Wednesday, September 24, 2014

The Alibaba Underwriting Fee in Perspective

The Alibaba Underwriting Fee in Perspective

The underwriters of the recent offering of Alibaba are splitting $400 million in fees.  Five firms, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, and Morgan Stanley received 15.7%, and Citi will get 7.9% from the pot.  A bunch of other firms will split the remainder.   Although $400 million is an eye-popping number, the fee is only 1.2% of the amount of proceeds raised in the deal.  Apparently, when Wall Street underwrites a $25 billion deal they’re willing to work for a discount.  Alibaba is a fairly complicated undertaking.  While the company mainly does business in China, it is incorporated in Grand Cayman and operates through a web of subsidiaries.  Clearly, the lawyers and accountants had their work cut out for them in preparing the IPO.  For their efforts, the accountants made $9 million (0.04%) and the lawyers made $15 million (0.06%), which also represents a big discount to the professional fees assessed in a typical deal.

As I’ve written before, investment bankers don’t get much criticism for their fees because they are calculated in basis points (hundredths of a percent) and netted out of the deal.  Lawyers and accountants still charge in dollars and put in separate invoices.  In reading the Alibaba prospectus, it sure seems to me that the lawyers and accountants deserved a bigger share of the fees.   Underwriting and selling the deal was a whole lot easier than cleaning it up for its debut on the New York Stock Exchange.

The Alibaba deal got me to thinking about underwriting fees in general.  While a huge deal will garner a discount, most IPOs are still done at substantially higher percentages.  Recently, Mobileye was charged 5% or $44.5 million to raise $889.7 million.  By the way, the accountants and lawyers made 0.08% and 0.40% respectively.  Mobileye is a software developer for camera-based Auto Driver Assistance Programs, was founded in Israel, and incorporated in the Netherlands.  Aside from earning a hefty fee, Goldman Sachs also sold 4.4 million shares in the offering worth about $100 million. 

If you’re only raising $115 million like iDreamSky Technology, the underwriting fees will cost you 7% and the accountants and lawyers will charge 1.1% and 1.7% respectively.  When you add up all the deal-related costs, iDreamSky will have incurred 11¢ in fees and expenses for every dollar they raise.  Even residential real estate deals are completed at a lower percentage of fees.  Although the offering was smaller than either Alibaba or Mobileye, iDreamSky’s deal has many similarities.  The company is an independent mobile game publishing platform operating in China.  The Chinese entities pass through a Hong Kong entity and a Cayman entity before having their shares offered in New York.  Nonetheless, iDreamSky incurred a heavy price for going public.

Many things have changed on Wall Street over the years.  You can trade stocks at fractions of a cent in fractions of a second across a myriad of platforms.  Even mutual fund fees have declined.  However, when it comes to raising public equity, the fees are exactly the same as they were over thirty years ago when I helped to raise money for a series of companies.  In those days, we didn’t have the enormous balance sheets that are now common at Goldman Sachs and Morgan Stanley.  Most investment banks were private firms where the partners were risking their own capital.  Thus underwriting a public offering actually put the firm at some risk as it attempted to sell a stock offering.  In addition, the distribution network of mutual funds, hedge funds, and other large investors wasn’t as deep or as global as it is today.  In other words, it was a bit more challenging to find buyers for IPOs.   Nonetheless, the fees (and resulting profit margins) have remained amazingly high.

I don’t think the situation is likely to change.  If anything, the number of major underwriters has shrunk dramatically over the years.  About fifteen years ago when Glass-Steagall was repealed, there was some thought that there’d be greater competition for equity underwritings as big banks battled big brokers/investment banks for business.  However, most big banks didn’t build their investment banking capabilities. They acquired them by gobbling up investment banks.  Then the credit crisis hit, and one investment bank after the other either failed or was swallowed up.  As a result, the remaining investment banks represent one of the most powerful cartels on the planet, and their fees for underwriting stock deals will remain ridiculously high.

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