How Wall Street profits from Twitter IPO
JPMorgan Chase, Morgan Stanley, and Goldman Sachs are set to collect a total of $37.2 million in fees as underwriters of Twitter's initial public offering next week, according to people familiar with the matter.
When Twitter Inc. executives came to town last week, JPMorgan Chase (JPM) executives mingled outside their offices while wearing jackets with the social-media company's bird logo. Morgan Stanley (MS) flashed "Welcome @Twitter to @Morgan Stanley" on a Times Square ticker. Goldman Sachs (GS) tweeted a photo of Twitter's logo taken at the securities firm's headquarters.
It was worth it. The three Wall Street firms are set to collect a total of $37.2 million in fees as underwriters of Twitter's initial public offering next week, according to people familiar with the matter.
The seven financial firms hired to pitch the $1.6 billion deal will get a combined $49 million if the shares slated to be sold go for $20 apiece, or the top of their projected price range.
Goldman Sachs's likely fee of $20 million as the IPO's lead underwriter amounts to less than one day of revenue for the securities firm. But there are lots of other ways that Wall Street can profit from the IPO.
The fees are largely compensation for banks tapping their client lists to find investors for the deal and for the labor involved in getting companies prepared for filings with regulators and meetings with investors during the "roadshow" that precedes the final IPO pricing.
Right now, Twitter executives are traveling around the U.S. to pitch to investors. They began meeting with firms in Baltimore and made a stop at a Ritz-Carlton in Philadelphia, according to people familiar with the meetings. Twitter executives were in New York on Tuesday meeting with firms and will host a wider group of investors at a lunch at the Mandarin Oriental in Manhattan on Wednesday, these people said.
Other stops include Boston, Chicago, Denver, Los Angeles and San Francisco, according to a marketing document. The IPO is expected to price on Nov. 6, the document said.
The fees will come in the form of a slice of the proceeds from the money raised in the IPO. But that isn't the end of the potential payback for working on the deal. There will be potential trading commissions from investors and wealth-management clients who come to the banks to help them buy stock once it begins trading, commissions from firms that trade with the bank to get access to the research reports expected to be published when a regulatory quiet period ends after the IPO, and any fees from new deals banks might land based on potentially enhanced reputations.
"Each IPO by itself might seem like it's a small fee. But if a banker has been selected to do Twitter, they're more likely to get the next deal," said Reena Aggarwal, finance professor at the McDonough School of Business at Georgetown University.
Also, amid the stricter regulatory environment since the financial crisis, IPOs have a fresher appeal for banks. The deals don't require taking proprietary trading positions, which means they would be largely unaffected by the "Volcker rule," which is still being finalized and intends to bar banks from making certain bets on their own behalf.
IPOs also don't require banks to hold big amounts of capital to cover potential losses, like some transactions do, because the banks don't hold the shares for more than a moment as they are passed from the company to the investors buying them.
Underwriting stock sales is one of banks' better businesses in terms of profitability, according to Brad Hintz, an analyst at Sanford C. Bernstein.
Bernstein research showed that investment banks take home more than 40 percent of the revenue generated by equity underwriting, which includes IPOs and other stock offerings, as profits, before taxes. That is in line with merger-and-acquisitions advisory work and far more than debt underwriting, which has a pretax margin of less than 10 percent, even though bond deals are a much larger business overall.
IPOs also tend to be major milestones for a company at a critical time in their growth and important life events for company executives who may become millionaires or billionaires on the day. The red-carpet treatment the companies get during this time helps burnish the banks' reputation with these individuals for future dealings.
"If you're the lead firm on an IPO … you're spending a lot of time with management. You form a very close relationship, and if you don't totally screw up, you build a good relationship for the future," said David Topper, a former senior IPO banker who is now an operating partner at private-equity firm General Atlantic LLC.
To be sure, IPOs aren't guaranteed to produce follow-up work, especially if the shares don't trade well in the open market. Banks sometimes drop research coverage if the stock is only lightly traded.
And companies don't always immediately produce a lot of deal flow. Facebook whose deal was led by Morgan Stanley, saw its shares fall after their debut before trading above the IPO price more than a year later. The company has yet to return to the market with any follow-on offering or to pay big fees to a bank on deals it already has announced, according to public documents.
The banks in the Twitter deal are expected to collect 3.25 percent of the money raised overall in the IPO. Goldman Sachs, which began working with Twitter when it confidentially filed for its IPO in July, will receive the bulk of the fees, or 38.5 percent, people familiar with the matter said. Morgan Stanley is set to get 18 percent of the fees, and JPMorgan Chase is in line for 15 percent, the people said. Bank of America's Bank of America Merrill Lynch and Deutsche Bank are slated for 8 percent each. Boutique Allen is to earn 7 percent and Code Advisors 0.5 percent.
Twitter has set aside about 5 percent of the fee pool as additional incentive fees, which in IPOs typically go to lead banks if they are paid out.
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