Arguably the biggest "surprise" in US-based social network Facebook’s $5bn initial public offering [IPO] filing on Wednesday was the position of investment bank Goldman Sachs as third place underwriter. But Goldman’s positioning could be regarded as a public relations coup while leaving the US-based bank with what it actually wants – money and a strategic information edge.
It had already been aired to the market in news provider Wall Street Journal Goldman might not be "lead left" for the flotation – the terminology for the underwriter which often calls the shots and commands the biggest fees in an IPO. Yet the demotion behind peers Morgan Stanley and JPMorgan, led news provider New York Times (NYT) to run a piece beginning "sometimes Goldman doesn’t come first."
The market had thought it fair to assume the social network’s biggest investment banking shareholder would at least occupy the so-called second left position, even if Goldman was to be elbowed out by Morgan Stanley, another Facebook shareholder, which invested undisclosed sums in 2010 and 2011 in buying shares from existing investors. It is arguably unsurprising Morgan Stanley was lead left given it is generally regarded as holding a market leading position for technology flotations. Yet JP Morgan looks to be a different case – it is not listed as a shareholder in Facebook’s S-1 regulatory filing, although it did raise a $1.2bn quasi-corporate venturing Digital Media fund last year to buy stakes in hot IPO prospects.
Goldman, however, had orchestrated a $1.5bn investment in Facebook in January 2011 – in what is the most high profile pre-IPO funding round this decade. Both the Journal and NYT have said the reason for Goldman losing its place was because Facebook executives were said to be unhappy with the January placement. This deal attracted unwanted regulatory scrutiny leading Goldman to sell the shares to non-US investors. Facebook declined to comment. Goldman did not respond to three requests for comment.
William Cohan, author of the excellent Goldman history Money and Power: How Goldman Sachs Came To Rule The World, said the placement had not been "the firm’s finest hour". He added: "I am sure this was not the outcome Goldman wanted or expected and that the disappointment was very high."
That Goldman came third arguably is the latest example of the tension created by its willingness to navigate the conflicts of interest of investing in as well as advising clients. These attempts by Goldman and many of its investment rivals to navigate the conflict of principal investment and advisory work is often regarded as one of the key reasons for the Dodd-Frank legislation which is being implemented in the US to rein in banks’ proprietary trading and private equity units.
But it could be seen as a public relations masterstroke. For a bank that Rolling Stone magazine memorably called a "great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money" showing some humility in coming third takes some heat out of the impression that it always comes first.
And, financially, Facebook looks to have been a great investment for the bank and its clients. It looks like the paper return from the pre-IPO investment will probably more than make up for the difference between coming first and third (if there is any) in what could be about $100m in total fees, even when many at the time of the 2011 placement thought the valuation was high. Now many observers are saying a $200bn valuation is likely, and investors at that circa $50bn valuation are sitting on a sizeable paper return, with an IPO expected at a between $75bn and $100bn valuation. It is fair to say Goldman was right to invest from a financial point of view.
As Cohan says: "In the end, as usual, it will be Goldman Sachs that will make more money off Facebook than any other firm — and that is probably what it cares about most of all."
Yet corporate venturing units often judge their success on both financial returns and strategic returns. If the Journal and NYT are right, investing in Facebook may have jeopardised its investment banking team’s ambitions to lead the initial public offering of the decade. But strategic success is about more than IPO positioning – a tactical concern – and, here again, Goldman has kept its edge.
Our publication views bank investments done in part to achieve a closer relationship with a client, as quasi-corporate venturing transactions; corporate venturing deals remain those where a bank invests to access technology or entrepreneurs that might affect its core business, such as deals done by Citi Ventures.
Newswire Marketwatch last month ran a great report on Goldman’s effective equivalent to Citi Ventures, its 19-person Principal Strategic Investments Group, which holds 62 trading- and market-related portfolio companies, including 34 trading exchanges and platforms, 14 technology, processing and clearing firms and seven market data companies, including Markit and formerly social network LinkedIn (Goldman made $39m by selling its LinkedIn shares at its IPO).
These deals are a way to bet on the evolution of financial services and shape it. Goldman often coinvests with its peers, such as similar groups as JP Morgan and Morgan Stanley, and in December took a stake in software provider Broadway Technology alongside bank BNP Paribas.
Facebook remains an unparalleled social network that could evolve from friends liking each other to a powerful crowsourcing model for funding companies and through its Credits has created an alternative source of money. Goldman’s early investment, therefore, gave it access and reach into what could be the preeminent new business platform of the decade. Goldman has won again by seeming to publicly "lose".
The only question is how Goldman and other banks adapt their corporate venturing-style investments in an era of increased regulation will be something our publication and most of the financial world will be watching closely.
Arguably, the Facebook IPO perhaps shows why other banks should welcome the law change – because potentially it could improve relationships with clients and level the playing field with Goldman even if it causes profitability to decrease. Many investment bankers have said they would prefer to have a good client relationship above all things – even fees. But no banker has ever voluntarily turned down his bonus without public pressure and most remain focused on winning deals even if the advice is on dubious ethical or moral grounds, which means calls for change are limited to outsiders or the old, such as Paul Volcker.