When Mike Lanigan advertised on Thomson Financial's AutEx one day recently to sell 100,000 shares of MDT, he didn't have an order. The U.S. Bancorp Piper Jaffray block trader wasn't betting on a downturn in the stock either. His purpose was simply to let the buyside know that Piper Jaffray was a power in Medtronic, a New York Stock Exchange-listed company.
That's the Minneapolis investment bank's equity trading strategy in a nutshell. Trade a select group of stocks every day, order or no order. At all times, put the Piper Jaffray name in front of the buyside. Win more of its business.
"Whenever any institution in the country wants to buy or sell Medtronic I want them to automatically associate that name with Piper Jaffray," said Tony Cecin, head of equity trading and a senior managing director at Piper. "I want them to think it doesn't make sense for them to go elsewhere because we are so dominant in that name."
That's the message Piper Jaffray hopes to send to its institutional clients. But it is also the message its bankers want to send to their clients and prospects. And, at Piper, banking is the endgame. If Piper's bankers can boast about the aftermarket trading prowess of Cecin's department they can compete more effectively for underwriting mandates.
"Our goal is to be the number one investment bank to growth companies," said Paul Karos, head of equity capital markets and a senior managing director. Karos, who's Cecin's boss, added, "To do that the buyside must view Piper Jaffray as one of the top firms in research and trading. It's crucial that we increase our market share with the buyside."
Piper has already won a can-do reputation in Silicon Valley among technology companies mulling a public offering and the venture capitalists that back them, according to Karos.
Winning over the three groups – the buyside, venture capitalists and issuers – is a key part of Piper's master plan to transform itself from a regional broker dealer to a national investment banking powerhouse specializing in technology and healthcare.
The process began five years ago with a decision to create a technology-banking infrastructure from scratch. Piper spent heavily to hire analysts, bankers, salespeople and traders. Still considered the new kid on the technology block, it faces stiff competition from such West Coast rivals as Robertson Stephens, Bank of America Securities, Thomas Weisel Partners and Chase H&Q.
But, since 1999, it has rapidly climbed up the underwriting league tables. It closed 98 IPOs and secondaries last year and has done a similar number so far this year. That compares to between 35 and 45 in each of the prior four years. Based on this year's numbers it's ranked tenth by New York-based deal-tracker CommScan. Based on its backlog, or deals registered with the Securities and Exchange Commission but not yet completed, it's ranked fifth with 34 deals in the works.
Piper's performance leaves in the dust such comparably sized regionals as Morgan Keegan and Raymond James & Associates. All recorded about 20 deals last year. "The gap between the winners and the losers has gotten much much larger in the last few years," said Rick Hines, head of Piper Jaffray's capital markets division and a senior managing director. "You're either considered a high quality tech shop or you're not."
His boss seconds that notion. "Regional expertise is worthless," Karos said. "If you don't know the industry you're not adding value. We get to know the industry very deep."
Pressure On
The pressure is on Cecin's department to support those deals. It needs to be considered the axe, or one of the top three market makers, in the stocks its bankers take public. But it appears to be meeting with success.
Piper promotional material, compiled from AutEx/BlockDATA statistics, shows Piper as an axe in 97 percent of the issues it underwrote from January 1, 1999 to June 30, 2000. That's about 150 stocks. At 97 percent, Piper has the highest "score" of the twenty-two banks in the survey. At the bottom of the list are J.P. Morgan and UBS Warburg at 56 percent and 52 percent, respectively.
The survey is one of two critical measures of the trading department's performance. The other is the McLagan rating. Chicago's McLagan Partners tallies the amount of trading an institution does with its brokers. For the sellside, it is a measure of industry market share. The figures are not usually publicly disclosed, but Cecin says Piper's numbers have steadily increased over the past five years.
The firm still has its work cut out for it. At least one buy-side trader doesn't think much of its execution services. "They've never been as big or as good as they think they are," said the trader who asked to remain anonymous. "They've gotten a little better over the last year, but I've always been disappointed. They talk a big game. They should be better." The trader actually prefers the services of Piper's smaller cross-town rival Dain Rauscher Wessels.
Another trader has found more to like. "We've never had a problem with Piper," said Sam Toy, head trader at New York's $30 billion Fortis Advisors. "They're making great strides in trying to break out of the regional mold with IPOs and by committing capital."
In any event, Piper is setting a blistering pace in Nasdaq stocks this year. From January to August, it traded three billion shares, according to AutEx/BlockDATA. That's 50 percent more than last year and puts Piper up five spots to number 24 in the AutEx/BlockDATA rankings. On the listed side, Piper traded an average of 12.5 million listed shares per month through August of this year, according to AutEx. That compares with 72 million shares in 1999.
Cecin, who at 54 is a 23-year veteran with Piper, emphasizes that the stocks of its banking clients aren't the only ones making up that volume. "We want to be the dominant research trader in all the stocks our analysts follow," he said. "We recently picked up a new analyst who will cover 18 stocks. She hasn't done any IPOs with us yet, but we intend to make her an important research voice in her sector. We'll do that through sales and trading." Piper trades all of the stocks its analysts cover, says Cecin.
Institutional and Retail
About 55 percent of Piper's volume is institutional; 45 percent is retail. With 1,200 brokers in 100 offices, retail flow is significant. The average trade size at Piper is between 300 and 500 shares. Retail orders are filled internally if Piper trades the stock; otherwise they're automatically routed out to another market center. An agency desk handles the larger outbound retail orders.
Piper makes markets in 450 Nasdaq and 200 listed names. The number of stocks traded has increased on average 20 percent annually over the past few years, according to Cecin. The trading chief has no plans for a large-scale ramp-up of his trading list, however, despite the vogue for that on the Street. "Given the volatility I don't think that makes much sense," he said. "Especially going into a decimalized environment."
Trading is handled by 21 Nasdaq market makers under the supervision of Nick Karos, Paul's brother; seven listed traders reporting to Mike Lanigan and Rod Smith; and 24 sales traders reporting to Jim Roane and Mark Donahoe. A ten-person agency desk headed by Cindy Witt and 15 on the floor of the Big Board round out the crew.
Including associates there are 125 people in the trading department. The desk is not run as a profit center for its own sake, but to support research and investment banking, Cecin says. All Piper Jaffray employees share in a single company-wide bonus pool.
Most of the trading staff works on Piper's new huge 10,000-square-foot trading floor. Market makers, seated six rows deep and 11 stations wide, face sales traders, also six rows deep and eleven stations wide, across a narrow aisle.
All of Piper's sales traders work out of Minneapolis. None are in the big buy-side towns of New York and Boston. "The buyside has told us they would rather have the sales trader sitting right in front of the market maker watching the order," Karos said. "That is more important to them than a local presence."
A state-of-the-art intercom system facilitates communication, but there's still a lot of yelling across the aisle. Cecin sees himself as a calming influence. "My role as a risk manager would be compromised if I yelled too much," he said. He has an office, but says he spends most of his time on the desk.
The new trading room is not the only change Cecin's group has undergone this year. At the end of June, all of the Nasdaq market makers were grouped into industry sectors. No longer do the best traders trade the most important stocks. Now traders are assigned "pads" of wireless or digital infrastructure stocks, for example.
Easier Communications
The change makes it easier for Piper's analysts to communicate with the traders. An analyst no longer has to talk with four or five traders handling his stocks. He may now talk with just one or two. It's a sign of the tremendous clout of the analyst at Piper. The analyst, and not the banker, is the central figure in the deal-winning process. Paul Karos, in fact, was a former top-rated airline analyst with Credit Suisse First Boston.
Cecin, not totally comfortable with the change, says there is a risk that a trader could become overwhelmed by volume and volatility, especially in a sector like the Internet. To that end, IPOs are still handled in their first few days by the head of market making, Nick Karos, a managing director, and one other senior trader, before the stocks are transferred to the sector trader. Karos also trades Yahoo!.
Cecin notes, however, the switch to trading industry sectors does add value to customer relations. When a buy-side trader asks a Piper sales trader for an update on a particular stock, the sales trader can get the lowdown on the entire sector from the market maker.
Trading Demarcation
Piper is taking sector-based trading only so far for now. Its market makers will not cross market lines. They will still specialize in either Nasdaq or listed stocks. They will not trade both even when a sector overlaps. "It's an option we'll utilize if we think it makes sense going forward," Cecin said. Another possibility is seating side-by-side a listed and a Nasdaq trader covering the same sector. Now the two groups work separately.
Differences between the two markets are predicted to blur at Piper in at least one important respect: pricing. Decimalization is likely to collapse spreads to a penny on many stocks. That will make it impossible to make a profit trading Nasdaq stocks on a traditional net basis. Cecin says Piper will most likely charge commissions on Nasdaq trades much the way it does today for listed trades. "Instead of having two prints go on the tape the buyer and the seller will both pay the same price, and a commission." he said.
Decimalization is also likely to increase volatility, Cecin says. That will play to another of Piper's strengths. Its strong capital base and its willingness to risk that capital will become even more valuable. The more volatile the market the more likely a seller on the buyside will ask his broker to buy his block outright. The alternative is to ask the broker to work the order and risk a poor fill. In transferring his risk to the sellside, however, the buy-side trader will typically pay more.
"The buyside will want immediacy," Cecin said. "The sellside will be called on more often to put their capital at risk to satisfy client needs." For its part, "Piper is not capital-constrained," Cecin said. Parent U.S. Bancorp has guaranteed its broker dealer subsidiary capital totaling five times its current average inventory balance, according to Paul Karos. That means Piper could trade five times its present average volume.
In fact, Piper would love to trade five times as much as it does now. Despite a sterling performance in the IPO aftermarket it rarely acts as the lead manager in a deal. It is usually one of two or three co-managers. The lead manager controls the allocation of the stock to the institutions and does most of the trading. The recent IPO for INMX, for example, saw 12 million shares traded. Piper handled 700,000. Lead manager Bear, Stearns & Co. traded the lion's share and is expected to maintain that dominance for at least a year.
Must Work Harder
Surviving on the crumbs left by the lead manager is better than nothing, but that means Piper must work that much harder to gain the attention of the buyside. Karos says Piper is lead manager on 20 percent of its deals. That number is 80 percent for competitors like Goldman Sachs, Credit Suisse First Boston and Morgan Stanley Dean Witter. Goldman's brand is a big plus, however, when it comes to winning mandates, according to Karos.
Karos wants to ratchet Piper's figure up to 40 percent in the next few years. "It's a huge goal," he said. "But we know how to do it. It's a brand challenge, but not a capability challenge." He'll need Cecin's trading department to get there.
