VideoLast August, when U.S.-based Dow Chemical (www.dow.com) became the first non-financial corporation to sell its bonds directly to investors through a Web-based Dutch auction, it was hailed as a watershed event in the investment banking world. The businesses of securities brokerage and trading had already been revolutionized by online brokers and electronic communication networks. Wall Street's most lucrative franchise, the control of new-issue distribution, was next. And corporate issuers could expect to reap the benefits of lower transaction costs and better prices for their securities.
Why then, seven months later, is Dow still the only industrial corporation to conduct an online bond auction? Two words: bear market. Thanks to widening spreads on corporate bonds, raising debt capital was a difficult proposition online or off in the second half of last year. And corporate issuers decided that in a bad market, they were better off with Wall Street underwriters pricing the deal, rather than the open market. "There is a fear among issuers that in a weak market, the transparency of online pricing might work against them," explains Ralph Cioffi, senior managing director at Bear Stearns in New York.
Maybe so, but it's hard to argue with the success of Dow's online auction. The company raised $300 million in five-year bonds using software developed by San Francisco-based investment bank WR Hambrecht. The auction drew a far broader investor base than usual, and every successful bidder walked away with a full allocation. Dow is paying about the same interest rate it would have paid had it taken the traditional syndicate route, and it had to cough up less than half the typical underwriting fee. "To me, it's a no-brainer," says Dow treasurer Geoffery Merszei.
It did, however, take some courage on Dow's part. Wall Street banks stand to lose a lot of power and revenue if they relinquish control of new-issue distribution, and they're not above fighting to save their bread and butter. Undoubtedly, plenty of corporate issuers will decide that a few basis points aren't reason enough to damage relationships with their investment bankers. But in the long run, Internet bond auctions, particularly for plain-vanilla investment-grade debt, could save corporate issuers a significant amount of money.
E-Bonds and Dutch Auctions
The first corporate bond billed as an "Internet bond" or "E-bond", was issued by Ford Motor Credit (www.fordcredit.com) in early 2000. The $1 billion offering of three-year notes worked much like a traditional bond underwriting, except that the prospectus and other marketing materials were posted on the Web, and orders were taken by email. The issue, however, was still priced by the lead manager, Lehman Brothers (www.lehman.com), not by the investors that ultimately bought the bonds.
Over the next three quarters, a handful of other Internet bond offerings followed, with issues by DaimlerChrysler, the World Bank and BASF, and, later in the year, by Bear Stearns, Deutsche Bank and, ultimately, Dow. While these offerings were all billed as E-bonds, the last three were the only issues priced and allocated through online Dutch auctions.
In a Dutch auction, investors bid for a particular amount of a security at a specific price. The best bids are accepted in the amounts requested until a clearing price is reached for the entire issue. All successful bidders then get their requested allocations at the clearing price. Offline, it's essentially the form that Treasury bond auctions take. But the Internet brings a new dimension to the process, making the model viable for securities with a smaller potential audience.
While most investment banks are fighting it every step of the way, virtually everyone in the industry agrees that the Internet is already changing the way securities are distributed. And at least some players are preparing for the future. "It's better to be on the train than under it," concludes Mark Millender, managing director of debt markets at Bear Stearns. Both Bear Stearns and Deutsche Bank have conducted their own auctions using proprietary software accessible through their Web sites.
Besides those from the two investment banks, the other E-bonds were priced according to the usual mysterious ways of the syndicate business. That process takes place in private among investment bankers with a long history of back-scratching and IOUs. The ultimate price of an offering has as much to do with who owes what to whom on Wall Street as it does with the level of demand in the marketplace. The Ford Motor Credit issue, notwithstanding the administrative and marketing work done on the Web, was no different from any other underwriting in this regard. "It's just glorified email," says Millender.
Dow, in contrast, used four co-managers for its deal: Hambrecht; Bear Stearns; HSBC; and Williams Capital Group. The two-hour auction took place at Hambrecht's auction Web site, and, according to Leland Crabbe, a portfolio manager at Credit Suisse Asset Management in New York who participated in the bidding: "It was the first [E-bond auction] that felt real to the market."
Reader Comments» Post a comment