It’s Hard Out Here For A Banker
Evan Spiegel’s Bankers Don’t Care About You, And They Really Shouldn’t
FOLLOW THE INCENTIVES
Since I started business school, the same question has bothered me nearly every single day: if the experts were wrong in 2008 — ya know, that time the world nearly collapsed because of a bunch of experts? — why should should I trust them now? Why should I trust the Goldman Sachs banker who swears up and down that the company for whom she’s written a glowing review isn’t actually on the verge of collapse?
Maybe that sounds dramatic, but on the reg, I hear smart, educated, sophisticated people who understand the nuances of markets and business in general, espouse the most asinine stuff. (Cue hubris) “Dude, you don’t understand! Goldman [Sachs] rated Snap a buy. They may have tanked in their first earnings call, but all the experts keep saying to buy.” Right, the experts.
In his post-Snap earnings meltdown piece for Business Insider, Traders betting against Snap made $150 million off its earnings disaster, senior markets reporter Joe Ciolli ends beautifully:
It’s not all bad news for Snap, however, as research analysts from several of the banks who underwrote the company’s IPO came to its defense. That included colead bookrunners Goldman Sachs and Morgan Stanley, who maintained their buy ratings on the stock and left their price targets unchanged.
Let’s clarify what Joe is telling us. What he’s saying here is that the investment banks (Goldman Sachs and Morgan Stanley) who were paid a ton of money by Snapchat (technically “Snap”, but the kids who use it probably don’t care) to structure the initial public offering (IPO), effectively purchase massive numbers of shares to support the stock, and shop the deal to institutional investors to ensure the IPO wouldn’t flop are now telling us that, even after a dismal first earnings call, that we should buy the stock because it’s AWESOME!
I’m not faulting Joe; he’s merely reporting what’s going on. What’s actually important here is understanding the lunacy of trusting the opinion of the expert who is selling you something. When a used car salesman swears up and down that the car he’s trying to sell you is obviously amazing, and that clearly you should buy it, you likely view his word as suspect. When a banker with “MBA”, “CFA”, and/or another three-letter acronym that notes his or her voluminous and impressive knowledge advises you that the company he was just paid to promote is a great deal, shouldn’t you be equally skeptical? Check that, we’re talking about your retirement. Shouldn’t you be even MORE skeptical? Not convinced?
As CNBC news associate Anita Balakrishnan points out in her reporting of Snapchat’s IPO back in March, “Wall Street banks made about $85 million in fees on Snap’s giant IPO, with Morgan Stanley and Goldman Sachs taking the lion’s share.” Damn, son! That’s a lot of kesef!
“So what, dude? Banks made some money for facilitating a deal. That’s what they do!” You’re right. And to be fair, the banks are awesome at piecing together these phenomenally complex deals and ensuring they work. They brings tons of value to their clients and soon-to-be shareholders for doing what is super tough to do. BANKS ARE VALUABLE. The services they offer are important. Banks should play a role in deals like this. That’s not the problem.
My gripe is that bankers are incentivized to peddle a deal even after it has closed. Even after Goldman and the like have made their money from structuring and pitching the Snapchat deal, they are still in a heated battle with one another over the next deal, and the next deal, and the next deal. It never ends. Bankers must consistently back their deals to not only support the deal, but to secure their own long term viability in the marketplace. If Goldman, JP, or the others ever hope to get another fat check from a client looking to go public, they need to continue to support the share price with their much-lauded opinions of the viability of the company and its certain stellar future. Those opinions — not the financial fundamentals — support the stock price. We’ve seen it before: even with billions on their balance sheets, companies can hemorrhage cash at ludicrously unsustainable rates (more to come on that in another post on Netflix) and still maintain high valuations in the marketplace.
Why does this happen? How can a stock soar when its financials tell the story of a dying patient who cannot be saved? Because markets are irrational. That’s it. Markets listen to experts, even when they know the experts’ incentives.
THE REMEDY (DON’T SUE ME, JASON. IT’S A COOL TITLE!)
The experts are incentivized to tell you something that drives behavior that lines their pockets. OK, got it. So, what’s a guy (or girl) to do? The answer is simple (though, not easy): brew a fresh pot of coffee (I’m prone to richness of Stumptown or Bluebottle), block out a few hours of your day, and dig in to the financials of the company whose stock you think you want to buy. It’s not easy. Really, it’s not. But you just have to do it.
You have to at least understand what you’re being sold and why. You have to put the time in to understanding something as complex as a company like Snapchat. When you put in the time to learning what is happening in a company from a financial perspective rather than through the lens of the aligned narrative the experts and executives offer, you see what’s real.
Companies live and die on their ability to make money, not the stories the experts tell us. Those incentivized to weave a golden yarn will do just that. Is it lying? Tough to say. I’m an eternal optimist, so I say no. Is there funny business going on? Maybe. But you won’t know until you look at the numbers because the numbers simply don’t lie.
Unless they do. In which case, the company is a fraud.