Bankers’ block: The trouble with big trades

 
Tim Wallace
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The banks did not want to invest in the firms, or at least not in that way

Two banks last week ended up holding stakes in companies they were advising. Why they take the risk?

Investment banks came in for a lot of flak over proprietary trading in the boom years – picking investments and trading on their own account. It came to symbolise the accusation of “casino banking”, and banks have either stopped doing it or moved the units into ring-fenced entities with far tighter rules on the risks they can take.
So it is embarrassing when a bank accidentally takes a stake in a business when a block trade deal goes wrong. But that is exactly what happened twice in one recent week.
UBS came to hold shares in Spanish firm Abertis Infraestructuras, while Deutsche Bank, days after saying it had placed all the stock, ended up with a seven per cent stake in Merlin Entertainments.
That is not what the banks intended – they did not want to invest in the firms, or at least not in that way.
So how did they end up with multi-million pound stakes in the firms?
Private equity firms holding the shares wanted to sell large stakes.
If they sold them on to the open market, the unexpected flood of shares would cause the price to plunge, hitting the value of the holdings for sale.
So the investors go to an investment bank, who can pair the seller up with institutions who will buy the stock.
The theory is that because the stock is already publicly traded there is no need for the sort of price discovery process seen in an initial public offering, where the banks hold a bidding process with investors to work out how much it is worth. Instead, the investment banks bid for the right to sell the stock, and underwrite it.
They agree to buy the stock directly, thus giving the seller a guaranteed price, and sell it on to investors. The idea is the bank will not have to hold the shares, as they know who will buy.
Occasionally, however, it goes very wrong. A typical problem is that the share price falls mid-way through the sale. Suddenly the price the bank paid is unattractive, forcing it to sell at a loss or sit on the stock in the hope that the price rises again.
And even if the price does rise again, the bank must drip-feed the shares on to the market for fear of depressing the price – the same reason the block trade was undertaken in the first place.
So why then do the banks take them?
Firstly, clients want them to – investment banks’ core role is to pair investors with opportunities, so this should be right up their alley.
Second, it is supposed to be fairly risk-free. Bankers receive a modest fee for placing a stock which is already public. It should not be that difficult, and in fact the vast majority run smoothly.
Third, it helps bankers up the league tables, showing rivals, clients and bankers’ own bosses that they can handle big deals and serve big clients.
And fourth, they do not have much choice. Other methods exist, such as the agency model where banks ring round big investors to see what they would be willing to pay. But given the shares are already publicly traded, this would only generate extra demand from investors who want to pay a low price – otherwise they would already hold the stock.
Ultimately, there is a risk involved, and the bankers are paid well to manage that risk. They choose the price they offer to clients, and if it goes well they are rewarded. If not, bosses and shareholders are right to question their judgement.

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