proposed a set of broad generalizations about how public markets have changed in recent years. Companies tend to go public later now, in part because they have an easier time raising money in private markets and in part because they are less capital-intensive than they used to be. The result is that public companies tend to be older, larger, more profitable, more stable, more boring. The speculative companies and explosive growth are found in private markets; by the time a company goes public it is in close to its final form. Obviously Nikola is an exception! People talk about companies that were founded in garages and then grew and went public and became multibillion-dollar companies, but Nikola is a multibillion-dollar public company that is just puttering around upgrading its founder's garage. God bless them, this is such an endearing 10-Q and now I hope it works out for them. I hope in 10 years all goods travel via Nikola trucks and they're a trillion-dollar company and in the Dow and an American institution and there are occasional wistful, incredulous articles in the financial press being like "little-known fact but back when it went public Nikola's future was so uncertain that it actually made money installing solar panels on Trevor Milton's house." Elsewhere in, you know, weird stocks beloved by retail traders, we have talked a few times about Eastman Kodak Co.'s controversial pivot to manufacturing drug ingredients, and the wild volatility in its stock since that pivot was announced. It would be great if, when Kodak files its 10-Q for the third quarter, it turns out that its entire revenue was $4.99 for developing a roll of film for its CEO. Everything is securities fraudIs it securities fraud for a public company to pay bribes to public officials in exchange for lucrative public benefits? Oh absolutely, every bad thing that a public company does is securities fraud, and honestly paying bribes feels even more securities-fraudy than a lot of other kinds of securities fraud. Still it is a little weird. Paying bribes to get public benefits is, you might think, the sort of activity that benefits shareholders. Sure they were deceived, and sure the stock price was too high because investors thought the company's good performance was more legitimate and sustainable than it was, etc., but the shareholders are strange victims. In effect, executives broke the law in order to steal money for the shareholders, and when the shareholders found out they sued? It seems a little ungrateful? Anyway there's a lot of it these days: FirstEnergy Corp. leaders collected more than $80 million, including $35 million in stock awards, in the three years that FBI agents say the Akron energy conglomerate bankrolled the "largest bribery, money-laundering scheme" in the history of Ohio politics. That's according to two new class-action lawsuits as shareholders blame FirstEnergy and its top brass for their investment losses. ... On July 21, federal agents arrested Ohio House Speaker Larry Householder and four other men, including lobbyists for FirstEnergy and its former subsidiary FirstEnergy Solutions (now known as Energy Harbor), which owned two nuclear power plants. Investigators say FirstEnergy Corp. and its subsidiaries funneled $61 million to Householder and his team members, who enriched themselves while pushing a $1.3 billion nuclear energy bailout bill into law. Within 48 hours of the arrests, FirstEnergy's shareholders collectively lost $7.6 billion as the parent company's stock price plummeted 34%, according to one of the class-action lawsuits.
Well but they got the bailout? I don't know how much it helped the shareholders—the bailed-out nuclear plants are in a subsidiary that FirstEnergy handed over to creditors in bankruptcy—but they did allegedly manage to get $1.3 billion of state money in exchange for $61 million in bribes, which seems like a good use of shareholder money, other than the illegality. Also: FirstEnergy executives and board members "misled investors and analysts by touting FirstEnergy's attempts at legislative solutions for its struggling nuclear facilities," according to one of the two more recent class-action lawsuits, which is a verified stockholder derivative complaint signed by shareholder Robert Sloan of Boynton Beach, Florida. The executives failed "to disclose that these so-called 'solutions' centered on the illicit campaign to corrupt high-profile state legislators in order to secure favorable legislation," Sloan complained.
I have to say that if I read a company talking about "legislative solutions" for its troubled nuclear business, I would pretty much assume they were bribing legislators in order to secure favorable legislation? I might assume they were doing it in a legal way, and be disappointed that in fact they were doing it in an illegal way, but these are matters of degree. Meanwhile in Chicago, Commonwealth Edison (a utility owned by Exelon Corp.) is also involved in an alleged "yearslong bribery scheme" involving state legislators. A utility regulator held a hearing on the allegations last month, and this happened: ComEd CEO Joe Dominguez, who has not been implicated in the scheme, told the panel that the money came from shareholder profits and it did not impact electricity rates. He also referred to the money paid to the Madigan allies — without mentioning any of them by name — as "inappropriate."
I suppose if you are talking to a utility regulator about your bribes, it is important to say that the bribes did not come out of customer money, since utility regulators are very sensitive to what ratepayers pay for. On the other hand once you say "oh yeah the bribes were taken from shareholders" you really are setting yourself up for a securities fraud lawsuit. Business efficiencyThere is a stereotype that the business of management consultants is to come into companies and tell them to do layoffs. "Efficiency, do more with less, fire a bunch of people," is, supposedly, the standard consultant advice. This is not really fair; consultants do lots of things. For instance at Wells Fargo & Co. the problem was not so much having too many people as it was doing too many illegal things, so it hired consultants to come in and tell it how to stop doing that: Wells became over-reliant on consultants as it struggled to deal with the fallout of a 2016 mis-selling scandal that cost the bank more than $3bn in penalties and forced radical improvements to its compliance procedures, said one of the people familiar with management's thinking.
Fine. The problem is that Wells Fargo did so many illegal things that its spending on consultants has become a key source of inefficiency: Wells Fargo is targeting dramatic cuts to its spending on consultants after an internal backlash against the bank's outlay on firms including McKinsey, PwC and Oliver Wyman, which has reached $1bn-$1.5bn a year. The savings form a crucial part of new efficiency plans to be unveiled by chief executive Charlie Scharf and will also include thousands of job cuts among Wells' 266,000-strong global workforce, said people familiar with the matter. ... "The things that we rely on outside people to do is beyond anything that I've ever seen," he said, as the bank promised to cut as much as $10bn from its annual cost base after swinging to its first quarterly loss in a decade. ... "Spending on consultants is off the charts," said another person. "You lose track of all of them really. It is comical."
I tell you what though, if Wells Fargo creates more fake accounts or whatever, it is not going to look good that they fired all of their don't-create-fake-accounts consultants just to save money. There will be some congressional questions about that. (Though "as well as the absolute cost, there were concerns that Wells' excessive use of consultants meant key skills were not built up internally," and it is true that you want your own employees, not just outside consultants, to know how not to create fake accounts.) Anyway a good consultancy business would be coming into a company and telling it to lay off its consultants. "Efficiency, do more with less, fire a bunch of consultants," it's a sort of meta-consultancy. Things happenBNP Halts New Commodity Trade Finance Deals as It Reviews Unit. Calpers CIO Resigns After Less Than Two Years, Missing Return Targets. Hong Kong Is Losing Its Charm for Expats as China Tightens the Screws. Slow start for CDS index reveals challenge for sustainable investment. Cash-Advance Tycoon Loses Control of Firm Amid Fraud Allegation. Wirecard business partner reported dead in Philippines. Goldman Says Covid-19 Vaccine Approval Could Upend Markets. More Farmers Declare Bankruptcy Despite Record Levels of Federal Aid. Can You Be Too Well Connected? Twitter teen's Bitcoin millions debated in bail hearing — that got Zoom bombed by porn. Wall Street Interns Find Creative Ways to Impress Bosses on Zoom. Penguin Guano Seen From Space Leads to Discovery of New Colonies. Police dog on first shift finds missing mother and baby on Welsh mountain. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! | 
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