Alibaba IPO Grew Out of ’80s Chaos and Guy From GoldmanLeslie Picker
In 1984, Eric Dobkin was working for Goldman Sachs Group Inc., selling large blocks of stocks to fund managers, when he was handed an assignment: The bank ranked ninth in equity underwriting. Fix it.
Dobkin, then 41, spent a few sleepless nights mulling the problem. At the time, initial public offerings were a scattered affair, as thousands of regional brokers hawked the paper to retail investors.
It finally hit him one morning in the shower, he said. If Goldman Sachs could sell equities to institutions, it could surely sell more initial offerings to them as well. Thus was born Wall Street’s new model for IPOs, earning Dobkin credit as the father of the modern-day way companies raise capital. By tapping money managers like Fidelity Investments, the change vastly broadened the pool of investors, while enhancing banks’ role as middlemen in pricing and stock allocation.
"I almost kick myself -- it became too obvious," Dobkin, now 71, said in a rare interview at Goldman Sachs’s Manhattan headquarters. The new model "created a long-term relationship between companies and investors that really was the secret sauce of what this turned out to be."
Almost 30 years later, IPOs are soaring -- topped by Alibaba Group Holding Ltd.’s proposed share sale -- revealing the transformation that has taken place since 1985. Companies globally raised $150 billion last year, up from $1.3 billion in 1980, adjusted for inflation, according to data compiled by Bloomberg. Alibaba’s IPO, expected to raise at least another $20 billion, shows how they’ve become global affairs that depend on the deep pockets of professional money managers and pension funds.
Critics abound. They say the system is expensive and opaque, giving too much power to big investors and banks -- which earned $18 billion in underwriting fees last year, up 23 percent from 2012. Sometimes this works to the detriment of the issuing company and retail investors, they say. Reflecting those complaints, Alibaba, China’s largest e-commerce company, plans to motivate the underwriters to work more on its behalf, providing one-third of the fee pool as a bonus.
"People try their best to do the right thing," said Dobkin. "Whether it’s the investors learning the story, or the investment bankers or folks making sure the prospectus is written in the right way -- it’s a meritorious process. It has to be in a very competitive world."
Goldman Sachs and JPMorgan Chase & Co, two of Alibaba’s underwriters, declined to comment on the specifics of the IPO.
While Dobkin retired as a general partner 16 years ago, he goes to his office three days a week, draped in the pinstriped-suit banker uniform. He sits on several committees and holds the title of advisory director and chairman emeritus to the global equity capital markets group.
Competitors playfully called the avuncular Dobkin "Okey-Dokey," in a nod to his cheerful demeanor. He won for Goldman Sachs some of the most notable IPO underwritings since the 1980s, including those of Microsoft Corp. and British Gas.
Dobkin grew up in Washington, where his dad worked at the Jewish charity B’nai B’rith International. He joined Goldman Sachs in 1967 after attending Marietta College in Ohio, followed by Harvard Business School. Dobkin was assigned to the Philadelphia office and then Chicago, before moving to New York. His wife of almost 49 years, Barbara, is a well-known philanthropist, focused on Jewish and women’s charities.
Dobkin’s boss in 1984 -- Jim Gorter, head of investment banking -- gave him the assignment to boost Goldman Sachs’s stock underwriting business, figuring his ties with institutions would be useful.
"What’s the difference between some place like Fidelity buying 50,000 shares of General Motors on the New York Stock Exchange in a block, or buying 50,000 shares of General Motors in an equity offering?" he said.
Dobkin created Wall Street’s first equities capital markets, or ECM, unit in 1985.
"I view Eric as the father of the modern equity capital markets," said Stephen Pierce, the current Goldman Sachs ECM head and one of the unit’s seven original staffers. "He was incredibly aggressive in terms of his approach to winning business. His detail orientation and intellect allowed people to understand that he really was a brain surgeon in a delicate operation like going public."
Other bankers such as Morgan Stanley’s Tom Saunders, who left the firm in 1989, were changing their IPO units as well, according to Bruce Foerster, co-author of the Capital Markets Handbook who worked in equity issuance on Wall Street from 1974 to 1994. Many of those efforts were focused within the syndicate group, and the firms eventually adopted the equity capital markets structure, said Foerster, who also credits Dobkin as father of the modern-day IPO.
Mary Claire Delaney, a spokeswoman for Morgan Stanley, declined to comment.
Equity underwriting has become one of Wall Street’s most profitable activities, with a pretax profit margin of 40 percent, according to research by Sanford C Bernstein & Co.
Goldman Sachs was the top underwriter last year, playing prominent roles in Hilton Worldwide Holdings Inc.’s $2.71 billion share sale and Twitter’s $2.09 billion IPO, according to data compiled by Bloomberg.
This year through April, more than 180 companies announced initial public offerings, while 317 firms are selling additional shares, according to data compiled by Bloomberg. Should the pace be sustained, it would make 2014 the busiest year since at least 2002, the data show.
Dobkin’s idea to focus on institutions coincided with a professional money-management industry that was growing a ravenous appetite for investing vehicles. Mutual funds, such as Fidelity Investments and T. Rowe Price, saw their assets increase from $134.8 billion in 1980 to $1.01 trillion a decade later, according to a 2013 Investment Company Institute report. Pension funds also became buyers of IPO stock as evolving law allowed them to hold riskier assets.
These changes flipped the model for selling IPO shares. Before 1985, about 80 percent of first-time shares were bought by retail customers, Dobkin said. Many of these were unsophisticated investors buying penny stocks, who tended to get burned as the shares declined, according to Jay Ritter, a professor at the University of Florida who studies IPOs.
In the years that followed, institutions became the majority buyers. Retail investors could obtain access indirectly through mutual funds and pension funds.
"It was pretty clear that having a business model that was much more institutional than it was retail and having a different balance to the complexion of an equity offering was absolutely what you needed to do," Dobkin said.
The process for initial offerings has been evolving for centuries. Among the first IPOs in America was in 1791 for the Bank of the United States, started by Alexander Hamilton. The offering, made through newspaper advertisements, allowed the public the right to purchase a share for $25.
"In the early days of the U.S., there wasn’t such a developed investment-banking industry," said Richard Sylla, chairman of the Museum of American Finance and an economics professor at New York University Stern School of Business.
Through much of the 20th century, bankers such as John Pierpont "J.P." Morgan would organize a syndicate to underwrite a stock or bond deal. They would market the deal to wealthy individuals and retail brokerages.
A prospectus from Ford Motor Co. to raise $658 million in 1956 illustrates a typical offering then. While seven banks are listed as the main underwriters, more than 600 brokerages also underwrote and sold the stock, with as little as 1,500 shares each. Among them are hoary names such as Bache & Co. and Dean Witter & Co.
More than 50 years later, Tesla Motors Inc.’s IPO in 2010 had only four underwriters -- Goldman Sachs, Morgan Stanley, JPMorgan and Deutsche Bank AG -- which were responsible for selling all 13.3 million shares, mostly to big money managers.
The shift to institutional buyers created the need for what’s known as the roadshow, where bankers accompanied by company executives market the deal to investors.
Before these events, "You had lunch or a 4 o’clock meeting with some cocktails where you invited some large number of retail sales people who would hear the story," Dobkin said. "So you were never attacking the real investor; you were attacking the proxy for the real investor."
Dobkin, known for his attention to detail, would make sure that company executives wore black shoes to the roadshow, instead of brown ones during presentations, Goldman’s Pierce recalled. Decades later, Facebook Inc. Chief Executive Officer Mark Zuckerberg wore a hoodie while marketing his company’s IPO.
Investors want to "know management as individuals -- to be able to look into the whites of the eyes of the CEO and CFO," said Liz Myers, 43, the global head of equity capital markets at JPMorgan, the only woman with that title at a large Wall Street firm.
A similar model has largely swept across the world. In the early 1980s, IPOs in Europe and Asia involved the public submitting orders for shares on pieces of paper, according to Ann Sherman, an associate professor who studies IPO methods at DePaul University in Chicago. This method faded as governments starting privatizing their massive state-owned assets, she said.
After the 1980s "Big Bang" of financial deregulation in the U.K., Goldman Sachs was hired to advise on Prime Minister Margaret Thatcher’s plan to privatize British Gas, which today has been wrapped into Centrica Plc.
When asked how he won over the Iron Lady, Dobkin answered: "I was 6-feet, 4-inches and good looking." In truth about 9 inches shorter than that, Dobkin told U.K. authorities that U.S. fund managers would be willing to pay a higher price than European investors. The IPO raised 9 billion pounds, or about $14 billion, not adjusted for inflation, in December 1986.
Companies paid around 5 percent in fees for each IPO in the U.S. over the past decade, data compiled by Bloomberg show, a figure that has drawn criticism.
"It’s a market where the middlemen, meaning the underwriters, take a really big slice of the pie," said University of Florida’s Ritter.
Bankers say that the fees are justified by the subjective nature of the deals and the time spent on the various aspects of assembling the deal.
"The amount of effort that goes into this -- I don’t think the fees are high enough," said Bruce Foerster, president of South Beach Capital Markets, an advisory firm in Miami.
One of the more controversial aspects of modern-day IPOs involves setting the initial price because there’s no precise formula to value a new share.
Lead managers used to call up members of the syndicate to gather information on how receptive retail investors might be at certain price points, Dobkin said. Bankers now obtain these "indications of interest" from institutional investors.
If the price is set too high, the stock will trade lower on the first day. If the price is set low enough -- known as the IPO discount -- the big investors can make substantial gains through day-one pops. Yet that can result in the issuing companies leaving money on the table by raising less capital than they could have.
That untapped money amounted to $8.6 billion last year compared with $113.7 million in 1984, adjusted for inflation, according to data compiled by the University of Florida.
"The institutional investors are clients that matter more to investment banks," said Colin McLean, chief executive officer of Edinburgh-based SVM Asset Management, which oversees $1 billion, and buys shares of IPOs in Europe and the U.S. Because banks will reap revenue through future deals with those investors, he said, "Keeping them happy is more important than overpricing an IPO."
Issuing companies "don’t really have a lot of influence or expertise to say it’s wrongly priced," McLean said.
Goldman Sachs’s Pierce said that while some IPOs tend to pop, a similar number will also drop on their debuts.
"The IPO process as it exists does a remarkable job of capturing input from hundreds of different investors, who are each modeling a new company’s cash flows in a different way with disparate valuation methodologies," Pierce said. "This process does a very good job of assimilating all of those inputs to try and come out with the best possible answer."
Google Inc. tried to find an alternative way to price its IPO in 2004. It used an Internet-based Dutch auction method, developed by former investment banker William Hambrecht, to enable the entire market -- not just institutional investors -- determine the price.
It didn’t work out well. The major institutions decided to bid lower, so they still "maintained price influence" in the process, Hambrecht, 78, said. Google lowered its price to $85 from as high as $135.
Over time, the biggest day-to-day change since 1985 in raising equity capital is the speed of communication, according to Dobkin. While Dobkin wouldn’t talk specifically about Alibaba, that fast pace might be necessary when the company starts selling shares a few months from now.
"I can call someone in Hong Kong right now and say, ’Do you want to buy this block?’ And he can give me an answer in 30 seconds," Dobkin said.
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