ECM 2006: Real alternatives
The growth in permanent capital deals has been one of the striking aspects of ECM business in Europe this year. Whether originating from property funds, hedge funds or private equity firms, they were all aiming to tap into demand for higher equity returns and a desire to get access to a new family of underlyings. Mark Baker reports.
Early in 2006, the talk in European equity capital market circles was of the resurgence of traditional IPO business after some fairly lean years. The previous year had seen some notable successes – and disasters – as sellers felt sufficiently brave to test the IPO waters once more, and 2006 was shaping up to provide some welcome diversity in the form of small and mid-cap, high-growth deals.
But it quickly became clear that the striking development of this year’s ECM business would be away from traditional corporate issuance and secondary sell-downs. Looking to tap into investor demand for access products were a whole host of non-standard equity issuers: property funds (often merely blind pools), equity funds backed by ABS, funds of hedge funds, and, perhaps most significantly, private equity firms.
The explosion of this type of investment is already alarming some in the industry. A research report by JPMorgan in early September was not the only example of analysts asking the question whether alternative investments are the next bubble.
Despite being very different vehicles, all of these investments share some aspect of the blurring of public and private equity that has been characteristic of the business this year. They are designed to tap into demand for higher returns than are achievable from standard equity investments and they are intended to give access to underlyings not usually available to traditional funds.
This was the investment case for the most dramatic deal in the sector – the US$5bn IPO on Euronext Amsterdam of KKR Private Equity Investors (KKR PEI), a new listed fund giving public equity investors the opportunity to co-invest in KKR funds. (See separate box story for details.)
“KKR was market-defining and market-closing,” said one ECM head. “We will probably not see another deal like it in our careers.” It defined the market in that it set the benchmark for others but the huge increasing from US$1.5bn to US$5bn sapped much of the demand for similar products.
Market-closing was an exaggeration, given the fact that Apollo brought a US$1.5bn placing of AP Alternative Investments just weeks after KKR. But the later deal – which involved a delayed listing in Amsterdam – was undoubtedly a tougher sell for having to follow KKR. Bankers at the time highlighted the fact that investors are unlikely to switch out of one investment to make way for the next, given the fact that these are long-term plays.
However, despite concerns over the remaining demand in the market, bankers at most major firms said that they are still being contacted by all the significant private equity houses about putting together similar deals, and they do not rule out at least a handful of such transactions coming before the end of 2006.
Over comes the hedge
Funds of hedge funds have also made tentative forays into ECM this year. The US$402m IPO of CMA Global Hedge came in slightly below initial expectations on size, but was still generally considered a success.
Goldman Sachs Dynamic Opportunities Fund followed, raising US$507m, above the initial base size. Both deals were structured with sterling, dollar and euro tranches, although while CMA saw very little demand in sterling, this was where the bulk of the Goldman deal was placed.
Again, the likelihood of a continuing stream of such deals is considered small, since the main investor base is banks’ private client networks, which have now been tapped for substantial sums.
The stream of property companies and funds floating in the first half of the year was also extraordinary, but the most ambitious deals were the structured credit transactions backed by CDOs of ABS. ABS-backed funds give investors access to the yield on the equity tranches of CDOs, which are the first-loss portions of such vehicles and are therefore the highest yielding.
When selling paper that gives access to these structures, bankers have described them as like mortgage REITs but without the real estate. Typically the investors in the equity tranche are fixed-income funds, but issuers have been keen to broaden the investor base – although with very mixed results.
Queen’s Walk Investments, managed by Cheyne Capital and which completed a €406m placing in December 2005, was arguably the most successful of these deals. Other names include Fortress Investments, a REIT, and Cambridge Place Investment Management.
The cancellation of Gulf International Bank’s US$125m Falcon Asset Backed Investments fund in early 2006 was largely attributed to the difficulty in educating a retail investor base that is used to the equity concept to the intricacies of what is essentially a fixed-income structure.
Others that fell by the wayside included Crownstone European Properties, AFI Europe and MV Leveraged Finance.
Their experiences illustrated the problem facing almost all of the “alternative equity” segment of deals seen this year: who will buy? Traditional institutional investors face a tough decision when considering other funds, however interesting the underlying exposure may be, with the result that such deals are often reliant on private client networks of high net worth individuals, or even less sophisticated retail buyers.
“These deals are basically all going to high net worth individuals, they are not institutional trades,” said one syndicate official who has been involved in several transactions in the sector. “The question investors ask is how can I, as a fund manager, give money to someone else to do the job that I should be doing, especially as my clients are paying fees on fees.”
“The other issue for investors is whether they are really getting access to something that they would not otherwise have had access to,” added one head of European ECM. Many observers argue that the private equity funds do achieve this objective, although the question remains about the speed of deployment of funds – and there is still the issue of fees.