With Wall Street's morality under fire daily, it's easy to forget that beside the threat of lawsuits and regulatory fines, investment banking remains a risky business that could get more dicey as the downturn wears on.
A case in point is
botched stock underwriting deal for
, a Singapore-based company. Merrill could lose about $30 million on the deal after failing to find buyers for some 393 million shares of newly minted Chartered stock that the company was trying to place with investors.
Merrill was forced to acquire the unsold shares, a move that gives it a 15% ownership stake in Chartered, after existing shareholders of the floundering foundry turned up their noses at the massive 1 billion-share rights offering.
Outside of Chartered's two largest institutional shareholders,
Singapore Technologies Semiconductors
, there weren't many takers for the new shares. That left Merrill holding the bag for some 35% of the offering's shares, which were not "subscribed" to, or bought by the company's existing shareholders.
Even if Merrill is eventually able to find buyers for the shares or took steps to hedge its exposure, it's unlikely that it will break even on the underwriting deal, which will generate an estimated $3 million to $6 million in fees.
Merrill isn't commenting on what went wrong with the deal, which generated about $600 million in cash for Chartered. But in a scandal-plagued year for Merrill, the failed Chartered transaction is another black eye.
Merrill's problem also could be a sign of things to come for other investment banks if the economy doesn't pick up. With bankers scrambling to get their hands on any kind of stock underwriting work, increasingly firms are being forced to take on added risk in some of the deals they bring to market.
, one of Wall Street's premier investment banks, had its own botched underwriting deal earlier this year. Goldman had to absorb a $150 million loss on a failed share placement involving
, the troubled French media conglomerate.
"In an environment like this, underwriters bid very aggressively for deals, and often that involves a commitment to putting up the firm's capital," says Timothy Ghriskey, president of Ghriskey Capital management, a Connecticut hedge fund. "And in a weak market for new stock issues, the risk of an undersubscribed deal increases, and that puts the underwriter's capital at risk."
But some on Wall Street see more at play for Merrill. They suggest Merrill may have been willing to take a loss on the Chartered deal in order to secure more investment banking work from Chartered in the future or from other Singapore-based companies.
That speculation stems from the fact that Singapore Technologies, which owns 60% of Chartered's biggest shareholders, is a government-owned conglomerate that invests heavily in other Singapore-based businesses. Indeed, some of those businesses already have directed investment banking business to Merrill.
Ties That Bind
Singapore Technologies, for instance, is a majority shareholder in
ST Assembly Services
. That semiconductor testing company retained Merrill earlier this year to underwrite a $175 million convertible bond issue.
"This could be a partial loss for what could be more fees down the road," says David Menlow, president of IPOFinancial Network, a new stock offering research company. "It seems somewhat inconsistent that an underwriter would go into a deal knowing they only had two-thirds subscribed."
Menlow said it's a bit surprising that
Salomon Smith Barney and
Credit Suisse First Boston
, the two lead underwriters on Chartered's initial stock offering in the U.S., didn't take part in the rights offering.
Neither Salomon nor CSFB would comment on the latest Chartered stock deal, but industry sources suggest that other than Merrill, there were few takers for the rights offering.
Merrill, meanwhile, was not part of the underwriting team on Chartered's initial stock offering in December 1999. However, last year, Merrill did underwrite a $500 million convertible bond offering for Chartered that generated $12.5 million in investment banking fees, according to Thomson Financial Securities Data.