It's pay day for float's heavy hitters

ANYONE wanting a lesson about the vigorous self-interest of investment banks need only examine the inner workings of the push to sell $5 billion in shares in the QR National float.

It is a given that behind the glossy advertisements inviting investors to Be Part of Something Big, a group of highly motivated individuals is being richly rewarded to sell shares in a 150-year-old Queensland coal hauler.

The retail offer closed yesterday amid expectations investors will eventually contribute about $2 billion to the float.

What is less well covered about the scrum of investment banks surrounding big initial public offerings is a market structure that is hardly in the best interests of investors. In QR's case, the structure has served to actively freeze out and sideline dissenting voices.

Perhaps in keeping with any high-stakes mandate, there is also evidence some bankers have pushed their sales drive to the very edge of what is acceptable. And possibly beyond.

Then there are signs of regulatory capture in an investment bank-operated mechanism called the "green shoe" to support prices after QR starts trading on the market.

But the cavalcade of investment banks apply for and receive explicit waivers from the law from the Australian Securities and Investments Commission and, consequently, the ASX, allowing them to actively support prices. The stabilisation manager, Goldman Sachs, does this by buying shares in the market if the initial public offering dips below its offer price.

Investment bankers are full of undoubtedly talented, driven and ambitious people. As demonstrated above, they know when to apply to ASIC to bend the law.

To give them their due, the self-interest in chasing big fees helps what are known as the capital markets - companies raising debt and equity - function smoothly and efficiently.

Today the Herald publishes exclusively a list of the top 10 investment banks and top 10 investment bankers in the annual East Coles Best Investment Bank survey. In the rankings, compiled from votes from executives within more than 100 companies, UBS came first, followed by Macquarie, then JPMorgan.

The wrinkle with investment bankers' talent, drive and ambition is you always have to be careful about whose interests are being looked after first.

The float of QR caps a patchy, even dreadful year for investment banks, when big fee-generating jobs have been hard to come by. This year's investment bank bonus season will be a none-too-happy contrast with the fat pay packets garnered from the $100-odd billion in capital raisings that investment banks worked on last year.

QR has offered a glint of sunshine for bankers, although the float is far from a return to fat 2.5 per cent commissions.

Based on the price range for each share of between $2.50 and $3, and with the Queensland government selling between 60 and 75 per cent in QR, total funds raised could be between $3.7 billion and $5.5 billion.

The haul is enough to earn it the title of the second largest initial public offering in Australian history.

The base fee for the five "joint lead managers" selling the QR shares - UBS, Merrill Lynch, RBS, Goldman Sachs and Credit Suisse - is $15 million in total. These investment banks then stand to share equally a 0.8 per cent fee on the total amount raised from fund managers. If fund managers pay in the order of $3 billion, it comes to an extra $24 million to be divvied up.

Then there's another $15 million in fees - albeit shared among 11 lower-order co-managers - to come from the $1 billion in broker commitments, and a further $10 million if there were to be $1 billion in retail applications through brokers.

In short, up to $65 million in investment bank and broker fees is riding on a successful float.

On one hand, the Queensland government has been prudent to enlist such a wide range of investment banks. It gives a broader distribution for QR shares than could be found by appointing just one large investment bank.

On the other hand, the market's information about the float becomes dominated by the joint lead managers' marketing material. Or, a chorus of voices singing from the same songsheet.

It is not a position universally admired, either among investment bankers or the fund managers they try to sell the shares to.

"I think it's healthy for this market for there to be divergent views," says Ross Barker, the managing director of the Melbourne fund manager Australian Foundation Investment Company.

"By definition, it's not healthy for this market to have one point of view."

Big floats and share offerings are routinely locking up a big slice of the analytical brainpower contained in the big investment banks.

In the Myer float there were eight investment banks. In the Westfield Retail Trust offer, there are eight investment banks and all four big domestic banks. In each case, those banks are restrained from issuing research recommendations to their client base because their analysis is seen as hopelessly compromised.

Rather than leaving a vacuum, however, it leaves a marketing machine that can relentlessly roll out the positive message to its clients and the broader market, in this instance: Buy more QR shares.

To be fair, Deutsche and Macquarie are among those not inside the QR tent.

The exclusion is widely rumoured to be based on the Queensland government's bitter experience in the Brisconnections float underwritten by the two banks.

The analysts from Deutsche and Macquarie have put a value on QR of $2.53 and $2.75, respectively.

Simon Cox, the co-head of equity capital markets at UBS, says the idea that a cluster of investment banks involved in big market transactions pushes the market in a certain direction is off the mark.

"I think institutional investors absolutely do their own diligence and so therefore the number of banks either in or outside of the tent, to them is completely irrelevant," he says.

"With respect to the retail investors, clearly the decisions they make invariably are driven by the advice they receive from both client advisers and their own personal perceptions of the transaction.

"Again I think whether the banks are inside or outside the tent is largely not relevant to them."

He said the motivation for the QRs and Westfields was not about tying up the market. "I think they consider it as a mechanism to ensure they have maximum buy-in from the market," he says.

AS A sign of the investment banks' commercial imperatives restricting information available to investors, QR management has not been made widely available for briefings to analysts from outside the tent.

Instead, QR's chief executive, Lance Hockridge, has been almost entirely reserved for briefing the clients of those associated with the float, as one of the privileges for those inside the tent.

Greg Fraser, an analyst with the investment newsletter Fat Prophets, said there had been no opportunities to question QR's management, something he sees as extremely valuable to better understanding the investment opportunity. "I wasn't invited to any management briefings," says Fraser. "I have relied fully on the information in the share offer document."

Of greater concern than being starved of information, Fraser raises the possibility that those inside the tent are being given more information than those outside the tent.

He cites an Australian Financial Review article that appears to attribute to QR, or a joint lead manager, projections of 19 per cent a year profit growth up to 2015, based on certain underlying assumptions.

It is good information and would be of interest to those looking at QR as an investment opportunity. However the information is not disclosed in the prospectus, which has forecasts that only go to 2012.

Inside information should be openly disclosed to the market. The AFR report raises the fear inside company information is being passed to selected groups. And if it did not come directly from the company, it raises the fear a joint lead manager with inside information about the company is going beyond prospectus forecasts in its marketing material - a no-no under its mandate.

By contrast, external analysts are free to publish whatever they like about the company.

A spokesman for the QR float said he was unaware of any external research that contained the forecasts reported in the AFR. But he denied that either the company or a joint lead manager (JLM) had been providing that information.

"No information beyond what was contained in the offer document has been provided to investors by either the JLMs or the company," he said. "To assert otherwise would be misleading."

In the hidden world of investor briefings it is hard to be sure, but on the AFR report alone it smacks of overreaching in the quest to sell shares.

One final testament to the smarts within investment banks is buried in the fine detail of the float, which spells out the "green shoe" mechanism. The mechanism is not widely questioned, and indeed many in the investment banking community support it as a valuable tool to provide overallocations and a stable price in the days after the float.

It is part of a post-IPO price stability mechanism that has become accepted practice through its use in the three Telstra offerings.

The theory is that new companies with uncertain pricing outlooks should be afforded a measure of stability when companies are floated on the ASX.

The practical application is that if the market price falls below the institutional offer price and there is an over-allocation of shares, the investment banks are explicitly allowed to enter the market and buy shares for two weeks, due to waivers from ASIC and the ASX.

Specifically, the prospectus states: "The joint lead managers have obtained a 'no action' letter from ASIC in relation to proposed after-market stabilisation activities."

It helps the issuer from short, sharp volatility - in the case of QR up to 6 per cent of the stock could be bought on market if it is over-subscribed by institutions.

It also helps the investment banks and the government to paint the float as an initial success - or at least not an unmitigated disaster.

The longer-term gains for the investor from the investment banks' fancy footwork is not quite so clear.

INVESTMENT BANKING HEALTH CHECK

Best investment bank overall

1 UBS

2 Macquarie

3 JP Morgan

4 Goldman Sachs JBWere

5 Deutsche

6 Credit Suisse

7 RBS

8 Merrill Lynch

9 Citi

10 Patersons

Best investment banker overall

1 Matthew Grounds - UBS

2 Nick Rowe - RBS

3 Richard Saywell - UBS

4 Jon Gidney - JP Morgan

5 Aaron Constantine - Patersons

6 Aidan Allen - UBS

7 Tim Longstaff - Deutsche

8 Tony Osmond - Citi

9 John Knox - Credit Suisse

10 David Smith - BBY

SOURCE: EAST COLES

The four questions

Which regions does your company consider in terms of offshore growth?

Supporting prices is normally known as market manipulation. It is illegal under various sections of the Corporations Act.

Asia 61%

Europe 26%

North America 26%

Africa 13%

South America 13%

All 8%

Oceania 5%

Developing Growth Economies 3%

Middle East 3%