Floats a sign brokers' bonuses are back
If the stockmarket can hold its gains through January and February a string of initial public offerings is set to hit the bourse, generating the fees that stockbrokers have gone without for the best part of four years.
Institutional investors have turned bullish recently, swamping smaller secondary offerings from Webjet and Cash Converters. They have not seen a major float since Queensland Rail in 2010.
The number of floats to emerge during 2013 will depend on the strength of the overall market, but also the performance of the first new offerings to hit the tape.
At this stage all eyes will be on the $300 million-plus float of online price comparison group iSelect, due to be launched in the first quarter. If the float is a success then it will generate publicity-grabbing headlines, encouraging more people to come to market.
In previous sharemarket recovery years, such as 1993, a string of floats appeared after several lean years. Strangely, when share prices move higher not only does it excite sellers of companies, it also encourages buyers back into the fold.
Stockbroking companies listed on the Australian sharemarket are already starting to feel the benefits of an improving sentiment towards equities.
Wilson HTM's shares have rocketed 157 per cent higher since July 2012, Bell Financial Group has risen a hefty 51 per cent since mid-November and Perth-based Euroz has won some latent support with a 23 per cent move in the past four weeks. These businesses are highly leveraged to a rising sharemarket and only Euroz managed a profit in 2012.
At the big end of town, shares in Macquarie Group have risen 56 per cent since the middle of last year. All these issues are still only at a fraction of the highs reached before the global financial crisis.
In the years leading up to the market peak in 2007, a stockbroker who did not receive a bonus was effectively being told to look for another job. For the majority, though, who operated in this wondrous world, the only genuine concern was the size of the bonus.
Move forward five years and the bonus for most stockbrokers is they still have a job. Big cash payouts that matched, or even dwarfed, the annual salary no longer exist. After four dry years many have left the industry, never to return.
Virtually every broking outfit in Australia has shed staff in a bid to lower costs, with Morgan Stanley recently adding to the casualty toll. Those left believe that the industry has changed for ever and the good old days will never return.
Stockbroking is an unusually cyclical business and has the ability to rise like the phoenix.
The cost base is primarily people, with some rent, technology and compliance costs thrown in on top. The staple revenue is commissions for executing buy and sell orders from clients. This commission has gradually been whittled down over the years - particularly by large institutional investors - but this margin erosion was offset in the main by ever-increasing trading volumes.
Market activity peaked in 2007 at about $6 billion a day. Five years on, most days only generate $3-$4 billion of turnover and the commission percentage is still being driven down.
Collecting commission on trades, though, really only keeps the doors open. The big money, the stuff that funded the six-figure bonuses, came from corporate deals such as secondary capital raisings, initial public offerings and corporate advice on transactions such as takeovers.
Since 2009 this corporate revenue has dropped by about 80 per cent as companies have shied away from poorly performing public markets. This work is juicy for brokers because they are able to charge a percentage of the overall deal as their fee. It is a much more lucrative business model than the hourly fee that most lawyers, accountants and doctors are stuck with.
With commissions down and corporate fees non-existent, brokers are in a world of relative pain. The downturn has lasted long enough for many to proclaim the industry has changed for ever and participants need to overhaul their business models to survive.
No doubt the same mutterings could be heard in previous bear markets in the 1860s, 1930s, 1970s and more recently the early 1990s.
On each occasion these dire forecasts proved to be premature and the stockbroking industry evolved and survived. The ability to transact on and research shares and to charge a fee for corporate transactions remains.
The wrist-slitting attitude that currently hangs over the market is surely a bottom for the stockbroking community. A pick-up in market turnover will lift daily commissions and a handful of successful deals, particularly floats, will see the much sought-after bonuses return.
Warren Buffett said: "Wall Street is the only place that people ride to in a Rolls-Royce to get advice from those who take the subway."
By the end of 2013 a few stockbrokers may be dusting off the Rolls-Royce catalogue.
Frequently Asked Questions about this Article…
IPOs and corporate floats generate lucrative corporate fees for brokers because they can charge a percentage of the deal. The article explains that those corporate fees — from initial public offerings and capital raisings — funded the big cash bonuses before the downturn, so a return of successful floats would help restore bonuses for stockbrokers.
The article notes a 19% rally in the All Ordinaries Index since early June 2012, renewed interest from cash-heavy investors and institutional buying, and a pipeline of possible floats (including a large iSelect offering). If the market held gains through early 2013 and the first new offerings performed well, brokers stood to win renewed corporate deal activity and higher turnover — a recipe for a comeback.
According to the article, the $300 million-plus iSelect float due in the first quarter was a key test: if it succeeded it would generate publicity-grabbing headlines and encourage more companies and investors to come to market, potentially sparking a string of further IPOs.
The article reports that daily market turnover and commission rates have fallen since pre-crisis highs (market activity peaked around $6 billion a day in 2007 and was typically $3–4 billion most days afterward). More importantly, corporate revenue for brokers — from deals, IPOs and capital raisings — dropped about 80% since 2009, removing the high-fee work that previously funded large bonuses.
As cited in the article, Wilson HTM rose about 157% since July 2012, Bell Financial Group climbed roughly 51% since mid-November, Perth-based Euroz moved about 23% in the previous four weeks, and Macquarie Group had risen about 56% since the middle of the prior year. The article also notes Euroz was the only one of those to report a profit in 2012.
The article explains commissions from executing buy/sell orders keep broker operations running but are a low-margin, gradually shrinking revenue stream. Corporate fees from deals, IPOs and takeover advice are much more lucrative because brokers charge a percentage of the transaction. For everyday investors, that means broker profitability (and industry incentives) depends heavily on corporate deal flow as well as trading volumes.
The article takes a cyclical view: many firms cut staff and margins were squeezed during the downturn, but historical cycles show the industry can evolve and recover. A pick-up in market turnover and a handful of successful corporate deals and floats could restore higher revenues and the bonuses that come with them, so the downturn may not be permanent.
Per the article, successful IPOs and rising turnover tend to boost market sentiment, attract more investors, and create more trading activity. That increased activity can improve liquidity and visibility for listed companies, but the article stops short of offering investment advice — it simply notes that a string of successful floats would likely encourage more companies and investors to participate in the market.
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