Monkey Business (12 page)

Once retained, the bank conducting the sale puts together an information booklet on the company being sold and mails it out
to all the potential buyers. The information booklet describes the company’s business. It’s
full of lots of colorful graphs and fancy fonts. That’s the extent of the banker’s value-added—making the information booklet
look pretty. The potential buyers all get to submit bids on the company, and whoever puts in the highest bid walks away with
the prize. Just like selling an old Dodge Dart, or a house, or a used diaper pail at a yard sale.

As the bankers’ competitive information advantage has waned, the bankers have gradually been forced to change their approach.
They can no longer rely on a relatively small number of loyal clients to generate advisory business for them year in and year
out. They now have to spend a much larger portion of their time scrambling to find new clients and new business. To justify
their existence, they now have to go out and pitch ideas to whomever will give them an audience in the hope that just a few
of the potential clients will sign on for the program. And when those clients sign on, the bankers have got to assume that
the next time there’s advisory business to be had with that company, it might not necessarily be them providing the advice.
In short, the banking business has become a whole lot more like most other businesses out there—competitive.

The banker’s second primary function is capital raising. Most growing businesses have an insatiable desire for capital, and
few are able to generate enough cash through their ongoing operations to fulfill that desire. That means they have to go somewhere
else for the
money. They have to go to the capital markets. In the most basic terms, a company that wants to raise money has only two choices;
it can either borrow the money or it can sell an ownership interest in the company. Debt versus equity, that’s the choice.
There are all kinds of arguments for why a company, the issuer, might want to choose debt over equity, or vice versa, but
the fundamental differentiators are cost and risk. The debt is a less expensive means of financing for the issuer, but if
the issuer screws up and has trouble paying back the debt when it comes due, then the debt holder gets to keep the company.
In other words, if the issuer fucks up they lose it all.

American-style capitalism puts a high premium on broad market discipline, and this has led to the development in America of
the largest and most sophisticated capital markets in the world. The investment bankers have positioned themselves squarely
at the crossroads of these public capital markets. They’re the toll collectors. They make it difficult, nearly impossible
in fact, to access the public markets without traveling on their parkway, and their parkway ain’t a cheap road to travel.

The investment banker is the consummate middleman. A company comes to the investment banker and says, “I need money. I need
lots of money.” The banker replies, “No problem, I’ll go out and find you some money. I’ll give you most of what I find, but
I’m gonna keep a little bit for myself.” The investment banker then goes out with his or her colleagues from the bank and
talks to the people with the money. That means the institutional investors—the mutual funds, the pension funds, the hedge
funds, and the endowments.

The investment banker goes to the institutions and tells them, “Look, I know this great company but they’re a little short
on cash. They’ve got this great new product, the best you’ve ever seen, but they don’t have enough money to develop it. It’s
going to be the next big thing. The guys at this company, they’re really a bunch of swell guys. If you buy some of their equity
you’re gonna get rich. I promise.”

The institutional investors cut the investment banker a check so that they can buy a piece of the deal. Sometimes they’ll
buy a piece of the deal even if they don’t like it too much. They do that because they’re worried that if they don’t buy into
the latest deal, then the bankers might not come back around the next time with the
really
big deal. No institutional investor wants to be the only one to miss out on the next big thing. The banker collects the checks,
cashes them, keeps a percentage, and gives the company raising the money whatever is left over.

The size of the chunk that the investment banker keeps depends on what kind of deal is being underwritten. A banker might
keep as little as 1 percent for a high-grade debt deal and as much as 7 percent for an initial public offering (IPO). Originally,
the investment banker kept a bigger percentage on some deals to compensate the investment bank for taking on greater risk
on those deals. It used to work like this: (1) a company would tell an investment bank that they needed to raise money (2)
the investment bank would write the company a check and buy the equity or the debt directly from the company (3) the investment
bank would turn around and try to find buyers for the company’s securities, and (4) the investment bank would hopefully be
able to sell the securities
and, in the process, get back not only all the money that they had paid the company for its securities but also something
extra to compensate them for their work. The investment bank was taking on risk because they were exposed for the period of
time between cutting the check to the company and selling the securities to the ultimate buyers. If the market headed south
in that time period, or the investment bank hadn’t valued the securities accurately, the bank could stand to lose money. Equity
is inherently more difficult to value than debt, so the investment bank got a larger fee for underwriting the equity than
they did for the debt.

Things don’t generally work like that anymore. Nowadays the investment banks limit their risk by going out ahead of time and
finding buyers for the company’s securities. They no longer have to hold the securities for the period of time between when
they buy them and when they resell them. If the bank can’t line up enough buyers for the securities ahead of time, they tell
the company, “No go, the market’s not right, we can’t do your deal.” The equity or the debt being sold effectively goes straight
from the company to the ultimate buyers. The investment bank just stands in the middle peeling off its percentage for having
arranged the deal. The banks have managed to cut out most of their risk, but they continue to take the same spread that they’ve
always taken.

If the market for investment banking services was an efficient one, the spreads would be a lot lower than they are today.
They’ve stayed high, though, because there has always been an unspoken agreement among the bankers that when it comes to underwritings
they won’t compete on price. The spreads are sacrosanct. He who cuts
spreads will himself become an outcast, condemned to a life of squalor among the filthiest of dogs. The investment banking
community has long been an oligopoly, with only a handful of real players with the size and scale to drive through the big
deals. The community of investment banks has always been small enough so that if one bank were to break ranks on the pricing
issue, the others could quickly join forces and squash the offender like a june bug on the grill of an 18-wheeler. Every banker
knows that the pricing issue is a slippery slope best avoided because once the price cutting begins, there’s no telling where
it will end.

Until recently, there weren’t many new entrants to the underwriting business. Because an investment bank needs a certain minimum
scale to operate profitably, there haven’t been many new players willing to make the necessary up-front investment. Increasingly
in recent years, though, as the risk of underwriting has come down and fee spreads have stayed constant, the economic return
has appeared increasingly compelling for potential entrants to the business. As this has happened, the new entrants have begun
to make their appearance.

The first new competitors through the door have been the U.S. and foreign commercial banks. Increasingly, the large regional
commercial banks have begun to set up securities underwriting subsidiaries and have begun to hire away investment bankers
from the DLJs, Morgans, and Goldmans of the world. New investment banks have begun to pop up with an operating model based
on online distribution of IPOs direct to retail investors. As the number of underwriters competing for each piece of underwriting
business has proliferated, the spreads have
begun to come down. With more competitors, it isn’t as easy anymore to close ranks on the offenders who dare compete on price.
There’s always somebody now who’s willing to tell the other guy to fuck off. The underwriters’ world has gotten more competitive,
more complicated, and less capable of being controlled. A crack has developed in the underwriting foundation and each year
now, as the aggregate amount of capital raised in the public markets increases, the average spread taken in by the investment
banks decreases. The fees are coming down. Slowly, right now, but they’re coming down.

One day, in the not-too-distant future, an old-school corporate executive may beckon his banker. The banker will walk in unkempt,
unclean, and wearing a $99.99 poly-blend suit from the Burlington Coat Factory.

“My God!” the executive will gasp. “What happened to you? The ties, the suits, the shoes, the gold cuff links…where did it
all go?”

“Away, my friend, away,” the banker will reply in a subdued voice. “The times have changed.”

A
s both the advisory side of the business and the underwriting side of the business have become increasingly competitive, the
new business pitch has gained importance as the bankers’ core activity. As Rolfe and I found out, there’s not much business
anymore in the banking world that can be taken for granted. Pitching became our existence.

The most telling evidence of this shift in banking activity has been the birth of what’s known as the “beauty pageant.” The
beauty pageant is a head-to-head competition among a bevy of investment banks for a new piece of business. The phrase is a
misnomer. Unlike the contestants in traditional beauty pageants, the bankers aren’t normally required to wear bathing suits
at the pageant, but if the client asked them to, they’d come in wearing the tightest nut-hugging Speedo ever seen. In today’s
ultracompetitive environment, bankers will do anything for a piece of business.

The company conducting the beauty pageant sends out word to a whole slew of banks that it’s looking to do a deal. The company
sets aside a day for the pageant, and each bank gets to select the slot that they want. Just like making an appointment to
get a cavity filled.

Bankers from each bank show up at the beauty pageant at their appointed time to meet with whoever is going to be running the
deal from the company’s side. The bankers always travel in packs. Even a crappy little deal usually merits the presence of
a managing director, a vice president, and an associate. The senior bankers like to arrive at meetings flanked by a few junior
bankers, like General MacArthur with his staff in tow. They think that the strong presence will impress clients and win business.

If the pageant is for an underwriting the bankers might also bring a guy from the capital markets group to the party. The
capital markets guy is a cross between a banker and a trader—he’s the illegitimate offspring. The bankers bring the capital
markets guy along to show the company that everybody at the bank, not just the bankers, is going to be involved in the deal
process. The capital markets guy always does the part of the pitch that focuses on the current state of the markets. It’s
usually something that’s straight out of that morning’s
Wall Street Journal
, but if he’s a smooth talker it sounds like he’s a real expert.

The capital markets guys are a double-edged sword. They’re notorious for behaving like chronic Tourette’s syndrome sufferers
by unpredictably spewing out random vulgarities and filthy jokes in the middle of the pitch. It’s
the trader part of their mentality that makes them so dangerous. Sometimes the clients appreciate the debauchery, but other
times they get offended and decide never to invite the investment bank back for another beauty pageant. The senior banker
always hopes that the presence of the capital markets guy will help them win the business, but then they spend the whole pitch
worrying that the capital markets guy is going to say something so offensive that it makes them lose the business.

The whole idea of a pitch is to convince the client that the bank delivering the pitch is the right investment bank to lead
the deal. Every bank makes the same pitch. They all go into the beauty pageant and tell the company “We’re the best. Our investment
bank does all the big deals for companies in your industry. We know all the big buyers and we’re the guys. We’re the only
investment bank qualified to lead manage your business.”

Although they all start out the same, every pitch turns out differently. Some go well, some don’t. Some are interesting, most
aren’t. Some managing directors light up the room when they’re making the pitch. Others go over about as well as Jesse Helms
at a gay pride rally.

At DLJ there were some managing directors who would make the pitch, win the business, and then wouldn’t show up again until
the closing dinner. We called them the Phantoms. They didn’t need to be around while a deal was getting processed because
there were hundreds of mindless vice presidents ready to do the processing for them. The Phantoms took the art of the sale
to the highest order. They were able to instill so much confidence in a new client at the outset that they completely neutralized
the need to hold the client’s hand along the way. Fucking amazing.

There were other managing directors, though, who got up to make a pitch to potential clients and froze up like a born-again
preacher in a Tijuana whorehouse. The pitch book was their security blanket. They read it aloud to the client like a kindergarten
teacher at story time, physically unable to deviate from its sequence of pages. Watching these managing directors deliver
a pitch was as painful as getting a steaming hot chocolate enema.