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JPMorgan Chase & Co
Morgan Stanley Focus Growth Fund
Morgan Stanley Focus Growth Fund
Morgan Stanley (MS), the underwriter that took Facebook Inc. (FB) public at a record high market value, said its own money-management unit bought more than 2 percent of the shares sold through the $16 billion offering.
Morgan Stanley Investment Management invested about $380 million in Facebook’s initial public offering, according to regulatory filings late last month, the first to show its IPO purchases. A dozen funds run by the advisory unit’s growth team, headed by Dennis Lynch, each allocated 6.8 percent of their net assets to buying Facebook stock at the IPO price of $38 a share.
Facebook has fallen (FB) 42 percent since its offering, increased in size and price at the 11th hour. The drop erased $39 billion in market capitalization, ranking the stock as the worst-performing large technology IPO ever based on the early loss in value, according to data compiled by Bloomberg. The decline crimped the performance of Lynch’s growth team, described as a “crown jewel” of Morgan Stanley Investment Management, and left the bank’s fund investors behind on the investment.
“Facebook has underperformed because they took the last dime off the table on the IPO price,” said Tom Forte, an analyst at New York-based Telsey Advisory Group who has been following IPOs since the 1990s. “They did an incredible job of getting every last penny for existing shareholders, seemingly to the detriment of the new shareholders.”
Funds run by Morgan Stanley Investment Management, including those sub-advised for outside firms, bought 10 million shares at the IPO price of $38 each, according to documents filed with the U.S. Securities and Exchange Commission at the end of August. That included 2.81 million shares purchased by Morgan Stanley Focus Growth and 1.53 million shares acquired by the Morgan Stanley Institutional Fund Growth Portfolio.
These were in addition to 6.6 million Class B shares that Morgan Stanley Investment Management acquired at an average price of $21.11 when Facebook was closely held, according to a May 18 regulatory filing by the Menlo Park, California-based social networking company.
Last month’s filings show how much of New York-based Morgan Stanley’s stake in Facebook was purchased in the offering, when the stock, which has ranged from a trading high of $45 to a low of $17.55, was near its peak.
Matt Burkhard, a spokesman for New York-based Morgan Stanley, declined to comment. He said Lynch, who joined Morgan Stanley in 1998 after working as an analyst for J.P. Morgan Securities, wasn’t available.
In the weeks leading up to the sale, Facebook increased the number of shares offered to 421.2 million from 337.4 million and lifted the estimated price range to $34 to $38 from $28 to $35. At the time, people familiar with the matter said Morgan Stanley, the lead underwriter for the IPO, was one of the banks primarily responsible for the pricing.
After Facebook said May 9 that growth in advertising had failed to keep up with user gains, analysts at Morgan Stanley and some of the other banks underwriting the deal cut their earnings estimates (FB) and relayed the new projections to institutional investors. Facebook’s underwriters ended up allocating more than 25 percent of the IPO shares to individual investors, people familiar with the offering said at the time.
“The amount of pressure they put on the sales force to pump it out was astonishing,” Gulbir Madan, the founder of Brahma Management Ltd., said in an interview after the IPO. “Morgan Stanley has made one of the biggest blunders that it possibly could have for the franchise,” said Madan, who was investing in technology stocks during the Internet bubble of the late 1990s.
Multiple lawsuits have been filed against Facebook and its directors in state and federal courts since May 22 alleging securities violations in connection with the IPO, the company said in a July 31 regulatory filing. Facebook said the suits lacked merit and the company was defending itself vigorously.
Morgan Stanley, whose growth funds are sold to institutional and retail investors, is the sixth-largest shareholder (FB) in Facebook, according to data compiled by Bloomberg. Accel Partners, Goldman Sachs Group Inc. and Baillie Gifford & Co. are the biggest holders based on recent filings, the data show.
Mutual funds managed by fellow Facebook underwriters JPMorgan Chase & Co. (JPM) and Wells Fargo & Co. reported buying 953,600 and 967,328 shares, respectively, through the IPO. Goldman Sachs, another Facebook underwriter, disclosed that its funds bought 694,674 shares.
Prior to the offering, Lynch and other Morgan Stanley managers were investing in other e-commerce and social- networking IPOs in which the bank was a lead or co-lead underwriter. Morgan Stanley Investment Management devoted $22.5 million to the May 2011 IPO by LinkedIn Corp. (LNKD), $50 million to the November offering by Chicago-based Groupon Inc. (GRPN), and $100 million to the December stock sale by Zynga Inc. (ZNGA), a San Francisco-based developer of online games, SEC filings show.
During the Internet boom of the late-1990s, tech companies that went public often soared in value as soon as their stock began trading, enabling IPO investors to reap a quick profit. This time around, the Morgan Stanley funds that participated in three of the four tech IPOs underwritten by the bank ended up paying top dollar.
Zynga and Groupon have declined 69 percent and 77 percent, respectively, from their offering prices. LinkedIn has more than doubled since Morgan Stanley took the business-networking company public.
“The atmosphere was obviously supercharged at that time, with everyone thinking that these things would double or triple on the first day,” said Michael Mullaney, the chief investment officer of Fiduciary Trust Co., a Boston-based firm that manages about $9.5 billion for wealthy individuals. “Maybe they just got caught up in all the hype,” said Mullaney, who attended Facebook’s pre-IPO roadshow and ultimately advised clients to limit their Facebook holdings to 1 percent of assets.
At least five funds run by Lynch’s team cited stock selection in the technology sector as the main “detractor” from relative performance during the second quarter, according to documents on Morgan Stanley’s website. Three said Facebook was the “leading detractor” among the stocks they held. A fourth, the Morgan Stanley Institutional Fund Focus Growth Portfolio, said Facebook was “among the weakest performers” in its tech holdings.
The Morgan Stanley Focus Growth Fund returned 15 percent this year through Sept. 17, trailing 73 percent of its peers, according to data compiled by Bloomberg. Its benchmark, the Russell 1000 Growth Index (AMODX), climbed 19 percent, including reinvested dividends.
Facebook, whose Class A and Class B shares were the fund’s third-largest holding at a combined 7.7 percent of the portfolio as of June 30, comprises 0.1 percent of the fund’s benchmark. Groupon and Zynga have smaller weightings in the index.
Lynch’s team has 16 members, according to Morgan Stanley’s website, including 11 “investors,” the term the firm uses in lieu of traditional titles such as portfolio manager and analyst. It also has a “disruptive-change researcher” who investigates “big ideas” and emerging themes, and who doesn’t speak with sell-side analysts or company managements. Stan Delaney, the current disruptive-change researcher, was formerly a category manager at online retailer EBay Inc.
The Focus Growth Fund managers are “willing to go wherever their best stock ideas take them,” Morningstar Inc.’s Janet Yang wrote in a July 17 report, adding that Lynch’s team is one of the “crown jewels” at Morgan Stanley Investment Management. They pay little heed to the sector weightings within their funds’ benchmarks, Yang said. Chicago-based Morningstar gave Morgan Stanley Focus Growth a gold rating, the research firm’s highest ranking, and said the fund generated an annualized gain of 6.2 percent since Lynch took over in mid-2004, compared with an average of 3.7 percent for its peers.
Lynch’s team favors companies with unique business models and sustainable competitive advantages that the funds can “own for the long term,” according to Morningstar. The funds run by Lynch sold at least some of their Facebook shares after the IPO, SEC filings and data provided by Morningstar show.
The Morgan Stanley Focus Growth fund’s Facebook Class A holding declined to 2.1 million shares as of June 30 from the 2.81 million purchased in the prior month’s offering, according to its most recent shareholder report (AMOAX). The stake held by the Morgan Stanley Institutional Fund’s Growth Portfolio declined to 889,238 shares as of June 30 from the 1.53 million acquired in Facebook’s IPO.
According to Fiduciary Trust’s Mullaney, investment banks that underwrite stock sales generally limit the number of shares allocated to their own mutual funds, in part to avoid the appearance of a conflict of interest. Federal securities laws also restrict the ability of mutual funds to participate in securities sales underwritten by affiliates.
As demand for Internet stocks surged in 1997, the SEC loosened these rules, originally designed to prevent underwriters from using funds they control as a “dumping ground” for undesirable securities, according to the agency’s website. The changes raised the portion of an offering that could be acquired by funds affiliated with the underwriter to a combined 25 percent from a prior limit of 4 percent.
Funds must buy the securities from an underwriter that is not an affiliate, and must put in place procedures that allow outside trustees to review such transactions. Mutual funds must disclose details on securities purchased through an offering underwritten by an affiliate in a semi-annual SEC filing known as Form N-SAR.
Morgan Stanley Investment Management purchased almost all of its Facebook IPO shares from JPMorgan, the SEC filings show. Morgan Stanley’s money managers had no incentive to help the firm’s investment-banking affiliate unload Facebook shares because their pay is based on generating high returns for investors rather than underwriting fees, said Jay Ritter, a finance professor at the University of Florida, in Gainesville, who does research on IPOs.
“Most of the portfolio managers at mutual funds are focused on, ‘I want to generate alpha for my fund,’” Ritter said in an interview. “‘My salary isn’t going to be boosted if I help out the investment bankers.’”
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