E-bonds: Will They Fly?

Internet bond auctions can help corporate issuers lower their cost of capital. But savings from lower sales and marketing costs may not be as great as you might imagine.

Like most investment bankers, however, Merli is in no hurry to see it happen. Investors who participated in the Dow and Bear Stearns auctions were reputedly discouraged by Wall Street salespeople. There were predictions that Wall Street dealers would refuse to trade the paper in the aftermarket, there would be no research to support the issue, the auction technology would fail, and not enough investors would participate.

Some suggested that without the moderating hand of the syndicate desk to set allocations, investors might end up paying too much for the bonds. It was also predicted that in a volatile market investors would beat down prices. “They were telling me it was bad for the issuer and bad for the investor,” says Credit Suisse’s Crabbe. “But it can’t be bad for everybody.” Underlying all the arguments was the not-so-subtle innuendo that auction participants could expect retaliation when it came time to allocate the next traditional deal.

For the largest, most-favored investors, that’s a significant threat. But smaller investors generating less commission for dealers and CFOs who manage their company’s pension fund in-house are already at the bottom of the pecking order at the syndicate desks: their allocations in traditional deals can’t get much worse. In a Dutch auction, where the best bid wins, smaller, less well-connected investors are on an equal footing with the heavyweights, and are much more likely to get their allocation than they are in a syndicate underwriting.

At the end of the day, the intimidation apparently had little effect. Plenty of investors logged on for all three online auctions, pricing was good for the issuers, and investors got their full allocations. Trading volume in the aftermarket may have been light, but that was a positive sign: successful investors were hanging on to their bonds. And according to Merszei, Dow has not been blackballed by other investment bankers. “Secretly, many of them — including senior managers — say this is the wave of the future,” he says.

The Merits for Issuers

The great promise of Internet bond auctions for corporate issuers is a lower cost of capital. But one of the biggest sources of expected savings — lower sales and marketing costs — may not be as large as first imagined. All the parties involved in the Dow deal insist that a successful Dutch auction requires an active effort by salespeople, no matter how good the technology. “Software doesn’t answer questions,” says Chris Williams, founding partner of investment bank Williams Capital Group. “It still calls for an educated salesperson to explain the underlying credit and the relative value of the issue.” Williams has a dozen people in fixed-income sales, and doesn’t expect that to change.

While the four managers of the Dow issue halved their commission on the deal (30 basis points versus 60), the discount may in part be a reward for Dow’s willingness to serve as guinea pig for the auction. “Everyone has assumed that OpenBook is aimed at cutting fees, but it’s not,” says Robert Goldberg, co-head of debt markets at Hambrecht. “For the issuer, it’s a method that results in a better price and more transparency.”

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