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Tuesday, 12 December 2017

1987: £7.2bn BP privatisation: the deal that defied Black Monday

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Living up to your commitments - For some, memories of the Thatcherite 1980s are dominated by football hooliganism, the cavernous North-South divide and the ascent of Welsh miners to the surface and straight on to the dole queue.

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For some, memories of the Thatcherite 1980s are dominated by football hooliganism, the cavernous North-South divide and the ascent of Welsh miners to the surface and straight on to the dole queue.

Among Thatcher’s many champions – more for economic achievements than social – are students of the equity capital markets for it was through her privatisation programme that global ECM took on its current form.

“The British privatisations really set the stage for the globalisation of the equity markets,” said Eric Dobkin, founder of the ECM group at Goldman Sachs and acknowledged as the father of modern ECM. “They occurred in the immediate aftermath of ‘Big Bang’ in the UK, at a time when investors were starting to pursue more global equity investment strategies.”

The UK government’s sales repeatedly broke records for the largest equity transactions ever, forcing the internationalisation of ECM and the development of new issuance structures. This provided a way in for US investment banks that could offer access to capital across the Atlantic.

Each trade was a benchmark in its time – Britoil’s £627m IPO that went largely unsold in 1982, the £3.9bn float of British Telecom that nearly doubled on its debut in 1984, and the £4.3bn British Gas float in 1986, which came complete with a £28m-plus ad campaign.

But it was an external factor – Black Monday – that made the £7.2bn selldown in British Petroleum the defining deal of its time.

Voters – more specifically taxpayers – were a focus of all privatisations, so deals were highly publicised, slow-moving and priced well in advance. It was in March 1987 when the planned £7.2bn BP follow-on was announced – but the deal wasn’t due to close until October.

As usual, pricing was set upfront to give retail investors certainty, but because BP was already listed, underwriters had to guarantee pricing for two weeks. They couldn’t have picked a worse time.

“By malign coincidence, the world’s largest ever share sale collided with the world’s most dramatic stock-market crash,” wrote Nigel Lawson, then the UK’s Chancellor of the Exchequer, in his memoirs.

The government was not looking to give shares away, so, with underwriters and sub-underwriters already signed up, pricing was set at 330p per share on October 14 versus a trading level of around 350p.

Then Black Monday hit. That day, October 19, saw the worst ever single-day drop in both London and New York stock indices. Over October 19–20 London markets fell by more than 20%, leaving underwriters staring at heavy losses – with the ongoing BP trade the biggest contributor.

By October 27, BP was trading at 262p, versus the 330p offer price. Fees of just 18bp did little to cushion the blow.

For UK banks and brokers the pain was bearable as the process of sub-underwriting meant the risk was shared among more than 400 firms. Size and BP’s desire to increase North American representation on its shareholder register, however, meant the US and Canadian allocations were substantial and held entirely by the lead banks.

Goldman Sachs, Salomon Brothers, Morgan Stanley and Shearson Lehman Brothers as US underwriters were on the hook for 22% of the deal. The prized mandate of sole lead in Canada went to Wood Gundy, which went out of business as a result.

Bankers met at Rothschild’s offices on Friday, October 23 and discussed triggering the force majeure clause but could not reach agreement. Back at Rothschild’s after the weekend the view had hardened and UK banks – foreign firms were present but had no vote – sought to exercise the clause.

The move was rejected, but the Bank of England did offer to buy partly-paid stock at 70p (versus the 120p initial payment) to avoid the apocalyptic events outlined by US underwriters – which cited an inability to place BP shares in the market at any price, heavy selling by now overweight sub-underwriters, and an open door for a hostile buyer.

In retrospect, those on the deal recognise it was the right move as the government had to consider its whole programme of sales and hold banks to their promises, or what Lawson called his “insurance policy”.

Richard Gnodde, now co-chief executive of Goldman Sachs International, had just joined the firm as an analyst: “It was my first lesson in risk management,” he said. “When we underwrote BP we didn’t expect the market crash, but we made clear we would stick to our commitments. You can only do that if it is a risk you can deal with. Today, when taking on new commitments you use the depth of experience that you have to hand, such as the likes of Eric Dobkin, who still sits on our commitment committee.”

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