Everyone thinks they get a raw deal on IPOs. Everyone.
Companies and selling shareholders fret about banks lowballing the valuation and looking after investors. Meanwhile, investors grumble that IPOs are often overpriced, and that they get no allocations with the hot deals and stuffed with the duff ones. Answering to multiple masters, banks are often perceived as conflicted and suspected by all parties of favouring someone else.
Since the financial crisis, some issuers and shareholders have turned to separate advisory firms for counsel on their IPOs, particularly in Europe where it happens roughly 40 per cent of the time. Whether these “independent” advisers add value or just additional friction to the fraught process of floating a company on the stock market has become a perennial topic of debate in equity capital markets.
Now that the IPO market seems to be awakening from a two-year hibernation, it’s worth revisiting the question. Delving into European IPO data from 2010-17, three researchers at Oxford’s Saïd Business School recently published a working paper to analyse the effect of independent IPO advisers. It hasn’t been peer-reviewed yet, but it is a formidable piece of statistical research and an interesting read.
Their findings suggest that once you control for selection effects, independent advisers don’t significantly alter the IPO outcome. The advisers can offer insights and put your mind at ease, but overall they don’t make a difference. Accordingly, hiring an independent IPO adviser is like taking a placebo.
FT Alphaville’s emphasis below:
When examining advised versus non-advised IPOs, we find no evidence that advisers in aggregate impact IPO outcomes, either by reducing first-day returns (or ‘money-left-on-the- table’ by issuers), by improving execution certainty (i.e. reducing withdrawals), or by lowering gross spreads. This aggregate null result is important since advisers have a correlation with reduced withdrawals and lower gross spreads in OLS regressions; however, this association disappears entirely when introducing controls for selection effects. In other words, advisers may be justifying their fees by pointing to improved execution certainty or reduced underwriting costs that are in fact due to the choice characteristics of their issuing clients. We argue that issuers appoint advisers either because they are unaware of these selection effects or because they value other benefits brought by advisers, namely hand holding and a desire to share the blame with an expert if the IPO is a failure.
At a more granular level, however, the study finds that “generalist” advisers with M&A arms — like Rothschild or Lazard — tend to play it safe on pricing compared to “specialist” advisers such as STJ Advisors or Lilja & Co.
But this just reflects the clients they have. In the grand scheme, the authors argue that the impact of each type of adviser seem to balance out (again FTAV’s emphasis):
For generalist-advised versus specialist-advised IPOs, we find significant differences in first-day returns, against a baseline of no effect on withdrawals or gross spreads. IPOs involving generalists that price exactly at the upper bound of the price range are priced very conservatively, leaving considerable money on the table. In contrast, IPOs involving specialists are more accurately priced throughout the price range and yield an overall reduction in underpricing . . . The outcomes are also preference-compatible for issuers insofar as certain issuers value the first-day return mitigation afforded by specialists, while others value the wider advisory services afforded by generalists and are prepared to pay for it by leaving more first-day money on the table.
It’s reasonable to conclude that the presence or absence of an adviser probably doesn’t sway the outcome, but the study’s distinction between generalist and specialist advisers seems overdrawn and overstated.
On the first point, it’s worth noting that investment banking clients — especially private equity firms — are generally smart, sophisticated and savvy. They have a clear idea of how to position their companies in the market and what price they want to achieve. Advisers, independent or not, are there to execute the plan. They don’t call the shots.
If the independent adviser doesn’t have much direct effect, why do some companies and shareholders hire them? For the same reason you book a package holiday: it’s sometimes more convenient, and it doesn’t cost any more — their fees are just taken out of the overall pot on offer.
It’s better to hire a firm to summarise 10 investment bank pitchbooks on one scorecard than to plough through the presentations yourself. IPO project co-ordination is tediously time-intensive, and it can make sense to outsource the job. Also, some clients worry (wrongly, in my view) that banks might favour investors’ interests over their own. They expect advisers to keep underwriters “honest” in their recommendations and approach.
In a sense, independent advisers are the capital markets equivalent of pension fund consultants — an external party hired to vet, monitor, and audit the main service-providers (in this case, underwriting banks).
As for the generalist vs specialist distinction, the study’s findings aren’t quite convincing.
For one thing, the categories overstate the differences. The IPO advisers perform the same basic function in roughly the same way, even if each firm has its own quirks and pet ideas. Moreover, this division means the sample size for “specialists” isn’t large or diverse enough: 51 IPOs advised by specialists over seven years, of which 33 by one firm.
More importantly, it’s tendentious to say based on the first-day performance that generalist-advised IPOs are “underpriced” and specialist-advised ones are priced “more accurately.” Judged on almost any timeline, European IPOs in recent years (with or without independent advisers) have underperformed benchmarks and often lost investors a lot of money.
Indeed, many bankers and fund managers complain that independent advisers goad companies into overpricing IPOs, resulting in a poor after-market performance.
Late last year, a couple of investors sent over data showing the calamitous performance of IPOs advised by one specific advisory firm. But these critics miss the point: the advisers are doing what they’re told (and paid) to do. Their job is to carry water for the client, not look after investor wellbeing.
In a way, the independent advisers remind me of Tommy Lee Jones’ US Deputy Marshall Sam Gerard in 1993’s The Fugitive. When Harrison Ford’s Dr Richard Kimble protests his innocence in the storm drain chase scene, Gerard tells him: “I don’t care.” His job is to hunt down Dr Kimble, not assess the substantive merits of the original prosecution.
(Admittedly, The Fugitive derives its dramatic power from Gerard’s journey towards eventually caring about Dr Kimble’s plight. But life-affirming character arcs are a staple of Hollywood movies, not so much financial advisory, sadly)
The debate around advisers obscures a deeper issue: performance accountability. On US IPOs the lead-left bank bears the brunt, while in Europe and Asia, responsibility is dispersed among multiple top-line banks with equal underwriting quotas. And when you layer on an independent adviser (primarily in Europe), everyone has a scapegoat if things go south. The involvement of so many capital markets experts fosters a culture of CYA and stifles original or truly independent thinking.
For issuers and shareholders, you can decide whether or not to have an extra adviser, but the choice probably doesn’t matter much. It won’t safeguard success or protect you from failure. You are the author of your deal’s outcome.
As the brain surgeon, rock star and test pilot Buckaroo Banzai says in the 1984 eponymous cult film: “Remember, no matter where you go, there you are.”
