The growth stock capital of the United States is rising again. After three years of plummeting stock prices, massive layoffs and brokerage house retrenchments, San Francisco is coming back. A slew of small and mid-sized investment banks is building up research, sales and trading in the city in a race to become Wall Street's dominant growth stock boutique.
The flurry of activity comes as San Francisco's old guard dealing firms retreat from the city, the growth stock business and even corporate existence itself. Robertson Stephens went under this summer. J.P. Morgan Chase shut its Nasdaq desk. Bank of America hired a New York-based executive to run an equity trading operation out of the Big Apple.
In their place has emerged a large group of locals and newcomers that specialize in analyzing and trading the stocks of middle market companies. These companies operate in the information technology, medical technology, specialty finance, wireless, semiconductor, online learning and other high-growth sectors of the economy.
Thomas Weisel Partners, Wells Fargo Securities, Pacific Growth Equities, W.R. Hambrecht, and ThinkEquity make up the hometown contingent. First Albany, Friedman, Billings Ramsey, Adams Harkness & Hill, and U.S. Bancorp Piper Jaffray are moving to San Francisco from the East and the Midwest.
The Carpetbaggers
The carpetbaggers are not flocking to San Francisco because of its beauty, culture and progressive outlook. But those are certainly perquisites. The locals are not hiring talent because Silicon Valley is booming. (Top Valley employer Advanced Micro Devices recently announced plans to fire 2,000 employees.)
Both groups say they are expanding for one critical reason: the retrenchment of the old guard. The Four Horseman of Emerging Growth, or H.A.R.M., as the old guard is known – Hambrecht & Quist, Alex. Brown, Robertson Stephens, and Montgomery Securities – abandoned its original growth stock focus after being acquired by four of the world's largest commercial banks in the late 1990s.
J.P. Morgan Chase, Deutsche Bank, Fleet Bank, and Bank of America, respectively, all acquired the Horsemen in the late 1990s. They refashioned them into large cap trading houses in the style of a Goldman Sachs or Morgan Stanley. In the past year the four acquiring firms began to dismantle their trading operations altogether.
Phase one of this restructuring led to fewer analysts covering up-and-coming companies. Phase two led to fewer employees as firms fired staff. The wave of layoffs climaxed with Fleet's decision to shutter the 700-employee Robertson Stephens.
All this thrashing about by the elephants has created opportunity for the small- and medium-sized broker dealers that previously worked in the shadows or – in the case of ThinkEquity – didn't exist at all. They are hiring because it's a buyer's market. They are boosting the number of stocks they cover because the demand is still there.
"We've been able to add high quality people as these firms either go out of business or downsize considerably," said Steve Massocca, head trader at Pacific Growth. "On top of that, their demise has created a vacuum in terms of the research that is available."
Not everyone is convinced the cycle for growth stocks has turned. Ben Hovermale, head trader at San Francisco's Wells Capital Management, says large brokerages, such as the group led by the Four Horsemen, have abandoned growth stocks because they are out of favor with money managers.
Nonetheless, some firms defy that pessimism. Pacific Growth added three sales traders in 2002. The desk now has seven sales traders and five market makers. It is adding stocks as well, making markets in 400 names. Massocca says the firm is profitable.
Pacific Growth, however, like all the new faces, is still a bank. And despite any good news on the sales and trading front, underwriting revenues traditionally drive growth banks. Unfortunately, that market is moribund. Deals are rare.
"I don't think anybody prospers in an environment where IPOs and secondaries are not done," said Sherman Bartley, who is in charge of research sales at W.R. Hambrecht. "But I think we can keep the doors open just doing regular business."
Conducting a regular business of sales and trading is perhaps more important at Hambrecht than at any of its competitors. The bank was founded in 1998 by Silicon Valley rainmaker Bill Hambrecht, chiefly to exploit a unique electronic "Open IPO" process. But after completing only eight deals this way, the firm came close to collapse last year.
Hambrecht's partners recapitalized the firm earlier in 2002. Although pushing Open IPO, the partners are still willing to work as co-managers in the traditional sense. "Bill's original intent was not to compete with the Robbie Stephens of the world because they were doing such a great job," Bartley said. "But things have changed so dramatically that there was a change in focus. Essentially the plan is to remake Hambrecht & Quist." (The legendary H&Q was co-founded by Bill Hambrecht in 1968.)
Converted Loft
To save money, W.R. Hambrecht operates out of a converted loft in an old industrial neighborhood four blocks south of the financial district.
Analysts cover 90 names (expected to increase to 120 over the next few months) in four sectors: technology, healthcare, branded consumer, and specialty finance. The trading desk handles 200 names.
"We want to be the dominant small to midcap investment banking boutique," said head trader Nick James, echoing a common San Francisco refrain. "We have a product that is undercovered due to the demise of the firms or a shift in their emphasis to value or mid-caps."
Hambrecht has six sales traders in the city and is adding two more. Five market makers handle the Nasdaq trades while two listed traders work with two dollar brokers on the floor of the New York.
"We're not going to be your call in DuPont," said head Nasdaq trader Matt Holscher. "But we can generate interesting ideas in names like Peet's Coffee' and Alloy Online'. If you can get an edge or an axe in those stocks, information-wise and trading-wise, you can make a lot of money for clients."
Holscher is a relative veteran at Hambrecht, having been with the firm for about a year and a half. James only just joined in August from Schwab Capital Markets, where he was a sales trader. It is his story that has become familiar.
Pros in this town are in the midst of a high stakes game of musical chairs as firms add and delete staff almost weekly. Sales traders are the most sought after, but market makers are being courted as well.
Employers have the upper hand in salary negotiations because the supply of pros exceeds demand. In the wake of the tech wreck, there is still an army of unemployed financial workers. The entire Nasdaq dealing community was whacked by the collapse of the market of course. But San Francisco was hit especially hard.
Perhaps the most dramatic story in the equity space is that of First Albany. The New York-based brokerage closed its Nasdaq trading desk about 12 months ago when it lured a clutch of traders off of J.P. Morgan Chase's desk in San Francisco.
Most of those traders were originally with H&Q. "You'd have to look pretty hard [within J.P. Morgan Chase] to find the remnants of Hambrecht & Quist," joked a trader from a competing shop. (In San Francisco, J.P. Morgan Chase is down to just sales traders, sources say.)
First Albany reopened its Nasdaq desk at the beginning of 2002 in San Francisco with H&Q vet Tom LaBenz at the helm. Soon, thereafter, it hired Rich Gimigliano, a veteran of Thomas Weisel and legacy firm Montgomery, to run its entire trading operation. Gimigliano is responsible for Nasdaq, listed and sales trading. (Listed trading is run out of New York, ironically by an ex-Robertson Stephens pro from San Francisco, Victor Pugliese.)
An Alternative
"People are looking for a boutique alternative," Gimigliano said. "We've been able to step in and fill the void pretty nicely. Our volume has grown by a factor of ten since the beginning of the year." First Albany has twelve pros on its Nasdaq desk and makes markets in 350 names, according to Gimigliano. Four of its 15 sales traders work out of San Francisco, including the recently hired Phil Johnston from J.P. Morgan Chase.
Gimigliano isn't the only Weisel vet to switch firms this year. Aaron Travis is co-heading a five-man Nasdaq desk at Wells Fargo Securities with Fred Hughes, himself lately of Robertson Stephens. Both traders report to San Francisco vet John Caruana who boarded the Wells Fargo wagon in January.
Caruana is mum as to why a Nasdaq desk of only three braves needs two chiefs, but acknowledges Wells is building up. "With the demise of some of our competitors we have been able to upgrade our personnel substantially without really increasing our overhead," he said. "We've put in a foundation of what we think will be a very special trading desk."
Soon after Caruana joined the firm, he signed a trio of old colleagues from his days at W.R. Hambrecht: Todd Clark, to head up listed trading, and Doug Princiotta and Jeff Phillips, for the Nasdaq desk.
All four had also worked together at the now defunct Volpe Brown Whelan before jumping to W.R. Hambrecht. Prudential Securities bought (and wrecked, some say) that firm in 1999. Most recently, Wells brought in a Robbie Stephens refugee, Mike Perrella, to run sales trading. Perrella joins fellow Robertson trading technology exec Ralston Roberts.
So, what is Wells up to? In 2000, Wells Fargo Bank bought a Utah-based commercial bank called First Security. Buried within First Security was a third-tier San Francisco investment bank called Van Kasper.
The San Francisco financial community questioned whether Wells had enough stomach for the ups and downs of investment banking to grow the renamed Wells Fargo Van Kasper. Unlike many of its peers, it had not bought an investment bank nor showed an inclination to do so.
Sometime last year though Wells decided to reverse course. Wells Fargo Van Kasper became Wells Fargo Securities. The Nasdaq desk ditched its FSVK market maker I.D. for WELS. It now makes markets in 205 names, up from 180 last December.
That's just the net figure. Behind that number is the addition of about 65 names and the subtraction of 40. Wells is clearly a brokerage trying to redefine itself. Signs of its growing pains emerged this spring when its Nasdaq volume soared to twice its average size and then fell back off. No Van Kasper traders remain on the desk.
"Our story is growth stocks," Caruana said, "whether exchange listed or Nasdaq." Growth stocks for Wells means consumers, financial services, healthcare and of course, technology.
Bubble Days
The high-tech biz of Northern California has seen better (or bubble) days of course, but hope apparently springs eternal in the hearts of traders and bankers. Silicon Valley is still very much in the picture for locals as well as those from out of town.
Friedman, Billings, for example, located in the heart of the Northern Virginia tech belt, recently opened a mini investment bank in San Francisco complete with bankers, analysts, sales people and one sales trader.
"The bubble burst, but it's by no means dead," said FBR exec Bob Leahy. "We firmly anticipate a comeback so having a presence near the Valley is important."
FBR is one of the few Wall Street firms thriving these days. Revenues doubled in the first nine months of the year compared to 2001 and losses turned to profits. Investors have taken notice, sending the publicly traded firm's stock up while beating down most of its competitors. "We're doing well so we can afford to buy talent right now," Leahy said. "And, obviously, talent is coming on the Street."
Most of the staffers in the new FBR office are from Robertson Stephens. The sole sales trader, Bill McKenna, is from Genesis Merchant Group Securities.
Asked whether FBR can have as much of an impact as the local players, Leahy said: "We are a local firm. All local players are local. We firmly expect to get our share of the pie. Our objective is to be one of the top three or four players."
Like most trading houses located on either of the two coasts, FBR decided it made sense to situate a sales trader on the opposite coast. It is more cost effective than flying back and forth and closer contact with the buyside creates stronger relationships, says Leahy.
Establishing a sales trading beachhead is typically not what motivates East Coast and Midwest banks to set up camp in Northern California. Most houses go west to build banking relationships with Silicon Valley entrepreneurs and only install sales and trading at a later date.
That is certainly the case with Adams, Harkness and Piper Jaffray. Both have had investment bankers in the Bay area for a few years. Both are just now adding trading. Boston's Adam, Harkness now has two of its 11 sales traders in San Francisco. Keith Conroy joined the firm from ABN AMRO in May after the Dutch player exited U.S. investment banking. Erin Foley joined in July from Deutsche Bank.
The firm is upbeat about the future. "We're seeing some light at the end of the tunnel," said Paul Mazzarella, who is in charge of sales trading at the Boston-based Adams, Harkness. "Some of the stocks in our universe have made some very rapid climbs in the last month or so."
Indeed, the technology-heavy Nasdaq Composite Index recently was up for the year nearly 30 percent at one point. Adams Harkness is also opening an office in New York with two or three sales traders. Interestingly, it has no plans to do so in Chicago. For that matter, neither do most of its growth-oriented competitors.
Although Chicago is probably the third largest money management center in the country, investors there prefer value over growth stocks. New York, Boston and the West Coast in general trade the most growth.
As for the Minneapolis-based Piper, it has maintained banking in both Menlo Park and San Francisco since the late 1990s. It has no equity sales traders in California, but recently hired Robbie Stephens' entire convertible bond desk – 15 pros in all.
The head trader, Tony Cecin, won't divulge the firm's plans for equities but does acknowledge Piper is scouring San Francisco's financial district for a bigger space. It hopes to consolidate two offices in the area and still have room left over to grow.
"We're looking for a lot of floor space," Cecin said. "We think we know all the talented people in the Bay area. We're in various stages of discussion." Cecin, noting the collapse of the Four Horsemen, added: "We see a unique, once-in-a-decade opportunity to establish a dominant presence in San Francisco."
