Tuesday, 16 October 2018

IFR European ECM Roundtable: Part 1

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IFR: The equity market has changed a lot in a year. The S&P is up 22%; the FTSE 100 is up 13%; the FTSE 250 up 27.5%. Looking around the rest of Europe, the rise is 19% in Switzerland, 19% in Italy, 23%in Spain to name a few. We have seen record inflows into European equity funds in the third quarter.

Perfect timing for equity issuance. It couldn’t be easier. Is that correct, Craig?


Craig Coben, Bank of America Merrill Lynch:The market is as open now as it has been for at least five years. A lot of deals are getting done that many of us hadn’t thought were possible.

But one of the consequences of this rally is that the discussions banks have with issuers about valuations quickly become obsolete, with valuations racing ahead as multiples have expanded. A particular challenge we face is ensuring our views are updated in real time so we don’t leave money on the table for our issuer and vendor clients.


Jens Voss, Commerzbank: I agree with that statement. We do see potential for more IPOs coming in the future, given the market environment and where valuations are heading. IPO discounts are heading back towards what we have been traditionally used to. But on the downside there remain macroeconomic concerns. There has been much talk about Fed tapering, for example, which could be harmful to the overall business going forward.


Reinout Koopmans, Jefferies: Absolutely right. If you look at what’s happening in terms of valuations, the IPO product in itself has become hugely competitive, relative to private equity. That’s obviously visible in the IPO volumes we see coming to market.

Equally interesting are the deals we’re not seeing: M&A-related financings. M&A volumes clearly still have some way to go, it has not been the source of equity business we have been used to in the past. But that is another point. Public market valuations are, in terms of multiples, high, discouraging some corporate executives to go down the M&A route.

At the moment, absolutely, global markets are very competitive in terms of the valuations and that’s been reflected in terms of the IPOs.


Luis Vaz-Pinto, Societe Generale: This time last year there had only been one US$1bn-plus IPO done in Europe, which was [Dutch cable company] Ziggo. Direct Line happened a bit later. I think we were at the worst possible point.

Clearly there has been a step change, not just in terms of volumes, but to use an old expression, in terms of the ‘risk on’. When you look at the composition of the deals you are struck by the appetite for markets which were previously seen as being unsellable.

When you listed the markets earlier you missed out the best performing market in Europe this year: Greece, which is up 32%. Ireland is up 29% and Spain is up 23% [as of Oct 21]. When you compare those figures to the FTSE and the DAX, clearly there’s a huge renewal of optimism. People want to buy into the periphery. 

Equity-linked issuance displays some interesting trends. Last year 40% of issuance came from Germany. This year about a third of it is from Spain, Greece and Portugal. There is a huge appetite for trickier stories which a year ago we would have found very difficult to sell.


Konstantin Dombrowski, SIX Swiss Exchange: We have noticed that, especially in trading volumes returning to the exchange. Last year was horrible for the exchanges. We haven’t seen a massive recovery but volumes on the blue-chip side are up 20%.

Interestingly the SME community has benefited from this and is returning to the market. Small and mid-cap trading volumes are up 22%. There has been plenty of debate about the opportunities for SMEs versus blue chips, but trading liquidity is absolutely there for SMEs as much as it is for blue chips.

In terms of primary markets I agree with Luis. Last year we had the window opening up in the first quarter with Ziggo and [Swiss outsourcing group] DKSH jumping in. Then the window closed for around half a year. This year the window has been open continuously, all year, excluding a little nervousness following the Fed announcements.


Jens Voss, Commerzbank: The numbers you just mentioned, do they represent the growth of trading – are they adjusted for the absolute share price development?


Konstantin Dombrowski, SIX Swiss Exchange: They are the trading volumes as we take them, the number of trades times the price. So yes, part of the rise is due to that price recovery.


IFR: A big theme of the second half of last year, which has carried through into this year, has been the reallocation of money from the US to Europe. That presumably

can’t carry on forever. Also the great rotation from bonds into equities hasn’t panned out quite as we hoped. So are we enjoying a windfall at the moment that will inevitably taper off?


Craig Coben, Bank of America Merrill Lynch: The issue in Europe, and generally, is that the rally has been primarily driven by multiple expansion as the economic recovery has started to take hold. It has not been driven by higher earnings. In fact third-quarter numbers have been relatively disappointing.

The question is, at what point will the market stop waiting for the earnings to materialise? As long as tapering is off the table investors don’t have any choice but to crowd into equities. Once that runs its course, if we haven‘t seen a recovery in earnings, a lot of stocks are going to look quite overpriced. But that’s probably a problem for next year.


Reinout Koopmans, Jefferies: The first wave of this year’s money mainly benefited UK equities. That subsequently shifted into continental equities, which are currently enjoying a lot of that inflow. That will continue for some time, no question.

The structural benefit of having US money back in Europe is the healthy competition it creates among local investors, in terms of price tension, when you want to get deals done. Maybe the flow of US money into European markets won‘t last forever, but it’s clear that US investors are here to stay and will remain a permanent feature of European deals.

In the past that lack of price tension in deals was a real disadvantage. We all know where that ended in 2010 and 2011.


Luis Vaz-Pinto, Societe Generale: A year ago the relative valuations between America and Europe were trading at a 40-year low, with Europe offering a higher yield. So we have a long way to go but there are fundamentals in play. Our analysis is the same as Craig’s, the corporate reporting season has been pretty weak so at some stage there will be a crunch there.

What is going to help us, and by us I mean EMEA, is that emerging markets have lost a lot of their shine, meaning that on a relative basis there are fewer places to go. Europe is benefiting from that, but the pressure is on to put its economic house in order because that will not last forever.


Jens Voss, Commerzbank: It doesn‘t even need to be a great rotation. Even a relatively small number of fixed-income investors switching into this market has made a notable impact because the bond market is so much


IFR: Let’s talk about the IPO market specifically because it’s been rather healthy so far this year. What have the key messages been so far? Last year it had to be yield, is that message changing? Is it easier tosell growth now? What do investors want?


Reinout Koopmans, Jefferies: Investors want exposure to economic recovery, particularly when it’s consumer-led. But investors have been very clear they want more than that, as evidenced by some of the defensive features you can get.

If the economic recovery takes one, two or three quarters longer than expected, investors still want to make a return on that. The most successful IPOs have been those with defensive features – either from yield or from structural growth, market share gains or underlying secular growth – independent of the economic recovery. These features ensure there’s still an attractive return to be earned on these stocks if the recovery comes later than expected.


Luis Vaz-Pinto, Societe Generale: Look at the numbers. Take all primary IPOs. In the third quarter we are at US$2bn, running at three times the volumes that we were last year, so clearly there is traction for that.


Craig Coben, Bank of America Merrill Lynch: Everything is working right now, be it growth, yield, emerging markets, developed markets, everything. Investors have made money on most IPOs – as long as that continues you’ll see healthy demand.

The question is at what point the pricing on IPOs gets adjusted for the new reality? That will make the upside a lot more limited for investors.


IFR: People who come to market now made their decision to proceed some time ago when valuations were lower. Anything extra they get is a bonus, so are sellers less focused on squeezing out every last cent at pricing?


Craig Coben, Bank of America Merrill Lynch: That’s the danger of some of the pilot fishing that all the banks now carry out well in advance of an IPO. We meet investors well in advance, which is good because it allows them to familiarise themselves with the company. But valuation discussions risk being crystallised too early. When the market jumps by 10% or 20% in the span of a couple of months, that valuation discussion is made redundant.

We would benefit from a rethink about how we approach IPOs. Conventional wisdom says marketing should be conducted early and often, but like a lot of conventional wisdom, it’s often long on convention and short on wisdom. We need to think very carefully when we’re pilot fishing. We want to introduce companies but not allow those investors meeting the companies to drive pricing.


Reinout Koopmans, Jefferies: I’m more cautious than Craig. We have seen a couple of IPOs being pulled recently. There is certainly a lot of focus among buyers on liquidity and deal size. Some smaller deals are getting done but it certainly affects pricing. Liquidity is a very important component still in these markets.

The natural resources sector, both mining and gas, remains more challenging than some of the consumer-led sectors. There are some situations where deals get done very successfully and there’s plenty of support in the market, and others where the market is more cautious.


Luis Vaz-Pinto, Societe Generale: When you reopen the market the top-tier companies have an advantage. Everybody’s very cautious, everyone wants to double and triple check everything, talk to investors, and that favours the blue-chips.

But as things pick up you get to the stage where it seems like every deal can get done, which entices the lower quality names and those less appropriate for the current market conditions.

I think there are other waves which we’ve also seen. Financial sponsors this year represent around 20% of market volumes in EMEA. That’s the highest ever.

Clearly they’re a very agile bunch. They’ve jumped into the markets and started divesting their companies because they need cash for their new funds, they needed companies with good valuations to entice investors. We’re now starting to see other constituencies, such as governments, come in and do successful privatisations.

Then there are the corporates, which will also change the nature of the market in terms of what’s coming through and in terms of what does and does not get done.


IFR: Liquidity is clearly an issue. There have been a number of deals where early excitement has proved misplaced. The leads were initially very excited about the IPO of Swiss high-end property firm Ledermann, which was seen as a really safe play and only US$140m, but liquidity became an issue. Then you have Cembra Money Bank, that is US$1bn – same exchange but a different sector, and it cleared easily [the deal was still bookbuilding but covered at the time of the roundtable].


Konstantin Dombrowski, SIX Swiss Exchange: It is indeed. Cembra Money Bank, I think the first covered message came out of the first day of roadshows in Switzerland. It was completely covered by Swiss accounts on the first day of bookbuilding, and demand grew as the roadshow continued. There was significant demand coming out of the US as well.

Ledermann just didn’t take off at all. Deals around the US$100m mark – and Ledermann was closer to US$140m – don’t have such long legs. Earlier on I said liquidity is returning to the SME space – that was in terms of trading volumes. In terms of raising fresh capital and primary market issuance, SMEs could use a little bit of help.

This is something we have thought about a lot at the exchange, how we as a market, as regulators, as exchanges, as primary market participants, can incentivise investors to do more on the SME side. Ultimately it’s all investor driven. But does it need governmental incentives? Does it need governmental money as an anchor, to kick off those smaller deals?


IFR: It’s tough because with IPOs all of the volume comes right at the start. Each day volume can fall by 50%, if not quicker to the point where by the end of the first week you’ve got no chance to build any position. That’s a dramatic pattern but it hasn‘t really changed much over time for IPOs, has it?


Konstantin Dombrowski, SIX Swiss Exchange: No, it’s still a US account story. If half of your book is US accounts and then you’ve got another 25% coming from the UK, that story certainly hasn’t changed. IPOs just follow the money. You guys will know more about this than I do but US investors still seem to be shifting into passive strategies.

Passive strategies tend to encourage big issuers because its the big issuers that get into the indices. All those Blackrock’s out there, they’re launching big ETFs on big indices with big constituents. This whole drive towards passive strategies encourages more money to be invested into bigger names and withdraws liquidity for smaller issues.


IFR: Italian notebook maker Moleskine seems a good example of the difficulty with smaller issues. Its €245m IPO was very well supported through bookbuilding but the shares then drifted down because it was so small and tightly allocated to long accounts. When there was some selling there didn’t seem to be anyone there to hoover the stock up.


Craig Coben, Bank of America Merrill Lynch: You’re seeing consolidation in the asset management industry. There are net inflows, but the bulk of that is going to a relatively small number of accounts, typically global, some of which are US based. They tend to dominate and predominate in transactions.

Five or 10 years ago, when we did an IPO for a UK company, the UK long-only managers were vital. Today they‘re still an important constituency, but they’re not the core constituency. The core constituencies are US or UK based global funds, hedge funds and long-only funds.

The winners are winning more and the stragglers are falling further and further behind. It‘s a much more difficult market for the small cap IPOs than it was before.


Reinout Koopmans, Jefferies: There’s also the fact that syndicates ultimately market deals to larger accounts. Compare the size of the typical investor at the time of an IPO with those holding the paper six to 12 months later. In the latter, around half of the investors will be managers with less than US$25bn in assets under management. At the time of the IPO that percentage is significantly lower.

I agree there’s consolidation happening on the buyside, but there’s also a huge shift that’s happened over many years where the focus is increasingly on the top 100 global accounts, at the expense of the rest. Marketing deals more broadly can be very, very supportive in the aftermarket.

We’ve done analysis where you compare deals with syndicates that have only bulge bracket banks to syndicates that have a regional bank or sector bank on it. It’s clear that the aftermarket performance is better when there’s a smaller bank than when the syndicate only has bulge bracket banks on the ticket. Not necessarily on day one or day two, but in the medium term there are benefits of broader distribution.


IFR: A couple of years ago getting any IPO over the line was incredibly tough and huge numbers of accounts started being zeroed because the most important accounts were the ones that would stay, and aftermarkets were so challenging. That may have led to concentration, but at least things tended to trade slightly better.

Do you feel that if an investor has spent that much time with you, six months or a year before the deal even launched, they deserve a reward for that in terms of a better allocation? They should also know the company better but it does lead to a very concentrated book.


Reinout Koopmans, Jefferies: There’s no reason that pilot fishing should be focused on the top 100 accounts globally. There’s no reason that you cannot do perfect pilot fishing with smaller buyside accounts.


Craig Coben, Bank of America Merrill Lynch: If you have a big IPO and you’re pilot fishing to small accounts you’re wasting management’s time.


IFR: Isn‘t it also a question of resources? If you’re pilot fishing numerous deals happening at varying times in the future, that’s a significant resource requirement, even before you get down past the 20 or 30 most important people.


Reinout Koopmans, Jefferies: In the IPO marketing process, just to focus on that, how many accounts does management ultimately interact with? That can be very significant. You can actually reach a fairly broad universe of investors.

The allocations go to the biggest names partly because they have done the work, and also because there are relationships there between investors and syndicate banks. There is a quid pro quo. There is definitely more going on than purely, ‘let’s get the best long term shareholder structure for the issuer‘.


Konstantin Dombrowski, SIX Swiss Exchange: Is it actually the result of this whole accelerated bookbuilding culture moving into the IPO process? We see accelerated bookbuilding on the rights issues, we saw it on the block trades. Is it now moving towards the IPO process to reduce the market exposure, to cut down the market risk?


Jens Voss, Commerzbank: It’s not truly accelerated bookbuilding, but of course there is a tendency towards shorter IPO risk periods. Of course you see the type of accelerated IPOs, all the pilot fishing is done on the back of that. I agree with Craig: you want big orders so you focus on the bigger investors. You want some benchmark demand there on the book.

At the same time, when you look at why deals struggled in the past, usually it was down to the macroeconomic concerns of banks during the bookbuilding period. There is a tendency to get shorter term risk towards the market. Nevertheless you will always have to take the exposure, you can‘t hold it for mere days.

But you can‘t forget about the aftermarket performance, you need liquidity to ensure the asset trades in the aftermarket.

You saw that to a certain extent on the Evonik IPO, that was done basically as a back door IPO to a selected number of investors. But in the aftermarket the liquidity suffers, compared to a widely spread IPO.


Reinout Koopmans, Jefferies: I‘m surprised you still call it an IPO.


Jens Voss, Commerzbank: It was an IPO that looked like a private placement.


Craig Coben, Bank of America Merrill Lynch: The process of corner-stoning has to be carefully handled. If you focus on too few names you risk limited liquidity, and also run the risk of having those cornerstones or anchors driving the pricing. You actually end up losing pricing leverage when all you’re trying to do is just de-risk the IPO.

That being said, I think it’s a waste of management’s time to pilot fish a billion-dollar IPO to an investor that can’t put in an order for €10m. That’s just a waste of everyone’s time. You do need to prioritise, that’s a fact of ECM and a fact of life. Somehow you have to get the balance right.

Right now most IPOs are trading well, whether that is by luck or design, who can say? Most IPOs are trading fairly well and the aftermarket performance suggests allocations have been done more or less correctly.

In the future we have to think again about how to get the right balance between the desire to take away the market risk and the desire to ensure an asset trades properly, with reasonable price discovery. We’re still having to adjust that on an ongoing basis because the market has developed in a way that most people did not expect.


IFR: How difficult is it to keep up when you’re giving feedback to issuers? You don’t want to overpromise but if the market is moving at the same time as you’re making those steps towards a transaction, how do you avoid leaving too much on the table?


Luis Vaz-Pinto, Societe Generale: Most pricing is not done on an absolute basis, it’s done on a relative basis. Once you establish what the comps are, those comps trade at a particular level and that’s what you’re shooting for. If the market is moving, the comps are moving so you’re not actually leaving money on the table. Yes those comps can move quickly and significantly, but it’s never you’re a billion dollar company and that’s a fixed number, you are going to be seven times Ebitda or 15 times Ebitda because that’s where your closest comp is trading. So, I don’t find that to be a problem.

I would like to come back to the allocation question. You can tell the old syndicate people here around the table. I do think that a deal that trades well is a deal that’s been allocated well.

I agree with Craig about de-risking versus leaving money on the table. That’s why when you look at cornerstone tranches, if you would call them that, they’ve been generally 20%–30% because that provides the good equilibrium.

Cash equity franchises are a very expensive machine to keep oiled. We have seen very significant cutbacks across the industry generally, which is a problem for bankers and a problem for clients. We have one particular case where there was a list of accounts who had supposedly been talked to, and who were reportedly negative about a deal, but when we called up ourselves we found the wrong people had been talked to.

That’s what you get when the cash equity franchises are under pressure, as they have been.

You have to make sure you use the right banks in the right way to maximise investor demand, as opposed to just relying on a few people with the bandwidth, credibility and the analytical skills to put in orders. But you want to make sure that you’re diversifying demand, also by the way between institutional and retail, to make sure you get the best pricing outcome for the client.

Private clients also play a big role in terms of investor appetite, sometimes for the smaller deals. We actually do a lot of small cap IPOs in France and a lot of it gets distributed to private banking retail. People love them. It’s price insensitive and they go on and trade very well. But that’s just finding the right way to maximise your distribution franchise so you get the best outcome for the client.


IFR: We probably shouldn’t complain about the success of pilot fishing. It’s a relatively new phenomenon and has been adopted seemingly successfully.


Luis Vaz-Pinto, Societe Generale: We shouldn’t complain about pilot fishing because it’s been done in the right way in Europe. In Asia it’s sometimes been done in the wrong way. The wrong people have taken stakes in companies for the wrong reasons. You can see that in the aftermarket. In Europe the right investors have been used as cornerstones.


IFR: Europe has been more informal too, without the lock-ups. The restrictions that are placed on cornerstones in Asia shrinks the IPO market dramatically and undermines liquidity.


Luis Vaz-Pinto, Societe Generale: Correct. That’s what I meant when I talked about keeping the cornerstone tranche relatively small, not overwhelming the deal, as sometimes happens in Asia.


Craig Coben, Bank of America Merrill Lynch: You want markets to offer an even playing field. When you start creating these formal cornerstone tranches it starts looking more like an insider’s market. That’s one reason why some Asian IPOs have had a mixed reception.


Konstantin Dombrowski, SIX Swiss Exchange: Should regulators step in and issue some sort of requirement stipulating how much cornerstones should be used, and what allocation they should get?


Reinout Koopmans, Jefferies: That’s a dangerous area, simply because of the potential impact on smaller illiquid deals. On the secondary side we see examples where creating a club is essential to get those deals over the line. There is a discussion to be had for large liquid deals, but if regulators interfere with allocations it will undermine the smaller deals, they need flexibility.

Where secondary deals are very illiquid we tend to do these wall-crossed follow-on offerings where we wall cross 10, 20, 30, 40, 50 accounts in order to get the deal done on a confidential basis, rather than have the market exposure and the deal doesn‘t get done – which has significant implications. If that is restricted it won‘t stimulate or make access to the market easier for these less liquid names.


Jens Voss, Commerzbank: And it would prevent strategic investors coming in or being willing to take a bigger block. It wouldn‘t only have an impact on IPOs but particularly large secondary placements. There should always be the freedom and flexibility to bring in one big investor if strategic concerns or considerations require it.


Craig Coben, Bank of America Merrill Lynch: Regulation already covers this. If you’re above a certain level you have a declarable stake, so it is hard to see the advantage of going further than that. You also have free-float requirements on the different exchanges which should cover any concerns around liquidity. I don’t think it’s a problem.

But when we’re doing follow-on offerings the regulator is taking a lot of interest in wall-crossings. Whilst a limited number of investors being wall-crossed is still permissible, banks find it difficult if for example they wall-cross 50 people. My compliance department would probably have a few questions about that.


To continue reading this roundtable, click the relevant section. Introduction - Participants - Part 1 - Part 2 - Part 3


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