Old-style underwriting dying out

ALMOST three years have passed since Stephen Byers, in his former role as Trade Secretary, ruled that little change was required to the way in which the City raised money for its customers. The decision followed a series of long, probing investigations by the Office of Fair Trading and the Monopolies and Mergers Commission (as the Competition Commission used to be known).

The OFT, the MMC and Byers agreed that the system as was needed little alteration. Under this system, a company's advising bank would arrange a fully-underwritten equity rights issue for a fee of 1/2%. The company's broker would receive a 1/4% fee for selling the stock and institutional investors would receive up to 1 1/4% for sub-underwriting the issue - that is agreeing to take the shares come what may.

Nine times out of 10, this was money for old rope. The 10th time, they earned their fees. US investment-banks disliked this system, preferring their home-grown method of bookbuilding. The underwritten way involves offering a company's shares to its existing shareholders first at a pre-agreed price. Bookbuilding involves marketing the shares to all-comers at a price to be determined by demand.

The underwriting fee is a maximum of 2%; the bookbuilding fee is between 3% and 5%. US banks maintain, however, that their way is better because the shares tend not to be sold at as great a discount. Traditionalists point out that the discount is immaterial if the owners of the new shares are existing shareholders.

Following Byers' ruling, the traditionalists appeared to have won. Practice tells a different story. Old-style equity underwritings are dying out. Bookbuilding is almost always the favoured way for companies to raise money. Instead of being assured of their cash and assured the new shares will come to market at a pre-arranged price for which they will have to pay a fee of 2%, corporates are assured of nothing and the fee has doubled. This does not seem like progress.

Hi-tech ideals

TECHNOLOGY shares have led the US stock market's surprising year-end rally in anticipation of a return to riches some time next year. The tech-heavy Nasdaq has risen 50% from its September low as investors look forward to an expected profits turnaround, predicting respectable growth by mid-2002, followed by a virtual profits explosion by early 2003.

Some companies, such as Cisco, have inadvertently fed into this anticipation, forecasting the possible bottom of the recession that has so crippled the US tech sector. Others, such as Cisco rival Juniper, recently warned of continued weakness and extreme caution on the part of customers.

For the most part, Wall Street market strategists side with the Juniper version of events. They do not see much possibility of the huge upswing in tech profits the equity market is betting on, at least not in the near future.

The overall sector has jumped so high in the past two months that the tech portion of the Standard & Poor's 500 index now trades for about 50 times projected 2002 profits, double the level of the average S&P share.

Merrill Lynch strategist Richard Bernstein says investors are paying Bentley prices for Volkswagen stocks and vice versa. It is hard to argue with his logic. Expectations of a strong and sustained tech rebound are far too optimistic.

Given the contraction of the past 18 months, it is doubtful the tech sector will bounce back with anything like the speed investors are expecting. There should be improvement by the second half of next year if the US and global economies recover as expected, but the tech sector probably will not be a leading factor, rather a lagging one.

How much longer will investors bury their heads in the sand and pay high multiples for risky stocks in the flimsy hope of a hi-tech return to former glory?