Business was great for investment bankers of Wall Street and Canary Wharf near the end of 2006. A splendid year of advising on juicy M&A deals and a series of megabuck listings including Hertz and Mastercard paved the way for a bountiful Christmas season.
Everyone got a taste of Goldman Sachs’ record profit of $9.5 billion through a massive $16.5 billion payout to the staff or $623,418 per employee. Yes, those were the good times.
Michael Holland jokingly said, “It doesn’t get any better than this.” The chairman of investment firm Holland & Co would prove to be prophetic.
The Rise of a New Threat
Generally, he was accurate. Aside from the set of new regulations brought about by the financial crisis, which transformed the industry’s landscape leading to the fall of several leading figures. Nowadays, the evolved leaders of Wall Street have a new thorn on their sides: Silicon Valley.
Although blockbuster Initial Public Offerings (IPOs) of technology companies such as Lyft and Uber are still producing substantial income for bankers, the growing strength and market leverage of their clients from the West are leaving them with limited options.
Underwriting IPOs remains a staple for investment banking. It earned $7.3 billion for investment banks in 2017, which is a hefty sum. However it would be a head scratching 43 percent decrease since 2000 when adjusted for inflation. Seeking Alpha research reveals that IPOs bank revenue generation has dwindled to 15 percent from previously 25 percent.
The influx of tech companies has increased the competition among bankers to list them as clients, resulting in lower fees. Who would have imagined Goldman Sachs and Morgan Stanley, among others, pegging their charges at a measly 1.1 percent? That is way below the standard custom rate of 7 percent more for investment bankers. This bargain deal occurred in 2012, when Mark Zuckerberg released Facebook to the public.
A significant number of tech companies have perceived doubts with regards to the high pricing of some Wall Street suits. This is why Silicon Valley entrepreneurs, Slack and Spotify included, are considering other courses rather than the traditional IPOs which have amassed riches for bracket firms for scores.
In spite of everything, underwriting a regular IPO is rewarding, but rather outdated work. Bankers undertake complicated legal work required by regulators. But the real goods banks have to offer is to sprinkle a bit of their magic dust of legitimacy over a transaction. An established entity endorsing a start-up company’s share offering, reassures the market that theirs is a legitimate business.
Tech Companies Opting for Direct Listing
Translating this intangible service into a price has always been complicated. A series of market failures by leading names in Wall Street is not helping out either. Their credibility is now tainted with deals similar to Goldman Sachs and Morgan Stanley last season.
They advised the ride-hailing company Uber that their IPO would garner $120 billion. They erred by roughly $50 billion, as the company’s worth is now at $68 billion after the May 10 listing. One of its low-profile billionaire investors, James Richman, is reportedly purchasing more shares despite all the controversies.
Lyft shared the same fate. It started with a decent debut with shares at $78 in March, but was trading lower by 25 percent last week at $58. Alternately, Spotify tried a different approach. The Swedish music streaming giant chose direct listing. It posted its shares on the New York Stock Exchange allowing the market to determine a price, rather than dealing with big Wall Street Firms.
Generally, Spotify’s roll of the dice paid off. Amidst caution that a direct listing would be dangerous and would result in fluctuation, Spotify’s shares have been at par with other recent tech IPOs — a reasonably good performance. The unseen profit would be in the form of millions in savings from not paying investment banking fees. Afiniti and Slack, also software firms, are planning to replicate Spotify’s bold action.
Banks Facing a New and Stiff Competitor
Areas of concern for Wall Street banks extend beyond being bypassed in IPOs. With the massive amount of cash circulating in Silicon Valley, venture capitalists, private equity firms and sovereign wealth funds such as the Saudi-powered Softbank Vision Fund, several technology companies are simply choosing to forego with the IPO market altogether. This leaves the investment banks engaging in a cut throat competition.
Tech companies also pressure banks in areas other than the IPO market. The span of the financial services industry allows new technology to open up and disrupt, this forced Jamie Dimon, chief executive of JP Morgan Chase, to act and famously warned in 2015, “Silicon Valley is coming… (with) hundreds of start-ups with a lot of brains and money working on various alternatives to traditional banking.”
A Call for Innovation
The senior banker, one of the few survivors of the financial crisis, was right. Banking is truly under threat from a collection of emerging financial technological companies not limited to Silicon Valley. From West to East, London to Beijing, a new breed of start-ups are outmaneuvering the big banks – from foreign exchange to mobile payments processing.
Dimon is a veteran, and his response has been to evolve by investing in technology himself. Some 50,000 employees of JP Morgan Chase are in technology and are financing artificial intelligence and machine learning.
Also, they have recently opened a new campus in Silicon Valley. The ploy could succeed and may fend off the competitive adversary they face. Nonetheless, the good old days of 2006 seem like ages ago.
Melanie Hudson is financial valuation analyst. She has has directly executed and advised on over $45 million in transactions across real estate, private equity, public equity, and venture capital. You may connect with her on Twitter.