Transforming The Art Of The Deal

Underwriters rethink their practices

When Network Appliance Inc., an Internet-friendly software outfit in Silicon Valley, wanted to raise $140 million in a stock offering in March, company executives couldn't face another stretch of plane flights, hotel food, and suffocating conference rooms. Instead of hopscotching across the country to meet investors on an investment banking "road show," they decided to try a better way. "We're a technology company, right?" says Chief Executive Dan Warmhoven. "So let's use technology to solve our business needs."

Lehman Brothers Inc., the company's lead underwriter, was happy to oblige. Technology investors knew Network Appliance because its stock was already publicly traded and many had met Warmhoven before. And with $290 million in annual sales, the outfit had a proven record. So Lehman set up a "virtual" road show. Password-packing investors clicked onto the Internet to hear Warmhoven describe slides about the company as they flashed across their computer screens. The investors tapped into the taped presentation at will. Then, for three days, NetApp took calls for questions, mostly from institutions. Says Marc L. Paley, co-head of Lehman's global equity capital markets unit: The technology "saves a huge amount of time and expense...and investors demand and want it."

Internet road shows are just part of a revolution in the way investment bankers do their jobs. Just as online trading is shaking up the way stock is bought and sold in the aftermarket, the Net is reshaping the way underwriters bring offerings to the market. From the pitch whereby Wall Street powerhouses offer their wares to companies that need money to the way the securities are priced and delivered, the Net is forcing underwriters to rethink their practices. At Merrill Lynch & Co., managers view adapting to the new investment banking as "the most critical and potentially most far-reaching change they will face in their careers," says direct markets chief Michael Packer.

NO LONGER SACRED? To be sure, the adjustments are coming fitfully and unevenly, with some Wall Street houses rushing to be early adopters and others decidedly skeptical, even a bit scared. If much of the underwriting process migrates to cyberspace, efficiencies could well erode the sacrosanct 7% fee. To drive acceptance of what executives call a "disruptive technology"--one bringing paradigm-shifting change--Merrill Lynch even went outside, to publishing firm Simon & Schuster, to recruit E-commerce expert Packer. While the firm is a leader in using the Net, Merrill equity capital markets chief Michael P. Ryan acknowledges change is tough. "If I put it to a vote," he says, "the majority would vote for the status quo."

Some Wall Street executives insist the Net can't replace person-to-person contacts. Pressing the flesh, says Goldman, Sachs & Co. managing director Lawton W. Fitt, will continue to dominate everything from bidding for business to persuading investors to buy. "When it comes to the way we render advice to our clients, I don't see it [the Net] as revolutionary," says Fitt, who deals regularly with Net companies seeking capital. "The human element is not coming out of the process."

Over time, though, the human element may become less important. The best example is the road show, where many underwriters now routinely schedule Net presentations instead of, or along with, personal visits. NetRoadshow, the Atlanta-based unit of, has found the demand for these events is growing rapidly.

Already, technology is forcing some soul-searching among firms and regulators. The Securities & Exchange Commission is revisiting rules that limit road shows to select institutional audiences. Regulators want to balance public demand for information against the risk that unsophisticated investors may get deluged. Says former SEC Commissioner and Brookings Institution senior fellow Steven M.H. Wallman: "We need to rethink some of the mechanisms that we use to ensure the information is appropriately scrubbed and accurate."

Still, the Net now is letting underwriters more easily put information in investors' hands. Prospectuses are available through such Web sites as Renaissance Capital Corp.'s, and Since claims a million visits a month, investors clearly crave such information. "Our users are looking for all kinds of things related to IPOs," says Brad Sinrod, Inc.'s president. (The company also provides data to BUSINESS WEEK Online.)

Eventually, the Net may allow underwriters to better target individual investors. And as they develop investor profiles, they could have a broad effect on the way the markets behave, reducing stock flipping and price volatility by careful stock placements, for example. "You can find the people who may not only buy your stock but may hold it for the long term," says Kenneth D. Jones, chief of staff at Thomas Weisel Partners in San Francisco.

But the Net is more than just a marketing tool. It has become a standard research aid, for instance, for Wall Street due-diligence reviews. "There's no question that the research that used to be done by going to the library is being done now over the Net," says Goldman's Fitt. "You've got much more information at your fingertips." By using such services as Yahoo! Finance, Hoover's, or EDGAR Online, researchers can quickly snare data about rivals, partners, and customers. Lead underwriters can also better coordinate with firms that co-manage deals with them thanks to E-mail or dedicated Web sites. That could make obsolete the conventional "data rooms" where deal materials are typically stored by the boxload.

MAVERICK. Still, the medium gives some underwriters pause, especially about pricing securities. Few East Coast firms like the approach tried by California maverick W.R. Hambrecht + Co.: taking bids from investors via the Net to get the most appealing price. In the two stocks the firm has taken public so far--Ravenswood Winery Inc. and investors were disappointed that there were no big post-offering price spikes. "Mediocre results," says Renaissance Capital analyst Randall Roth.

Of course, defenders of Net auctions say the lack of a spike only proves that the pricing is fairer, since it comes from a broader audience. Underwriters generally price such deals now by informally taking "indications of interest" from a few institutional buyers, but the small field means the pricing can be off. "What we're really trying to do is to broaden the market for IPOs," says firm Chairman William R. Hambrecht.

Even if Hambrecht's method proves too radical for underwriters, the Net still could influence pricing. Underwriters could easily contact more potential buyers to get better soundings. "If you can cast your net far enough, you'll get enough information about the marketplace to price IPOs and not leave that much on the table," says Merrill's Ryan.

Hambrecht is really unsettling Wall Street with another Net-inspired thrust--this time aimed at underwriting fees. Since the Net can save hefty amounts of money, he says, firms ought to make do with 3% to 5%, instead of the standard 7%. That would play nicely to regulators troubled by the lack of fee competition. Antitrust officials at the Justice Dept. in April launched a probe of the major brokerage firms for alleged underwriting fee price-fixing.

Wall Street's insurgents, of course, are pushing the uses of the Net hardest. Upstarts such as Wit Capital, E*Offering, and the unit of Friedman Billings Ramsey Group Inc. of Arlington, Va., are driving change--and winning business. But corporations still prefer the big names because of their prestige, market clout, and research capabilities. Goldman, Morgan Stanley, and Merrill together managed 55% of the initial offerings in the first half of this year, up from 35% in 1998's opening half, according to Securities Data Co.

As the mainline firms make more use of the technology, they will likely keep their edge. It's no wonder that Goldman in March took a 22% stake in Wit Capital and that Lehman, on June 28, cut a deal with Fidelity Investments that gives Fidelity access to Lehman's research prowess and stock offerings. "The technology is here, and it is additive," says Lehman's Paley. "You can't fight it." Indeed, the firms that turn out to be faster, more efficient, and better underwriters will likely be those that prove the most Net-friendly.