No concrete details on the Facebook IPO allocations have been released as of this moment but I thought a discussion on how the process works for private investors was worth spending a little time.
From (registered rep): Morgan Stanley Smith Barney declined to comment on how shares would be allocated. A source at the firm said only that “there are a lot of factors, overall size and nature of book, quality of relationships, and consistency in new issue participation.”
When I was working in the global investment bank private wealth management industry, I saw hundreds of deals come down the distribution channel. Earning “Lead Left” status on a hot IPO is huge for a firm for several reasons; prestige, branding, huge fees and it gives them responsibility to get the deal done (which translates to the largest allocation of shares to then sell). The Facebook IPO is without a doubt the highest profile deal in a long time, and high profile deals are crucial to this business. You can read between the lines to figure out why.
A little background into this business line may be helpful. ”Taking a company public” is one of Wall Streets key businesses. They help a private company sell a portion of ownership in the company to the “public”. Before a new stock trades on the open market, its IPO is sold directly to the initial holders before it trades on the secondary market. This is where the IPO comes into place. The banks underwriting the IPO are responsible for allocating shares to to investors, usually their clients. The investors who partake in the IPO are sold their shares at a specified price and are holders as of the time the market initially opens for secondary trade of the shares. In an ideal situation the stock will open to the secondary market at a higher price than the IPO price, enabling the company and the IPO clients to profit from the transaction. The company by selling their ownership to the IPO clients and the IPO holders by the appreciating stock price.
So, the question is, who “gets” to buy shares during the IPO offering? In many cases, shares don’t even make their way down the channel to “retail” clients (individuals, families etc). The firms institutional clients (mutual funds, hedge funds, pensions etc) often buy up all available shares. An institutional buyer is considered more important because they are thought to be less likely to sell shares and are more likely to buy in large volume. However, when shares do make their way to retail clients, it is rarely as simple as putting in the order. There is a hierarchy to who is allowed to participate. The comment at the top of this post is a comment heard by every broker attempting to get IPO shares for their clients. A little detail on what lies between the lines of that comment should help you understand a little better.
“Overall size and nature of book” This refers to how big of a producer your broker is for the firm. If the broker has size (a large number of clients, with a large average account balance) then, the firm will look favorably upon allocating that broker shares. Secondly, if the nature of the broker’s book of business is profitable for the company (meaning that the broker routinely sells high margin products to his clients) the firm will look favorably upon allocating that broker shares.
“Quality of relationships” This refers to how long the broker has been with the firm as well as how long the clients of the broker have been with the firm. If a broker has recently joined the firm from a rival, hot IPO shares can go miles in helping bring his old clients to the firm and away from a competitor. It also refers to a broker who isn’t happy having seen his stock options in the firm lose their value over the last ten years. Allocating shares to an unhappy broker can help him generate revenue for the firm and commissions for himself.
“Consistency in new issue participation” This is the real kicker. This statement refers to how many of the firm sponsored underwritings (IPOs) the broker has sold to his clients. Like I mentioned earlier, the IPO process is big business for these firms and being able to count on a broker to sell his clients whatever issue the firm is trying to allocate, is worth rewarding. When the investment bankers go out to pitch their services, they need to be able to document success in allocating IPO shares. They NEED the brokers to sell clients on as many of these deals as possible to show a solid track record of getting the IPO shares allocated. This is not an easy thing to do. For every high profile IPO there are ten or twenty low profile deals that still need to be sold. For every Facebook IPO, there is a Zynga. The investment bank needs to know that the broker will sell their clients whatever the firm sends down the distribution channel, not just the ones his clients are interested in. If you want to get allocated shares in an IPO you really want, then you better be there buying the deals you don’t want too.
I left this business model over a year ago and I have absolutely no inside or specific knowledge of this deal in particular. I just wanted to try and shed a little light on how the process for this type of deal works and hopefully help readers understand some of the nuances a little better.