What Use Are Banks in An Era of Intellectual Capital?

Banking is being disrupted. Employment is down, deals are harder to come by. Corporate mergers and acquisitions seem to happen primarily through conversations between founders.

This is not, however, due - as some would have it - to the heavy hand of regulation or because of new entrants into the market.

It is happening because the terms on which such deals are done no longer require spreadsheets and comparables and all of the standard analyses that investment advisors used to be able to peddle to secure their fees.

Increasingly, these deals are done because knowledgeable tech executives understand that the drivers of value can not be found on balance sheets or income statements. Not because they don't create value, but because the factors were not deemed worthy of consideration by those who, for so long, served as the gatekeepers to the financial markets. And they did not believe in the potential worth of such factors because they were thought to be 'soft,' which meant to some, lacking in rigor, but to others, simply not the traditional means by which deals were concluded and handsome fees paid.

But the irony is that those avatars of financial wisdom were so dedicated to book value and depreciation and amortization and other measurable relics of the industrial era whose time has passed. Real estate? Factories? Property, plant and equipment? Who cares besides the high priests of increasingly complicated - and irrelevant - accountancy. The reality is that while finance has employed technology with some effectiveness, it has not learned the lessons of an economy in which terms like 'look and feel' are a significant source of value.

And until the banking system catches up with the value chain, its own status will continue to be ephemeral. JL
Felix Salmon comments in the Financial Times:

Silicon Valley deals are not based on factors that bankers can model.
It is merger season in Silicon Valley. More than $100bn in technology deals were done in the first half of this year alone, according to Mergermarket. The numbers for the second half will probably be even bigger. The year-end tally will include Facebook’s $19bn acquisition of WhatsApp, Oracle’s $5.3bn purchase of Micros Systems and a significant entry from normally deal-shy Apple, which has agreed to buy headphone maker Beats for $3bn.

Amid all of this, one element is missing: bankers. Investment banks are used to earning big fees when corporate clients absorb other companies. But many big deals are being completed without the buyer using any investment bank at all.It is no coincidence that the rise of the self-advised mega-merger has coincided with the rise of the California-based venture capital industry as the most important single funding source for technology companies. There are still initial public offerings, of course, and gigantic public companies: Google and Apple have a combined market capitalisation of $1tn. But Silicon Valley, as a rule, does not fund itself in the stock market any more. The flotation of Apple in 1980 and of Microsoft in 1986 came at a time when those companies were investing heavily in developing the Macintosh and Windows systems.

But the 2004 and 2012 IPOs of Google and Facebook did not give those companies money they needed for anything. They already had big cash piles, and have made much more money since. Going public was a way to allow shareholders to cash out, not a means of investing for the future. These days, if a technology company wants to raise money to invest in generating growth, it will call on well-connected venture capitalists who provide more than just cash. Silicon Valley has more than enough money to fund itself in-house. Bankers and capital markets are not the only game in town.

Founders do not want to negotiate with bankers: they want to negotiate with fellow founders, such as Larry Page or Mark Zuckerberg

In fact, many technology companies are finding that banks are not even necessary, as The New York Times has reported this week. A Morgan Stanley analyst armed with a beautifully formatted, discounted cash flow projection would not be able to help Mark Zuckerberg, the Facebook chief executive, work out whether Snapchat was worth $1bn or $10bn, or whether WhatsApp was worth $2bn or $20bn. After all, Mr Zuckerberg knows better than anyone how a transaction that looks optimistic today can look like the bargain of the century tomorrow.

Today’s big Silicon Valley deals are not based on corporate synergies, or the amount that earnings per share will increase after the deal closes. They are not, therefore, based on the sort of thing that bankers can model. (Very few of the acquired companies have any earnings at all; some even lack revenues.)
Instead, they are based on attributes that are much harder to quantify. Will this company’s product change the way that billions of people interact? Is it run by the kind of visionary who could prove to be a lethal competitor if she is not brought into the fold today?

In situations such as these, it matters little if the acquiring company overpays. After all, big tech companies have never had more cash than they have today, and they are finding it just as hard to put their money to work as everybody else is. The logic behind Facebook’s acquisition of WhatsApp, a smartphone messaging platform that is more or less free to use, is simple: capturing a slice of the time people spend on their mobiles matters more than money. It wants to become the dominant technology company of the mobile age. That is not an area where bankers can help. Indeed, they would be harmful, adding an extra layer of meetings and spreadsheets that only serve to dispirit a potential target. Founders do not want to negotiate with bankers: they want to negotiate with fellow founders, such as Larry Page or Mr Zuckerberg.

A banker with gold cufflinks and an expensive suit might be useful if you are interested in buying a public company run by a board of grandees and a hired chief executive. But such deals are now few and far between. In a Silicon Valley devoted to transforming the way we live, bankers have been disrupted: they have gone from being a necessary evil to an unnecessary one. And no one is shedding any tears.