Morgan Stanley’s Facebook curse

By Mark Elzweig
May 10, 2012

As Morgan Stanley’s retail force is learning, it’s hard being the anointed one. To most of the world, Morgan Stanley got the plum job of lead manager for the most important public stock offering since Google in 2004. But among the retail sales force at the firm, the Facebook Blessing might as well be known as the Facebook Curse.

The refrain from Morgan Stanley’s rank and file: The IPO of the decade is a lose-lose proposition. That’s because retail investors as well as smaller institutions are likely to be disappointed with their Facebook allotment. Institutional players know how things roll, but for the retail brokerage force, the situation is particularly vexing. Many clients assume that because it is a lead underwriter, Morgan Stanley brokers are on the inside track. That’s true, but means less on a popular IPO like Facebook’s. Financial advisers in the lead group, which also includes Goldman Sachs and JPMorgan, do have an edge over the 30 other investment banks tasked with distributing shares. But it’s not much of an advantage. Global demand for the $11 billion in shares appears to be much bigger than the deal itself. Institutional salespeople at Morgan Stanley are already warning clients that they expect the deal to be 20 times oversubscribed, one source explained to me.

It’s always been the case that only a thin sliver of retail investors would be able to get hot IPO shares. They were typically high-net-worth clients who reliably invest in every single IPO that would come their way – hot or not. Shakier deals, of course, were always available to retail clients. In its heyday, Lehman Brothers brokers used to say that some of the mediocre IPOs they pushed were from the “institutional waste basket.”

Over time, retail investors have been even less likely to win any meaningful amounts of shares in hot IPOs. That’s in part because fewer companies are going public. Meanwhile, institutional investors have grown bigger and bigger – which means that they need a bigger slice of a new issue if it is to have any impact on portfolio performance. The most recent super-hot, social-media IPO, LinkedIn, went to a remarkably few number of institutions, my sources tell me.

These facts don’t do much for morale at Morgan Stanley, which announced earlier this year that advisers who have produced less than $500,000 per year in gross commissions would not get any shares in IPOs – that is, they don’t get to share in the syndicate for Facebook. That was just before Facebook announced its plans to go public. Talk about timing. Morgan Stanley’s joint venture with Smith Barney has not been the smoothest; adviser count has dropped 5 percent in the past year; this year alone, the firm lost at least 87 advisers who managed about $7.2 billion in assets. The Facebook deal is adding oil to that simmering fire. One broker at another wirehouse told me disaffected Morgan Stanley clients have announced that they will move their accounts to him if they don’t get any Facebook shares.

Meanwhile, another Morgan Stanley broker complained to me that even marginal clients are trying to ingratiate themselves with him in the mistaken belief that they can get a piece of the Facebook IPO from him. The joke’s on them. He doesn’t expect to get any shares. Even big producers who are confident that they can get some shares are bracing for flak because they are unlikely to get enough to satisfy client demand. Some are hoping that the firm will bend some rules by factoring in client account sizes, not just broker gross commissions, as a basis for handing out the prizes. This would widen distribution to large clients whose brokers aren’t usually part of the syndicate group.

So far, Morgan Stanley is sitting on the powder keg filled with shares. But Facebook is sending out a message that it wants to be sure the people who made the company what it is, get a piece of the IPO. The New York Times suggests that that could mean 20 percent to 25 percent of the deal, up from the usual 15 percent. E*Trade was recently added to the list of distributors, and Fidelity and Schwab say they will have access to the IPO. That’s a great gesture, but odds are pretty good that it won’t be as meaningful as some hope.

The major wirehouses are under big pressure to satisfy their big customers. It also happens to be a lot cheaper for them to do it that way. As it is, Morgan Stanley and its co-underwriters are said to be earning a fee of 1.1 percent on the Facebook IPO – a fraction of the usual payout. That puts even more pressure on Morgan Stanley to watch its costs. Financial advisers get a cut of 40 percent to 45 percent on gross commissions, which is pretty skinny in this case. Institutional salespeople are typically on a base salary plus discretionary bonus. And then there’s this: As an executive recruiter in the retail broker and asset management business, I can tell you that broker franchises are much less loyal and more likely to jump to rival firms than institutional ones – which makes it more attractive for firms to keep as much of the deal as possible on the institutional side of the house.

Remember Robertson Stephens and Hambrecht & Quist – the best high-tech boutiques, felled by the dot-com bust? Their brokers built entire businesses on handling the accounts of corporate insiders whose companies their firms had taken public and made rich. They had plenty of hot IPOs to pass around. Now, hot deals are scarce.

But here we are at Facebook, the most yammered-about IPO since Google. Whether or not you think it’s a good deal, it’s an important one. Lots of people write about the travails of the small investor – and with reason. But it’s not just the small investor who’s feeling miffed; so is his adviser. The marketplace, as always, smiles on the big guys. Curses.

PHOTO: An investor holds a prospectus explaining the Facebook stock after attending a show for Facebook Inc’s initial public offering at the Four Seasons Hotel in Boston, May 8, 2012. Facebook CEO Mark Zuckerberg took questions in New York about the No. 1 social network’s slowing revenue growth and its $1 billion Instagram purchase, kicking off a cross-country roadshow to promote its IPO.  REUTERS/Jessica Rinaldi

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