Internet Investment Banks Pitch Their Own Brand of Business

To raid the underwriting market, Internet investment banks may have to do more than trade on their sexy Net association.

The door to Internet underwriting already has been squeaked open by online brokers, which offer customers IPO shares through partnerships with traditional Wall Street investment banks. But new Net investment banks want to go further.

Internet banks aim to woo issuing companies with cheaper prices, the same idea behind the ultrasuccessful online brokers. Internet road shows, electronic trading and electronic information distribution can bring big savings over traditional methods, they figure.

But many observers believe that to compete for significant underwriting jobs, online investment banks will have to borrow just as much from the traditional I-banks as from the Internet revolution, which could undercut their advantages.

The list of entrants into this field includes W.R. Hambrecht & Co., founded by Bill Hambrecht, who co-founded Hambrecht & Quist (HQ Quote) 30 years ago. It plans to charge just 3% to 5% of the IPO proceeds, compared with the traditional 7%. Then there's E*Offering, which was founded by investment banking veteran Walter Cruttenden, former Cruttenden Roth CEO. Its investors include Sandy Robertson, another IPO notable, and E*Trade (EGRP Quote). It also plans to charge less than traditional fees.

In addition, W.R. Hambrecht aims to change how IPOs are priced -- letting offering prices fluctuate with demand -- which could bring issuing companies more money.

"I do expect Internet investment banks to put pressure on the sacrosanct 7% spread," says Michael Flanagan at Washington, Pa.-based Financial Services Analytics. "When you talk to Goldman Sachs and you're paying 7%, you may ask how come one of the Internet banks can do it for 4%." This might be particularly true during a bull market, when many offerings appear to sell themselves thanks to demand from not-too-picky retail investors. In this environment, issuing companies may be more likely to forego the well-established promotional expertise of traditional banks.

Some venture capitalists say they would consider an Internet investment bank, especially for an offering that had particular appeal for Net investors. But they might not be willing to trade cost for quality. The concern is that discount prices might come with discount services.

"The key is the ability to support the offering, the distribution, the aftermarket follow-through and the research support," says David Hathaway, general partner at Venrock Associates, a New York City venture capital firm.

The savvy of traditional banks in promoting and supporting offerings, especially with research, is something that has to be considered before jumping to a Net bank, says Peter Loukianoff, associate partner at Technology Funding Venture Partners, a San Mateo, Calif., venture capital firm. Flanagan at Financial Services Analytics says distribution, sales and aftermarket support may not be a part of the Internet investment banking package.

"If I were Goldman Sachs, I wouldn't be concerned," says DuBose Montgomery, managing director and general partner of Menlo Park, Calif.-based Menlo Ventures, a VC firm. "After you go public, you need people who are writing about the company who purchasers are going to listen to. It's always been important and will be important for the Internet investment banks, too."

Since it's so early in the game, Internet investment banks are still determining their services, including what to do about research. Wit Capital, an online investment bank pioneer that distributes small pieces of IPOs underwritten by traditional banks, recently hired Jonathan Cohen from Merrill Lynch as director of research. He will head Wit's effort to produce research on companies it helps underwrite. W.R. Hambrecht plans to offer research on a wider array of technology and consumer products companies than currently covered by Wall Street using a quantitative model that will require fewer analysts. E*Offering says it will provide research coverage as well.

Research is a critical part of supporting an offering, especially when attracting institutional stockholders. And while companies may want greater retail and online investor access, few want only retail investors. Respected analysts can influence big buyers, provide insight into new companies to a broader audience and maintain relationships with company management.

Some other aspects of Internet investment banking also leave observers unconvinced. For example, communicating online might save some bucks, but it doesn't provide face-to-face interaction with potential investors or cement key distribution relationships. For retail investors in a tougher market or for institutional investors generally, information presented online won't satisfy, says analyst Charles Vincent at PNC Institutional Investments.

But the catch is that if Internet investment banks flesh out their services to lure attractive clients, they may not be able to offer the discounted price. As a result, venture capitalists say they're most likely to consider using an Internet investment bank for Net-related offerings or companies with a strong consumer orientation, where there is an enthusiastic pool of retail buyers. In such cases, using a Net bank could also be a nifty marketing tool.

In addition to a natural affinity with high-tech offerings, observers are looking for Internet investment banks to first appeal to companies looking for smaller deals. The micro-cap and small-cap market is underserved by traditional investment banks but has attracted the interest of retail investors, says John Payne at Cerulli Associates, a Boston-based financial institution consulting firm. By focusing on selling small deals to primarily retail investors, the banks could use the Internet to cut costs but still deliver a valuable service.

The three brokers have admitted to a limited role for themselves, at least at first. Len Purkis, E*Trade's chief financial officer, says E*Offering will aim for deals in the range of $30 million to $50 million, which big firms shun. He says E*Offering has about 30 deals lined up.

W.R. Hambrecht says it has received interest from companies planning large offerings but admits that companies with deals in the range of $10 million to $20 million might be particularly interested.

Wit, meanwhile, seems content to let traditional investment banks take the lead, though it wants to boost its participation in offerings to 20% to 30% from the current 5% to 10%, says Andrew Klein, founder and chief strategist.

Observers agree that in some form, the role of the Internet in underwriting, and an Internet investment bank or two, is here to stay. It's just a matter of whether they become all-purpose underwriters or niche players.