Banker bashing has become a national pastime.
So it was with some interest that I read the column of my good friend and colleague, Joe Nocera, on Saturday about how the bankers behind LinkedIn’s initial public offering “scammed” the company. Usually I nod along in agreement with Mr. Nocera’s columns, but this one had me scratching my head.
The basic premise was that the bankers that underwrote LinkedIn’s I.P.O. badly underpriced the offering since the stock zoomed from $45 a share to over $120 on the first day of trading. Worse, Joe posits that the bankers did this on purpose to line the pockets of their clients at the expense of the company, which could have used the money to grow.
Before diving into this, let’s stipulate at the outset that the current I.P.O. system is not perfect and that other more innovative approaches — like a Dutch auction in which the buyers set the price — may be a better alternative.
Let’s also stipulate that the bankers behind the offering, Morgan Stanley and Bank of America Merrill Lynch, could have gotten a higher price for LinkedIn, from which they collected significant fees. At the same time, however, it must be noted that the banks have clients in the form of investors, so clearly the banks are playing both sides.
While we’re at it, let’s also stipulate that many people on Wall Street and elsewhere are rightly worried that a bubble is forming around social networking. LinkedIn made only $15.4 million in 2010 and is now valued at more than $8 billion.
With that context, here is another way to think about the LinkedIn I.P.O: the offering price was generous — and maybe even too high.
If you believe that LinkedIn’s stock price is part of a bubble and that it may fall back to earth, how should the underwriters’ pricing be judged in the future? If Morgan Stanley and Bank of America had priced the offering at about $94 — the price it closed at in its first day — and it subsequently fell to $45 a share, the public (and perhaps Mr. Nocera) would be up in arms that Wall Street had foisted a lousy deal on its unsuspecting clients, who were clamoring for a supposedly hot deal.
Note, too, that Goldman Sachs, which was an early investor in LinkedIn before the offering, sold its entire stake at $45 a share at the open, leaving some $30 million in missed profit on the table. Goldman clearly did not believe that LinkedIn’s stock price — even at $45 a share — was sustainable. What do they know that the rest of the world does not?
None of this is to suggest that Morgan Stanley and Bank of America got the pricing right; they clearly could have done better.
But unless we learn that the low price was determined, in part, to help themselves through kick-back schemes with favored clients, it is hard to argue the banks purposely “scammed” their client. (It is, however, something we should watch out for in this latest I.P.O. mania.)
It is also worth mentioning that LinkedIn only sold a fraction of the company, a little more than 5 percent. So if the stock price happens to hold up, the company will be able to raise a lot more cash. That is what the company’s management actually cares about.
Back in the dot-com bubble, the banks were often criticized for using their “credibility” — some readers may laugh at that word — to bring companies public that had no business being brought to market. And news organizations and reporters like me took those banks to task when the dot-com bubble popped and the stocks dropped like a stone.
All of this points to the inherent conflict that the banks face in underwriting initial stock offerings. On one side, they want the highest price for the company they are taking public. On the other, they want a price that will make their investing clients happy.
And in the middle, they want to come up with a fair price so they do not appear to be jerks to either constituency. By default, this is an untenable position.
There has got to be a better way. Let's start that conversation.
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