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Market Oracle FREE Newsletter

5 "Tells" that the Stock Markets Are About to Reverse

Wall Street Stock Market Syndicate Still at Work

Companies / IPOs Mar 09, 2017 - 02:55 PM GMT

By: Rodney_Johnson

Companies Maybe they benefited from divine intervention… or maybe they were just lucky. Either way, the students and staff of St. Francis High School in Mountain View, California must be pretty happy right now.

In 2012 the school took a chance, investing $15,000 in a small, little-known app maker called Snapchat. Last week the school sold two-thirds of its shares for $24 million when the stock went public. I’m sure they’re still giving thanks.


Other people took home some dough that day as well. The co-founders, Bobby Murphy and Evan Spiegel, both cashed out $272 million. Their remaining shares make them both members of the billionaire’s club.

All told, the company sold 145 million shares and insiders/early investors sold 55 million shares. The company netted around $2.4 billion to fund expansion and operations, while the individual sellers walked away with the remaining $1 billion.

This part of the story is fun, but it can’t hold a candle to the folks that really got away with all the cash… the syndicate.

The early investors and insiders took a chance on a company that currently generates revenue, but hemorrhages cash. In 2016, Snapchat brought in $404 million and lost $515 million. And there’s no end in sight.

For the uninitiated, Snapchat is essentially a photo- and video-based social networking service. It’s a hit mostly among teenagers and millennials, but parts of other demographics have caught on too. Direct messages, or “snaps,” disappear forever after someone views them. The app also has group chat and story features, and many big media and publishing brands have their own channels within Snapchat.

The company has 158 million daily users, so clearly those involved think there’s a way, perhaps somewhere in the distant future, to turn those eyeballs into dollar signs.

Stock investors that bought shares the day of the IPO also see some hope. The shares priced at $17, but opened at $24. Those buyers who were allocated shares in the IPO before trading opened earned a cool 40% instant profit.

Which brings us back to the mob, er, syndicate.

Long ago, in a galaxy far away, I worked on Wall Street. I learned the ins and outs of investment firms and eventually landed on a bond trading desk. Equity IPOs were part of the learning curve. We had to know how all of it worked.

Back then, attractive private companies – like Snapchat – would interview investment firms and choose a lead underwriter, who’d then put together a syndicate of investment firms to file all the paperwork necessary and handle the initial public offering of shares.

To fetch the highest price, the syndicate would go through the expensive, time-consuming process of generating sales material about the company and then holding dog-and-pony shows around the country to highlight the coming offering. This all culminated in the day of the offering, when the company and the underwriters found out if their marketing efforts were going to pay off.

For this effort, the syndicate of firms earned an eye-popping fee that could run between 5% and 10% of the funds raised. I can’t say the fee earned was in line with the efforts. It always seemed extravagant. But now, things are wildly out of proportion.

On Snapchat, the underwriter charged a “modest” fee of 2.5% of the funds raised, which works out to a mere $85 million. But, as they say in late-night TV ads, “Wait, wait! There’s more!”

In addition to this upfront fee, the underwriters have a 30-day option to purchase 30 million shares at the IPO price of $17, minus an underwriter’s discount. So not only do the mobsters, er, investment bankers, earn the difference between the current price of the shares and the IPO price, they also get an additional break.

At the close of opening day, this would have been at least an additional $210 million, bringing their IPO fee to a nifty $295 million.

Now, let’s review the heavy lifting that Morgan Stanley and Goldman Sachs had to do to snatch this fee from Snapchat. They had to file all the documents required by the SEC, verify holdings of early investors, map out the number of shares the company and insiders would sell, and gauge interest from investors to determine the appropriate price for the shares.

A handful of associates with working knowledge of SEC filings and telephones could have done all of these things

What syndicate members didn’t have to do was introduce anyone in the investment world to Snapchat. The app store on everyone’s smartphones handled that. So the most time-intensive, personality-driven part of the process, the marketing of the company and selling shares to potential investors, was done for them.

And yet they earned almost $300 million. What a job!

These firms will go to great lengths to explain how much groundwork they had to lay ahead of the IPO, and how their research departments will support Snapchat in the years to come. But all that masks the real reason that companies, even ones that seem the newest of age like Snapchat, still use Wall Street. They’re scared that investment bankers will give them the cold shoulder if they cut them out.

If a company goes public without prominent underwriters, it risks such companies refusing to follow the stock in their research department, which precludes the clients of the investment firms from buying the stock.

And then there’s the matter of getting loans from these companies later, or further rounds of stock sales. Essentially, if companies don’t play ball, Wall Street can put financial hurdles in their way for years to come.

It sounds a lot like another syndicate… the one that controls the docks, garbage pickup, and cement in New York.

I’m guessing Murphy and Spiegel, the co-founders, don’t care. They did walk away with more than a quarter of a billion dollars in cash, after all.

But this is one more area, like politics, where I thought the internet was going to dramatically reduce the influence of money. I thought information would flow so freely as to cut out the middlemen, resulting in lower fees and greater access across the board.

That might be true one day, but the Snapchat IPO proves that today it still pays to be a member of the syndicate.

Rodney

Follow me on Twitter @RJHSDent

By Rodney Johnson, Senior Editor of Economy & Markets

http://economyandmarkets.com

Copyright © 2017 Rodney Johnson - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Rodney Johnson Archive

© 2005-2018 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


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