Wednesday, 19 December 2018

IFR IPO Roundtable: Part 2

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IFR: Isn’t it fair to say that the hair on some of the transactions has been obvious earlier on? Everyone went into Ocado with their eyes open, and Pandora took forensic accounting in order to build historical results. So is it always a surprise?

LEACH: The markets tell you they were a surprise. When the markets drop a lot, it is by definition a surprise because otherwise the market would know already.

You have to take risk in investments. Part of our job is to take calculated risks. What we don’t like is when there is something that should have been uncovered by the diligence process that hasn’t been uncovered.

Let’s take some examples. Cadogan didn’t actually have proper ownership of the assets. Or Sino-Forest, outside Europe, where the analyst didn’t actually get on the plane and visit to make sure they had the assets they said they had. These small boutique research outfits like Muddy Waters and Citron work it out within days, so why can‘t the due diligence teams at the investment banks work it out?

BENNETT: Ocado is an example that is relatively close to Fidelity’s heart. We are the largest institutional shareholder in it and we were the largest investor at the time of the IPO. Clearly no one likes a stock price that goes down post-IPO, but we added to our position since the IPO because we believe in the long term story. That is our view, and we have gone out there and done the due diligence on it.

But there is a difference between two investors having opposing views about the correct price for a stock, and a situation where you make an investment and three months later something becomes public which the management have kept quiet, causing the stock to drop 50%.

NACHTIGALL: You are hitting the nail on the head. This debate seems to imply that every IPO trading down is viewed as the bankers doing something wrong. There is no question that in some deals that is the case, where companies have been dressed up as something that they aren’t. But not all deals.

Preparation is key. In the cases where we come on board as advisers, that usually happens over a period 12 to 18 months prior to the IPO, to prepare the company for the process. Sometimes we advise a company not to do a deal.

LAW: To some extent the ECM market has been spoilt by the relatively benign conditions that prevailed in the period leading up to 2007/2008. Some of that old good judgement and the skills associated with managing the early stages of an IPO and anticipating problems have been lost.

At a general level, people might be too focused on running the process, and not enough on figuring out whether that process is actually going to be successful or not.

Consequently, so many deals are being launched which subsequently fail. It is ridiculous that half the deals that are being launched are trading down in price. Something is fundamentally wrong with people’s ability to anticipate or judge the appropriateness of the asset in the market. Or maybe it is mismanagement of expectations around pricing. But all of these problems could be anticipated.

HAMPTON: I suspect in some cases people do not wish to derail a transaction in a difficult market. I am in the real estate and gaming world, so I have red flags around a lot of things that we do before we start. These days you have a hugely competitive bake-off process to start with, contested by a number of very proactive and aggressive investment banks. You know which ones have the best intentions of getting a transaction done, but within that context you invariably have different underwriters who have more experience of the company than others, or maybe a better understanding of certain elements.

It does become very awkward when you are one voice among six in a room that is trying to raise an issue, which can lead to a situation where the only thing you can do is resign. That has public reputational consequences because the market can see it.

IFR: Reinout, you presumably are quite well positioned to see those various views coming back from banks and how candid they are if you are in a multi-bookrunner situation. Do you see people pulling their punches because there are so many other voices in the room and no one wants to be the one saying: “No, no, this is wrong”?

KOOPMANS: Personally I haven’t really experienced that in the transactions that I have worked on. But I can imagine that has happened.

GERBAULET: I agree. I think it is a problem that we see with big bookrunning syndicates. There is a little bit of game theory here. Are you the one who drops out? Are you the one who raises the alarm? If we think about structural changes, one solution is to have a smaller group of working bankers or a working banking group of perhaps two or three banks that take responsibility and cannot hide behind a bigger group.

KOOPMANS: The industry goes through this cycle every three or four years. It tries to introduce competition into the IPO preparation process, before we figure out there is too much competition and the best advice is going out the window amid all the optimism. We did it with the competitive IPOs and we did it a few years ago with the much bigger syndicates, where some of the IPO advisers provided a platform of maximum competition in order to achieve the best price for the issuer. All that breeds advice that is incredibly opportunistic, definitely not the best advice for the issuer. We are seeing it again now in some of these structural issues. It is very important.

IFR: So when you say that the IPO market is broken you mean the process is correct but it isn’t being followed correctly? Is it a question of whether people are taking the right judgements at the right time? This year 19 out of 26 IPOs failed at the end of book building. Clearly it was apparent much earlier on that these deals weren’t going to succeed. Shouldn’t someone have picked up on that?

KOOPMANS: There are two things. One is how the process is run: large syndicates; maximum competition between the banks in order to optimise the advice, but the best advice goes out of the window. But the second component is that investors do not have enough time to analyse the investment case.

If you look which transactions get done, too often the deciding factors are technicalities. The deal is large, or liquid, or optically cheap, rather than it being based on the fundamentals of the investment case. Large liquid deals sell themselves. But there are very few platforms that can sell interesting, exciting stories. We at Jefferies did it with 3Legs. If there is enough time and you have the right franchise then you can distribute a deal like that on the basis of your finances. We need to see more of that back in the IPO process. Building high-quality supportive shareholder bases centred on fundamentals, rather than optics and momentum and sentiment and trading etc.

NACHTIGALL: My impression is that everybody participating in the market is doing “a little bit too much of what they are supposed to be doing”. ECM bankers are supposed to do as many deals as they possibly can, because that makes money for the banks. Bankers/advisers are supposed to position the companies favourably, but within reason, not dressing them up as something that they aren’t. And investors are being paid to get the companies as cheap as they possibly can. It seems to me there is a little bit too much competition between the various constituents. A little bit too much second guessing in the process and trying to optimise at the margin.

This is one of the reasons why trust has broken down. If we all step back and return to the fundamentals of the process – good quality preparation, good quality disclosure, a reasonable, transparent discussion around price, honest feedback on the side of investors that is not designed to push the price down – that would be an improvement. It is not one factor causing the problem, but if all these things happened together, I am sure we could get back to a functioning market where deals get done appropriately.

OAKES: Another element of this is that there is a tension between a very labour intensive process on the one hand and the finite resources on the buyside on the other. Whilst I have not spent time on the buyside, the feedback we get is there is a heavy pipeline in Europe which is particularly focused around accounting windows and holiday periods.

This year in particular, we saw a crunch around April or May. An IPO process that starts with pilot fishing and moves into the two-plus-two is fine with assets that everybody agrees are desirable. But typically you have parallel processes and only a few portfolio managers have the necessary authority and skill to analyse them. So you have a lot of banks forcing a lot of product down a narrow pipe.

That is a big part of why deals are failing at the very last minute. The ECM bankers and other advisers have an incentive to keep the process going in the hope that it will happen. They are only willing to admit defeat when they know for sure it won’t happen.

GERBAULET: I would take that one step further. We discussed before about honesty and candour, and about ECM bankers being a bit cynical. But I want to put the ball back in the investors’ court. I am not a fan of pilot fishing. I understand that investors want to get to know the company early, to learn about the model, the management and strategy. But it doesn’t help us when we go pilot fishing and we get feedback saying, “It is interesting, you can come back again in four weeks and then we see.” That leaves us in the dark.

We need another solution, one where we present you with a company early, so that your sector specialist can get familiar with it, but leaving the question of pricing until later. All this very ambiguous feedback makes it really difficult for us. We approached one fund manager in Spring and he had 25 pilot fishing meetings in one week. The process is too complicated. We need to give investors the opportunity to deliver honest feedback, but sometimes that’s only possible if they’ve been able to properly meet the companies at an earlier stage.

LEACH: Pilot fishing exercises can be very productive. But I am often astonished about how few questions I am asked on a pilot fishing case for an IPO. Bankers should be harassing me, bullying me to give an opinion on valuation, and where I would buy serious amounts of it. But my analysts and portfolio managers get away with some fairly flaky feedback.

Having set the company on the road, bankers should be pinning investors down, incentivising them to give you the answers you want. You could tell them that if they give you the proper information then you will make them an anchor investor. If they can’t give you that, don’t invite them on the next pilot fishing exercise, because it is not productive.

BENNETT: I will come to pilot fishing in a second, but I just wanted to pick up on the syndicate sizes. From the investors’ perspective these large syndicates are absolutely counterproductive. Large syndicates lead to a bombardment of investigation meetings, with different people phoning and constantly looking for feedback. There is little coordination; the priority seems to be to get feedback regardless of who it comes from. It seems to be almost irrelevant what the feedback says, as long as they get it, and that is very counterproductive. It undermines the ability of the investment banks to give good advice.

What happens is you have, say, six joint bookrunners, with a week in the UK, seeing all the major international investors. You have 30 odd meetings, divided up with each bank seeing five investors. They are the ones you are responsible for, and you can’t get proper feedback from the others because you didn’t organise their meeting. How can you come to a view about where a company should be pricing its IPO after five meetings in the UK? You can’t.

The whole process hits a lowest common denominator. Banks don’t earn the right fees on the transaction, so they put lower quality individuals on the deal, or fewer people on the deal. Sales teams aren’t focused on the deal because they have got five other bookrunners working on it. If they are only working with one joint bookrunner on another deal, they end up focusing on that.

This is absolutely something that the issuers can resolve. Investors can’t resolve it. No one ever asks us because we are part of the deal. And that leads us onto the understanding of the business and the pilot fishing.

I spent 14 years on the sellside, so I have been where you are. But ever since I have been at Fidelity I have been stressing the importance of seeing companies early. We are not talking about a pilot fishing meeting two weeks ahead. We want to see these companies, to build relationships with them. Part of the reason companies in an IPO come at a discount to listed peers is that lack of track record, that lack of relationship with the company; the management; the business model. We are not looking for the management accounts 18 months in advance or a detailed financial – we want to know the individuals who are running that business.

We want to know the business model and we want to be able to follow it and work with it.

The biggest investments we have made in the last 12 months in IPOs have been in situations that we have been very, very close to for 12 to 18 months. Those are the deals where we anchored the transaction.

I find it encouraging that in the last 12 months the language coming out from the investment banks has definitely changed towards more early meetings, that is a noticeable change. But we have got to keep pushing on it and pushing the issuers and pushing the companies to start having those meetings.

The pilot fishing meeting two weeks in advance is better than no meeting. At least it gives us two chances to meet the company. But it is only just better than no meeting. Frankly, you turn up with a presentation – which we are not allowed to keep – so we try to digest it, we look at some vague financials and try to listen to the management talking to us and think of intelligent questions. Then you take the presentation away and walk out the door. Then you ask us what we think. Under those circumstances it is hard to have a clear view.

I slightly disagree with Rob here, in terms of pinning down for feedback on valuation. How can we come up with a valuation when you have taken all the numbers away from us? In terms of our investment process, valuation is almost the last thing we come to. We need to understand the company and the model and the business and the competitors. Where it stands, how its markets work. Only then can you have a view on valuation.

I also want to answer the point about investors low-balling whenever we give feedback. As if we have a figure in mind but then take 25% off just for fun. At Fidelity we have done a lot of pilot fishing meetings and we always give feedback and we try to give the best quality feedback we possibly can, given the limitations we have been put under. The feedback I give on valuation is our honest assessment of where we think that business would be of interest to us, but I am not going to give you an order that early.

But I do sometimes wonder how such a gap arose between what we think and what the company has come out with. Maybe the research analysts might be somewhat ambitious, but the gap between that and the price range the company comes out with can be significant, and it is not because we go out there and low ball.

To view the Digital Edition version of this Roundtable please click here.

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