Tickets & Markets, Part 1 (On the shoulders of investment banks…)

Why is it that the market for (event) tickets is so dysfunctional? It’s not the first time I’ve written on this subject, and I had promised to revisit it… Over the last couple months a number of (notionally unconnected) events has catalyzed me in to making good that promise. As way of introduction, let me elaborate on my question: efficient organized markets in tickets for events have not been allowed to develop despite the fact that: (a) the existing market structure is horribly inefficient to the detriment of both buyers and sellers and (b) a vastly more efficient, tried and tested, robust market structure which could very easily be applied to ticket markets already exists and furthermore, especially given modern web technology would be easily adaptable to ticket markets.

Let me take each of these points in turn.

For any event, there are a number of roles that need to be fulfilled: the end product (the entertainer(s), sports teams, etc.), the producers (those who contract the end product and organize the production), the venue (real physical property but also broadcasters), the risk takers (those who underwrite the cost of the production and take the financial risk), the distributors and brokers (those who sell the tickets) and the audience (those that purchase the rights to see the event.) For some events these roles are fulfilled independently, for others the roles are sometimes combined (for example a promoter might both produce and underwrite an event) and most often, especially with respect to distribution, there are multiple participants for the same event. If you were to illustrate this process in a flow chart it would look something like this:

And this is typically how tickets are sold and distributed for the first time, in other words the primary market. And strangely enough it looks amazingly similar to how securities (bonds, shares) are sold and distributed in financial markets:

Trillions of pounds (euros, dollars, etc.) of securities have been (mostly) successfully underwriten and distributed over the years using this basic arrangement (or a variety of variations thereon); and the key reasons this framework has developed to help issuers sell securities to investors are basically twofold: (1) to arrive at a price that best achieves the goals of all parties and (2) to optimally allocate risk during the sales process to those best able and willing to accept and manage it.

Price discovery is at the heart of this process, and is driven by the goals of the issuer which almost always include getting the highest price but often qualified by meeting certain other – sometimes competing – objectives such as ensuring a certain distribution profile – perhaps encouraging new investors, or repeat investors, or certain types of investors; or seeking to engender a certain trading performance in the aftermarket – usually a gentle rise but sometimes a more explosive rise to attract publicity for instance; etc. In investment banks charged with underwriting securities, the job of advising the issuer on what price will best achieve their objectives falls to the syndication desk and the syndicate managers who are responsible for collecting, analyzing and synthesizing all the relevant information that goes into determining the optimal price. This includes such things as: investor demand or indications of interest, the size of the proposed offering, potential competing offerings concurrently in the market, general market conditions and prevailing secondary market prices for similar securities.

Let’s take this last point; I think you will find that if you as any banker or syndicate manager what they consider to be the most important factor when looking to start the price discovery process for a new security it will be the prevailing secondary market prices of similar issues. If their exist many true comparables, the market will hone in very quickly on the clearing price for the new issue; when the security being issued is relatively unique (no other issuers or securities in the market with comparable financial metrics and/or in a similar business for example), the early indicative pricing will most likely need to be tested with investors through an iterative feedback process, which in its most structured form is called ‘bookbuilding’. In this process, the underwriting syndicate solicits ‘indications of interest’ from investors, where they are asked how much they would be willing to buy and at what price. (In some instance, particularly in the bond markets, they might also be asked to give feedback on other parameters such as maturity and the size of the issue.) By building up a picture of demand, the underwriters can optimise the match between what investors are looking for and what the issuer wants to achieve.

Starting in 2001, just after I had joined DrKW, we invested heavily in building an online system to manage this process which until then had been managed (if it was at all) by the industry via manual collection and consolidation (in a spreadsheet) of email, (Bloomberg) electronic messages and yes – I’m not making this up – post-it notes brought to the syndicate desk by sales people. Indeed the term bookbuilding comes from the 19th/early 20th century practice of underwriters writing orders by hand into leather-bound ledger books that recorded the distribution of the new securities. So in over 100 years, the industry had only managed to replace the (aesthetically pleasing) leather books with Excel. Despite much resistance – and the fact that DrKW was a relatively modest player in the debt new issues market – within a few years, online bookbuilding became the norm in Europe. In my opinion this was a result of the higher level of competition amongst underwriters in Europe which gives issuers more leverage in the process and the incredible gains in efficiency and transparency enabled by online bookbuilding were quickly understood and appreciated by issuers. Of course anytime you introduce transparency to a process, those embedded in the system, at the heart of the process lose power, and the skills needed to succeed evolve. Historically the syndicate manager was alone in ‘knowing what was going on’ and was ‘indispensable’ and there were many banks and syndicate managers who were loathe to see this paradigm pass. Of course, the advent of e-bookbuilding opened up whole new avenues and possibilities for underwriters and their customers but not seeing the possibilities of change is not unique to investment banking… Interestingly – and perhaps this has evolved since I left the market a year ago – the US debt markets have not adopted these modern methods (and this despite their European businesses being amongst the largest players in European new issue markets, so they can’t say they aren’t familiar with the technologies and the possibilities), due in my opinion to the smaller number (of larger) players on Wall Street. (I didn’t say oligopoly!)

Typically in a bookbuilt issue, all the investors are sold the securities at the same price (a modified dutch auction process) and all distributors are engaged contractually (by their underwriting agreement) to adhere to this price during the primary selling period. In the fixed income markets this innovation (yes until 20 or so years ago this did not exist) is called a ‘fixed-price reoffer’. This gives buyers the incentive to show their best price, knowing that if the securities are sold more cheaply, they will not be paying over the odds. In so doing, the likelihood of achieving the highest clearing price (meeting all the issuers other objectives) is highest.

Thinking about the methodological continuum of issuing securites, if ‘bookbuilding is at one end of this spectrum, at the other extreme we find the ‘auction’ and in the middle the ‘bought deal’. Of course there are many different ways to conduct an auction (the most commonly used in securities markets is the ‘dutch auction’ and variations thereon) but in the context of this continuum I would simply describe an auction as a distribution mechanism where price is the only selection criterea (for buyers) and where the seller shoulders all the pricing risk. This is usually an optimal distribution strategy for an issuer who regularly accesses the market, has securities that are easily priced by the market (due to extensive secondary trading history in similar securities) and has no additional (to achieving the best clearing price) distribution goals. Nobel prizes in economics have been won discussing the different kinds of auctions and optimizing outcomes, so I’ll leave it to you to dive into the literature if you want to learn more. The bought deal on the other hand has the underwriter shoulder all the pricing risk; this is simply where the bank(s) ‘buy’ the deal from the issuer and then subsequently sell it on to investors. The advantage to the issuer is that they have certainty of pricing, but as in an auction give up control of the ultimate distribution of their securities. This form of issuance is generally used by frequent issuers with a well established (and unlikely to change) investor base.

One last element worth highlighting – to round out this whirlwind primer of how securities are priced and distributed in international capital markets – is the ‘grey market’. This is a (contigent) market in the new security traded on a “when and if issued” basis (between parties who are outside the underwriting arrangements.) Grey markets tend to appear and/or trade actively if investors and dealers believe that the likely issuance price is wrong (either too high or too low). When Stanley Ross first introduced the idea of grey markets in when-issued securities 30 years ago, he was met with massive resistance from the underwriting community: after having ruled the roost – “like it or lump it” – for so long, I guess the syndicate managers of the day didn’t like being told, very publicly, that their pricing was wrong. Of course there are times when good reasons exist for a discrepancy between the issue price and the grey market, and smart syndicate managers today know when the divergence is justified and when it signals a flaw in their pricing and distribution strategy. And so grey market trading has become just one more tool in the new issue market’s price discovery toolbox.

To wrap up Part 1, I suggest you draw two conclusions: (1) the international capital markets over the last 30 years or so have developed a very sophisticated and robust methodology and process for pricing and distributing new securites, and (2) many (if not most) of the innovations that led to this state of affairs were vigorously resisted by the existing establishment at the time of their introduction (and this continues today). It is worth noting however that the power of good ideas and the forces of competition allowed these innovations to ultimately prevail. (Moral of the story: you can either ride the wave or stand in front of it and get dashed against the rocks…)

In Part 2, I’ll try to illustrate how I think all this is relevant for markets in tickets for any kind of event.

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