Tuesday, 16 October 2018

Germany 2007 - Small and imperfectly formed

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ECM activity in Germany is running at its highest level since the market peak of the Neuer Markt days. The focus of international banks is on large transactions, leaving an opening for others to compete with smaller issues. But while volumes are soaring, it remains a challenge to bring Mittlestand firms to market. Owen Wild reports.

The result of record activity in Germany is many banks having to narrow their focus due to the size of the ECM pipeline. This is most common at the top of the market with some of the established banks looking only at larger deals.

"Activity is so high now that it is impossible for all banks to compete for every deal," said Georg Hansel, head of German ECM at Deutsche Bank. "Equally investors cannot give attention to all deals. The result is we are more selective on smaller deals as they will not attract investor focus without a real angle."

This is a significant shift as in 2005 Deutsche Bank had a stranglehold on IPOs, including deals of only €100m. With other international houses also focusing on the larger deals, an opportunity has opened up for smaller houses and newer entrants to compete for deals of up to €200m.

The supply of IPO candidates from the Mittlestand of small and mid-cap companies is stronger than it has been for five years. A contributing factor has been the promotion of the Entry Standard, a junior market in the mould of the LSE's AIM. The market allows companies to list using German GAAP accounting and has limited corporate governance requirements. While many firms easily exceed the minimum requirements, the Entry Standard significantly reduces the cost of listing, which has increased the flow of sub-€100m deals.

The result of greater activity is that many banks are looking at Germany with renewed interest. However, completing deals is not necessarily easy. Strong markets ensure companies can achieve good valuations at IPO, which leads many firms to consider listing when otherwise they might not. The challenge is that some of these companies are not suitable to list, but are keen to do so.

Risky business

This sentiment is underlined by the example of OpenBC which completed its IPO in December 2006 despite having revenues of less than US$10m. The business contacts company was seen as holding great potential, which enabled it to appoint Deutsche Bank and Goldman Sachs are joint bookrunners. However, the decision to come to market in late 2006 rather than wait for the business to grow and prove itself led to Goldman Sachs quitting its position and being replaced by Lehman Brothers. Subsequent comments from bankers that remained involved highlighted Goldman's likely reasons for withdrawal.

“Investors were taking a gamble,” said a banker at the time of the IPO. “Next year this could be worth double or it could go very sour.” Some have since speculated that while the deal priced and completed, it was not fully distributed. The banks did not comment on coverage at the IPO.

The apparent success of OpenBC had both positive and negative connotations for the market. The fact that investors were willing to take a bet was positive for all banks with similarly youthful companies in their pipeline that were yet to prove their concept. However, the suggestion that the deal may not have been fully covered and the loss of a bookrunner highlighted how challenging it is for the small deals to get away.

“Small cap stories are usually more sensitive and tend to require careful positioning - it is almost always easier to complete a €500m deal than one for €50m,” said Achim Schaecker, head of German ECM at Credit Suisse. "Nevertheless we see a substantial pipeline of small cap IPO candidates currently evaluating the feasibility of a listing."

In 2006, 26 IPOs with proceeds of over US$50m were successfully completed, but several deals failed to complete. Four IPOs, each of less than €100m, launched and failed to price in the second half of 2006, though one was subsequently revived at a lower valuation and much smaller size. In each case it was not entirely clear what had caused the deals to fail.

For example, SiC Processing attempted to list in December 2006. The company has a patented recycling process for sawing slurries used in slicing silicon, which ties it to the solar power industry. This link was hoped to have prompted interest as solar companies have been the best performing IPOs in Germany in recent years. A further boost was the success of the Swiss IPO for Meyer Burger a week earlier that ended 8.4 times covered. Meyer Burger makes the saws used in the SiC process. But that success failed to transfer to the IPO for SiC Processing, which was unable to price its IPO following bookbuilding.

The failure of these companies cannot be attributed to one single factor as other deals completed successfully during the same period, unlike the failures during the market trade-off in May and June 2006 that was less discriminating. That said, all the failed deals had one thing in common in addition to their size – they all used the same de-coupled listing structure.

De-coupled debate

The de-coupled process was pioneered by Deutsche Bank and Commerzbank in 2005 for the IPO of Conergy. The structure adjusts and often truncates the usual four-week process to market. A traditional IPO sees two weeks of pre-marketing, followed by two weeks of concurrent management roadshows and bookbuilding. The de-coupled structure sees pre-marketing run as usual, though often it is shortened to a little over a week, followed by the commencement of management roadshows. Bookbuilding and setting a price range does not occur until partway through roadshows when early feedback has been received. This process ensures the best quality feedback from investors by allowing them to meet with management before giving valuation opinions.

Success with Conergy led to widespread adoption of the de-coupled approach. Deutsche Bank proclaimed that the structure would become the standard for its German IPOs and many other banks quickly followed suit. UBS, Commerzbank, Unicredit (HVB), Cazenove, Sal Oppenheim and others have all used the structure on IPOs.

Banks hoped that holding off on valuation until after roadshows begin would help small IPOs by allowing management to explain the company’s story and engage investors in unique stories. This seemed particularly appropriate for firms such as SiC Processing, quartz manufacturer QSIL, telecom billing software company LHS and biotech Biofrontera. Yet in each case the deals failed on their original terms, leading some to reconsider the use of the structure.

“The result of each de-coupled IPO contributes to opinion on the structure much like case law,” said Kay Steffen, head of syndication and corporate broking at DZ BANK. “The first deals were very successful in terms of timing and aftermarket performance, but the market was different then.”

While the process still seems to be en vogue, there are a growing number of bankers who consider the de-coupled method to be short-sighted.

“Analysing the potential merits of the decoupling concept is of interest to almost every issuer but doesn't necessarily lead to better end results," said CS's Schaecker.

Steffen added, “On smaller deals we received feedback from investors that you should have an idea on pricing so decoupling may not be the solution. You can wait and see what feedback is, but that can be seen as weakness or lack of confidence and you could then lose investor attention.”

When the market is busy, it can be a challenge to get international investors to focus on smaller deals. The original argument was that decoupling was positive in this environment due to the shorter bookbuild. This focused attention and the lack of early price range also ensured no investors were turned off too early. However, there is an increasingly convincing argument that this is actually negative for investors.

If investors are short of time, they would prefer to be given price leadership for early evaluation, rather than be asked to provide price leadership to the banks only to have to reassess the valuation on the final range. The decoupled approach requires the investor to assess valuation twice, which is not ideal during a period of high activity.

Yet the structure looks to remain widespread as there is agreement that at worst the process has no impact. So the focus is instead turning to the structure of smaller deals. Ordinarily, heavy selling from existing shareholders at IPO is seen as a negative but increasingly it is being encouraged by banks on small deals to satisfy liquidity demands.

“If a company has a specific need for capital then it is ideal to raise that at IPO, but in some cases that may not lead to a sufficient freefloat,” said Ralf Darpe, head of German ECM at SG. “In that case, investors appreciate if additional shares are sold by major shareholders in the transaction to reach an acceptable liquidity and freefloat level for the stock.”

This was seen on the first IPO of 2007 for HanseYachts, which saw the founder sell a quarter of the shares in the IPO to boost the freefloat to over 30%. The move was welcomed and the deal priced successfully. Another factor may have helped the €66m deal succeed. The leads were MM Warburg and LBBW, banks specialising in smaller IPOs and with the investor contacts to support such a deal. The group of boutique houses that previously were limited to deals of under €50m are increasingly working on deals of up to €150m. Banks such as Commerzbank and Unicredit have seen the competition from Deutsche Bank pass, only to be replaced by the likes of MMW, Viscardi and Equinet (see profile).

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