Citigroup Bids Where Goldman Won’t Go to Win Big TradesMichael J. Moore and Dakin Campbell
Gus Levy, who ran Goldman Sachs Group Inc. in the 1970s, used to stomp around the trading floor proclaiming that his bank wasn’t relevant if it lost out on a block trade.
Now, Levy’s successors are more wary about chasing deals as they watch competitors make ever-more aggressive bids, including one trade where Citigroup Inc. paid more than market price, to take the lead in buying big chunks of stock from investors.
Block-trading remains a bastion where Wall Street risk-takers can still wager at a time when regulators are clamping down on banks betting with their own money and computer software increasingly controls stock trades. Competition is as hot as it has been since 2005, and a couple of recent deals have left companies at risk for losses.
“One of our competitors bid over -- over -- the settlement price to buy a block of stock,” Goldman Sachs President Gary Cohn, 53, said at an investor conference in May, without naming Citigroup. “Didn’t seem like relative great pricing to me. Not market share I was looking to chase.”
Unlike initial public offerings, in which banks are paid a fee for their services, block trades are about buying low and selling high. Banks typically make money by bidding on shares at a discount to the current price and selling them for slightly more. The discount helps protect the firm from a price drop and pays for the risk the bank takes while it locates new buyers.
Those rules didn’t apply to the case Cohn cited. His comments referred to a block trade New York-based Citigroup did for KKR & Co., which wanted to sell a $773 million stake in hospital operator HCA Holdings Inc., according to two people with knowledge of the matter. Instead of buying the stock at a discount, Citigroup bought the shares from KKR for two cents apiece more than the closing price.
Citigroup’s winning bid reflects the intense competition for block trades, according to interviews with more than half a dozen bankers involved in the market. That has led to the narrowest discounts since 2005 amid deal volume almost double what it was four years ago. Rising, calm markets have led firms to believe they can get out of a position at a narrow spread to the prevailing price or hold the stock and benefit from its appreciation, the bankers say.
Block trades, also called bought deals, offer companies and major shareholders an alternative to a typical secondary stock offering that provides the ability to sell a large stake at a set price and without the time or expense of marketing it to investors. For banks, they offer a chance to generate revenue by selling the shares overnight or within days of buying them.
Some deals are exclusive to a specific bank, which negotiates a price with the seller. The majority are done through a blind auction, where several banks often have only a few hours to pull together information and make a bid, bankers said.
The risk is that an underwriter can’t unload all that stock quickly, or that something happens overnight to drive down the price. That can mean losses of more than $10 million or $20 million on a trade, bankers said.
Recent purchases of blocks of stock in Marvell Technology Group Ltd. and Booz Allen Hamilton Holding Corp. were followed by an immediate drop in share price below what banks paid, and both companies are now down more than 4 percent since the deals.
The underwriters are “exposed to a lot more risk because they are buying shares at a price they have guaranteed to the issuer before they have a clear idea” of the sale price, said Jay Ritter, a professor of finance at the University of Florida who co-wrote a 2010 paper that looked at such deals.
That hasn’t deterred Citigroup, which ranks first among all banks in block trades this year, data from London-based research firm Dealogic shows. Citigroup’s dominance in such trades has propelled the lender to the top of the U.S. equity-underwriting rankings, with three of its four biggest deals being block trades, according to data compiled by Bloomberg. The firm’s equity capital markets business for the Americas is co-led by Philip Drury and Doug Adams.
Citigroup has bet correctly most of the time. Block trades made up 29 percent of its global equity underwriting this year, the most of any major bank, according to Dealogic, and even on the deal criticized by Cohn, it saw the stock jump. HCA, buoyed by a share buyback announced concurrently with the block trade, rose on each of the four days after the May 19 auction and has remained above the price Citigroup paid.
A $1.2 billion deal Citigroup did for Allison Transmission Holdings Inc., a Carlyle Group LP-backed auto-parts maker, has remained above the $29.95 the bank agreed to pay on June 3.
The portion of Citigroup’s business that comes from block trades, which has climbed from less than 10 percent in 2011, has been driven by a few large deals involving long-time clients, according to person with knowledge of the business who asked not to be named because he wasn’t authorized to discuss the matter.
“We are focused on creating the best solutions for our clients to meet their needs across all areas of the equity capital markets,” Rob Julavits, a spokesman for the bank, said in an e-mailed statement.
Barclays Plc also has relied on block trades, with a No. 3 ranking this year in that business, which makes up 22 percent of the London-based bank’s equity underwriting, according to Dealogic. New York-based Goldman Sachs ranks second in bought deals, which account for 14 percent of its total. Its equity capital markets business for the Americas is led by John Daly.
In addition to revenue brought in by a block trade, the boost to a firm’s ranking can help banks when they pitch for other deals. Block trades also provide the potential for future investment-banking business from the company as well as inventory and equity-trading business.
“Some banks have been using block trades as a ticket to increase their overall profile in the cash-equities space and equity capital markets,” said George Kuznetsov, head of research and analytics at London-based Coalition Ltd. “The traditional ECM market is driven very much by relationships and the ability to lend and distribute. So, block trades have been used as the differentiating factor when some banks need to compete more aggressively with the large ECM houses.”
Citigroup ranked ninth in equity-trading revenue last year and Barclays was seventh among the top nine global investment banks, according to Bloomberg Industries.
Block trades typically aren’t executed on an exchange. Banks can match buyers with sellers or purchase the shares themselves. Levy helped develop the practice of banks taking principal risk to buy blocks as a partner at Goldman Sachs before running the firm from 1969 until his death in 1976, according to William Cohan’s book “Money and Power,” which described Levy’s tantrums over missed block trades. He was featured on the cover of Finance magazine in 1968 under the headline “The Biggest Man on the Block.”
While block trades often are done by equity-trading divisions, the largest ones usually are registered with regulators and involve banks’ equity-underwriting units.
Such offerings have grown in popularity in recent years, especially among private-equity firms looking to sell stakes in companies they have taken public. There were $90.8 billion of deals last year, up from $50.5 billion in 2010, according to Dealogic. The total this year through June 18 was $41.5 billion, the data show.
While some bankers said the volume may drop as private-equity firms finish selling stakes of companies, others see the change as permanent.
“It’s a secular move,” said Joe Castle, head of equity syndicate at Barclays in New York. “The trend in equity capital markets is for paper to come quicker and to be absorbed faster than it ever has at any other point in my 20-year career. Private equity drives it, but at the end of the day, the move toward blocks has a lot to do with the development of the equity capital markets and the depth of it, and the focus on it from the buy side.”
In the early part of the last decade, banks bought stakes at a discount of 2.5 percent to 4.3 percent, according to Dealogic data. Discounts jumped after the financial crisis, peaking at an average of 6.8 percent in 2009, the data show. They fell to 3.1 percent last year and dropped to 3 percent so far this year, the lowest since 2005.
Even at smaller discounts, bought deals offer banks the chance to reap all the gains instead of splitting them with other firms as in most IPOs. Two of the bankers said the goal is to sell the shares for 1 percent more than they paid and that spreads are currently compressed by competition and low volatility. They’ll widen again when swings in equity markets increase, they said.
The competition in block trading was on display in the pricing of several recent deals. On June 9, Credit Suisse Group AG agreed to purchase $165 million of stock in Sealed Air Corp. at that day’s closing price, or a zero discount. Sealed Air, the maker of Bubble Wrap, also agreed to buy a chunk of stock from the selling shareholder, and the shares rallied the next day, remaining above the sale price.
On May 21, Barclays and Credit Suisse agreed to buy $852 million of stock in video-game maker Activision Blizzard Inc. from Vivendi SA, once its controlling shareholder, at $20.54, a discount of 1.6 percent to that day’s close. The shares dropped to $20.53 the next day, before climbing 7.2 percent over the next month.
Block traders have benefited as the Standard & Poor’s 500 Index rose 7.4 percent this year with little volatility. The index hasn’t had a move of more than 1 percent since April, and the Chicago Board Options Exchange Volatility Index, or VIX, is trading at about half its long-term average.
Chris Kotowski, an analyst at Oppenheimer & Co. in New York, said it’s unusual for a bank to misjudge the market so badly that it ends up with shares it can’t sell for a profit.
“Is there a risk you get stuck?” Kotowski said. “Yes, but generally investment banks only do bought deals where they are pretty sure that’s not going to happen.”
Still, two recent deals show the pitfalls. Investors and traders are aware of the volatility that a block trade may cause, and if there’s a sense that one may not clear, short sellers may jump in to capitalize on the price decline brought on if a bank is forced to sell, according to one of the bankers. Short sellers borrow stock to sell with the expectation of repurchasing it later at a lower price.
That could mean steep drops even when the broader market is calm. On June 5, KKR sold a $336.6 million stake in Marvell Technology, a Hamilton, Bermuda-based chipmaker, for $15.30 a share to an undisclosed bank. The buyer was Citigroup, said bankers with knowledge of the transaction. That day, the shares dropped 5 percent to $15.22. They have yet to close above that price, and closed at $14.63 last week, down 4.4 percent from the purchase price.
On May 28, Barclays and Citigroup together bought $230 million of stock in Booz Allen Hamilton from Carlyle for $23.07, a 2.4 percent discount to that day’s closing price. The next day the shares dropped 6.4 percent, and haven’t closed above $22.29 since. They closed last week at $21.42, 7.2 percent below the purchase price.
Citigroup declined to comment on whether it made or lost money on the Marvell or Booz Allen Hamilton deals.
“Volatility has been pretty low recently, so I would say it has lower risk than historically,” said Ritter, the University of Florida finance professor. “Sometimes they have everything sold by the opening of trading the next morning, sometimes part of it is sold. There is always the chance of something substantial happening.”