GRPN, ZNGA, FB: what were the underwriters thinking?

I’ve been writing over the past couple of days about Groupon and Zynga, stocks I consider prime examples of the Greater Fool theory in action.  GF answers the question of why any investors, particularly professionals, would buy shares of either  offering, given the obvious flaws in their operating models.

Let’s take the other side of the coin today.

Why would anyone want to put his firm’s name on the red herring as a sponsor/seller of merchandise like this?

More than that, in both the GRPN and FB cases, the companies submitted initial S-1 registration statements to the SEC that the regulator rejected.  GRPN tried to define a new kind of operating “profit” that excluded major cost elements.  FB didn’t mention that its high-earning US and European businesses were being hurt dramatically by users’ shift from access by computer to smartphones.  Why would underwriters take the reputational damage that comes with encouraging/condoning such behavior?

The reason not to push these names, or to try to paper over problems, is obvious:

the stocks in question were arguably overpriced, with nowhere to go but down.  Money management clients would lose money by buying them.  This would make them unhappy, endanger their careers and generally weaken the bonds of trust that tie them to the underwriters.  The flow of commission money to the underwriters would decline.

Also, in my (long) experience, such anti-money manager behavior is highly unusual.  In fact, the only parallel I can come up with is the waning days of the 1980s junk bond market, when very weak offerings were the order of the day.  (To be clear, I don’t believe that anything like the unhealthy and unethically close relationship between Drexel and key junk bond fund managers exists today.)

So, why?

I have three thoughts:

1.  The underwriters–both the firms and the individual investment bankers–spent a lot of time and effort courting the companies.  Especially for the individual investment bankers, a payoff on this investment was much more important than maintaining good relations with money management clients.

2.  Their unusually anti-money manager behavior implies to be that creating successful (read: very high-priced) debuts for GRPN and ZNGA were do-or-die events for the fortunes of the tech bankers involved.  They apparently saw no percentage at all in considering how money managers–or individual investors–would be hurt by subscribing for the issues.  It was okay for the issues to crash and burn.  Therefore, no new social media IPOs are on the horizon.

3.  The bankers think the negative fallout on their business from these dud issues will be minimal.  Yes, some managers may lose their jobs.  So what,the bankers think  (read Liar’s Poker if you think this is too harsh).  The new guys won’t know what happened in late 2011.  Less starry-eyed portfolio managers will have short memories.  They won’t hold a grudge and will evaluate future issues on their merits, not on the present bad behavior.


Of these conclusions, I think the most interesting is the suggestion that social media IPOs are over for the foreseeable future.  But the series of dud offerings may also be harbingers of a more adversarial and confrontational attitude in the future between bankers and portfolio managers.