Commentaries

The commitments committee

The bursting of the dot-com bubble pales in comparision to the financial crisis. In retrospect, it seems a comic-book lesson about the all-too-obvious consequences of irrational exuberance: What were they thinking?

Yet the Internet bubble was in many ways a warm-up for the much larger credit bubble. The common thread, Jonathan Knee, a senior managing director at Evercore Partners, writes in DealBook, is the enabling role played by financial institutions.

In both crises, a bank had to agree to sponsor the poisonous security, whether shares of a profitless dot-com or a risky debt instrument. Banks leave such decisions to the commitments committee, a “once-hallowed, almost sacred institution.” Knee says:

The seriousness with which these firms undertook decisions to underwrite reflected not only a self-interested preoccupation with the long-term value of their own reputations but a genuine belief that they were playing an important role in protecting the overall integrity of the financial markets.

The fundamental question asked by commitments committees was: should their respective institutions sponsor a particular security? It was not just a cynical assessment of whether there was a market for the stock or bond issuance at hand.

“The Internet boom,” Knee contends, “marked a wholesale break with this tradition.”

Knee, the author of “The Accidental Investment Banker,” sounds almost misty-eyed in recounting the standards of yore. Was Wall Street ever so upright and just? He is also not very convincing in suggesting that the recent consolidation in the financial industry should mean a return to standards because the institutions that remain “have a more deeply vested interested in ensuring the health of the overall system.” Wasn’t that also true in 2007?

Still, he is right to note that regulatory reforms in the wake of the dot-com bust failed because “none spoke to the core question of maintaining underwriting standards.”

Bankers leave little upside for new Hong Kong IPO

A dozen or so companies have raised money in Hong Kong over the past month to cash in on rebounding equity markets, but that window is threatening to close after a string of poor debuts.

   Glorious Property was the latest, falling by 15 percent on its debut on Friday. Its poor performance came on the heels of China South City, a real-estate developer in Guangdong province, which had the worst trading debut in Hong Kong this year by falling 23 percent.     Even companies in more stable businesses, such as men’s clothing retailer Lilang and sports shoes maker Peak Sport, also fell below their offer prices last month.

   One reason for the wobble is that issuers and investment banks seem to have been greedy. IPOs are generally priced at a discount to comparable listed stocks to reflect risk and to encourage trading in the after market. But with strong investor demand, they have steadily been whittling away at the discount and relying on the froth in the market to get issues away.

   Of late, IPOs have often been more than 100 times oversubscribed with institutions as well as retail investors vying for stock. Thanks to cheap and freely available money, it has been possible for investors to borrow to fund their IPO purchases. Banks have been offering interest rates on IPO loans as low as 1.8 percent.

   But market sentiment has changed dramatically, with the Heng Sang Chinese Enterprises Index <.HSCE> down almost 10 percent in the past two weeks. This has suddenly made IPOs which had set aggressive ranges seem expensive. Glorious Property actually priced its IPO towards the bottom of the range but it still received a poor response.

   From a position of excessive enthusiasm, sentiment has now snapped the other way. Retail investors have become more cautious. Some banks have stopped offering IPO loans to retail investors, which will further temper demand for new issues.

   But the message hasn’t yet got through to some issuers. Las Vegas casino company Wynn Resorts priced its Hong Kong IPO at the top of its indicated range, which values it at a much higher multiple than Macau gambling tycoon Stanley Ho’s flagship casino firm SJM Holdings. This looks pretty daring.

Start-ups better off with angels than VCs

Self-financed angel investors are often found where venture capitalists fear to tread. They typically provide seed financing to start-ups that is counted in the thousands or tens of thousands instead of the millions VCs have to throw around.

A newly released academic study (52-page Acrobat file) finds angel investors also cut the start-ups they invest in better deals, both in early financing rounds and in cases where the company eventually makes its way to an initial public stock offering.

If our conjecture is correct, then an entrepreneur may be better off avoiding a venture capitalist altogether and going to an angel to obtain their financing. …. While venture investors are prone to underprice IPO firms, reducing the proceeds from the offering, angel investors have incentives more aligned with non-venture capital, pre-IPO shareholders.

The working paper by William Johnson and Jeffrey Sohl  of the University of New Hampshire’s Center for Venture Research found that a substantial number of initial public offerings have angel investors as their only investors — 13.4 percent.

The authors of the study also find that firms with at least some angel involvement exit via IPOs earlier than purely venture backed firms. They suggest another factor is at work here — angels are typically not just wealthy individuals with a passive interest in the companies they invest in but former executives or professionals with an intimate knowledge that can give entrepreneurs a leg up in terms of business experience.

The bad news for entrepreneurs is that angel investment appears to have fallen sharply relative to venture capital. An annual survey by the Center for Venture Research released earlier this year found angel investment declined nearly 26 percent  to $19.2 billion in 2008. That compares to the $30.9 billion invested by VCs last year, an 8 percent decline from 2007, according to data from the National Venture Capital Association and Thomson Reuters (See Jan 24, 2009 release).

But don’t count angels out just yet. A check of Google shows searches for venture capitalists falling steadily since data started being kept five years ago. Searches for venture capitalist in 2009 are only slightly above those for angel investor.