IFR: Sometimes it can be very clear from the pre-marketing what price an issuer is aiming for, and there is no room for negotiation. How much of an impact does that have on your engagement in the process?
OAKES: And to what extent will you be happy to be an anchor investor in that situation, knowing that the top end of a range may include an ambitious element?
LEACH: Clearly more companies are focused on selling their IPO at fair value than at a discount to fair value than in the past few years. We want that discount because that is where we make a return for our investors. That used to be well understood but it has been lost.
This came up at the start of the year in one well-known situation. We pilot fished several weeks before, we actually had an analyst that used to cover the stock when it was previously listed, so we knew the company well. But the bank involved was not happy with our feedback and valuation. They wanted me to see the company again, they thought I would come to their way of thinking on valuation. So they came in to see me, and I had the same opinion. Speaking afterwards with other investors, everyone was in the same ballpark. Then a range went out which was 10% or 20% above where the feedback was. They were shooting themselves in the foot. If you give 10% away at your IPO and then you do a small issue, you make most of your money back and you have a good shareholder base.
But there are also great issuers, like Brenntag, Kabel Deutschland and Amadeus. There are some good examples of people doing things properly with high-quality companies. They should be the benchmark of how we do these things.
BENNETT: Rob hit the nail on the head. The bankers don’t seem to realise that we sell stocks at fair value. We don’t buy there. That is fundamental…
LEACH: It is our duty to fundholders and investors.
BENNETT: …I can understand why an issuer wants to sell at fair value, but you just can’t expect us to buy it.
NACHTIGALL: Investment bankers understand that. But the debate is what is fair value? What is the right peer group? How much premium or discount? This should be a healthy debate.
I have no doubts that an institution like Fidelity is not low-balling, and is giving honest feedback. But when I look at the feedback we get on transactions, it is not uncommon that we see gaps of 30% to 40% between the lower and higher feedback. So clearly somebody in that panel is low-balling. So it falls to the bankers to establish who means what he says.
As advisers, we push investment banks very hard on quality feedback. We sometimes get pre-marketing or roadshow feedback saying: “Likes the story, is still doing the work.” What does that mean? It doesn’t mean anything to me. It means probably that a sales person has picked up the phone and spoken to the investor and the investor has said “I haven’t made up my mind yet,” and put the phone back down. So we need to go back and push for real feedback.
BENNETT: But that is a fair response. They may not have made up their mind.
LAW: Feedback, process and valuation are to some extent at the core of the debate. The best way to look at the IPO is as a transition of ownership from private to public markets, when the IPO occurs the seller is going to be a larger shareholder than pretty much anyone else in the book. That is how people should think about it. When monetising an asset through the public market, ultimately the seller makes their profit on the investment on their last sale, not on the IPO. Unfortunately not everyone has that mentality when they come into the public market.
As KKR, we spend so much time with our portfolio companies. We spend years preparing and developing them, working with them to optimise their strategy, to create value around the assets. We know the asset itself extremely well. We will always have a different view on value versus the public market, and that is a function of us having spent time nurturing these investments throughout our period of ownership.
The pitching process for IPOs does little to manage issuer expectations around what value can be achieved. Issuers probably make the mistake of choosing banks that suggest the business is fantastic and imply the highest value. A bit like selling a house, you tend to go to the estate agent who tells you they think they can get the best price, versus a lower price. That pitch process has become incredibly competitive and very intensive, and valuation is a massive focus – rightly or wrongly. It crystallises the issuer’s view of what the valuation is. During the next three or four months preparation, not much is done to manage those expectations.
So there is frustration amongst investors that feel they are not being listened to, and frustration amongst issuers that they are not being told the reality around valuation until the eleventh hour – not even necessarily at the time of price range setting but at the time of final pricing. So then the question is how do you manage that process? The solution is talking directly with investors, which gives you an accurate view of what is going on, which then can be triangulated against what you are hearing from the banks. But most issuers just aren’t set up to do that and have to rely on the banks.
IFR: In terms of meeting the companies, is there a difficulty if the seller is a sponsor and the IPO is just one of the exit options?
LEACH: We are willing to make the investment if the IPO is a credible option.
BENNETT: With most sponsor owned assets you tend to have a pretty good idea whether an IPO is a likely exit route. Those are the opportunities where we are pleased to have a meeting. If ultimately they go with the M&A route, either through a trade or a secondary sponsor buy out, then so be it, it has not been a waste of time. At least we found out valuable information about the market place, and have gained some understanding.
LEACH: We rarely waste time talking to a big issuer company about their business.
LAW: Meeting investors always gives us very interesting insight and feedback.
GERBAULET: On the other hand, the sponsor – when doing a dual-track sale – also drives the prices up by putting pressure on the bankers and then also on the investors. I can understand why you are doing dual-tracks, because it gives you more options. That is absolutely rational. But if you compare a trade sale to an IPO, you have to bear in mind that with an IPO you buy an option to have several sell downs at higher prices.
The pressure is often quite high on us ECM bankers to achieve the IPO price at a trade sale price, so not factoring in this option. It isn’t always the bank pushing up the prices, but the sponsor comparing exit routes that, from a structural point of view, you can’t compare. Issuers have to understand that with an IPO you may have to price it lower, also because there is no control premium that you have with a trade sale, but then it trades up nicely and you do a sell down later on at a higher price. You saw that with KDG and Brenntag, which are very positive examples.
LAW: It is not the banks that are ultimately determining the price of the assets, it is the investors.
KOOPMANS: But it is still important. It is a price negotiation. It is worth emphasising that at least two-thirds or even three-quarters of the feedback indicates the low end of the price range. But when it comes to pricing I am essentially negotiating the price on your behalf. Yet it always surprises me that investors give me so few tools to effectively negotiate. If I find myself opposite a fairly aggressive issuer, seller, shareholder, I need price limits. If there is a book that is two or three times covered at the top end of the range, I have no option but to price it at the top of the range. The investor might not like that but I am not being given the tools to change that. I am always surprised investors are not more explicit on where they see the values.
LAW: The problem is the person sitting in front of us from the banks is not the person who had the conversation with the investor. It has probably gone through the sales person, syndicate desk to ECM person and maybe an adviser en route, and that has diluted the message.
OAKES: Also with bookbuilding, the initial order is not always the final order. There is an assumption – or at least an opportunity – that an order can be increased, and a limit can be removed or reduced. So even if an investor has clearly set a limit, you can‘t assume that limit is a real, fixed limit. That doesn’t help the price discovery process either. There is always an element of gaming which is factored into the price.
LEACH: This comes back to what I was saying. Syndicate desks aren’t doing their jobs thoroughly enough. They should know all of the top 20 or 30 investors well enough, they should almost pick their investor base and then find out the correct price at which those accounts will buy.
KOOPMANS: Banks cannot ask for price limits. It needs to come from you.
LEACH: No, no. You can ask where sensitivity is. You should know it.
KOOPMANS: We see where the sensitivity is.
LEACH: You don’t need to sit with a chart of a thousand accounts. You need to know the key guys that you want to be involved and you should model the whole allocation process and the pricing based on that. It is not about finding the median and the mean of where everyone is, it is about establishing where everyone is comfortable. I use limits and I am sure Greg does.
BENNETT: Yes, we do. But the point is everyone needs to be clear about who is actually going to make the deal happen in terms of the IPO process, the aftermarket, further sell-down should there be any in future months and years. It is making sure that the price discovery process is focused on those individuals at those institutions who are actually going to make the difference.
On deals, on IPOs and blocks, I will often, if not always, get called and asked, “Look we see your order, I just want to be clear as to where you care.” So the messages do go in, but as Ed astutely points out they don’t always make it all the way through the process. The vendor is looking to take every penny, we have seen that particularly in some of the Eastern European/CIS transactions.
Just because the book is three times covered, it doesn’t mean that you have no choice but to price it there. That is fundamentally wrong. You have got to look and see who is in that book and why they are there.
KOOPMANS: Obviously we do. The objective is clear, building a quality shareholder register.
IFR: Is that true? There has been such a focus on getting a covered message out early during book building there have been instances where banks have sent out a covered message and technically it was true, but in reality they wouldn’t dream of allocating to a lot of the people in there.
So when someone says a deal is three times covered, does that even mean anything to you?
LEACH: it means nothing to us. Mature investors will take a view on the valuation of the stock. It doesn’t matter if it’s three or five, or 20 times covered, it shouldn’t affect anything except your allocation. What we care about is that is that we are aligned with good people. It is about the quality of the people that you are investing with, and that is what we really value feedback on. Not necessarily name by name, but you want to know you are alongside the right people.
IFR: So you are looking around at your peers?
LEACH: I like to know that it is a good shareholder base from syndicate.
LAW: As an issuer you are led to believe that it is a helpful way to manage price expectations through the process. Unless all investors are just coming in at strike, which often isn’t the case, it could be very difficult to manage pricing if there was no messaging within a specific range.
GERBAULET: It is a chicken and egg problem we face on the syndicate side. Investors indicate that as soon as the book is covered they will come in. But if we are not forced to send out this message so soon, and instead talk about quality, it would be much better. But I think a lot of investors are spoiled and expect those messages. It is a difficult task.
BENNETT: You have to look at this in reverse. The reason people don’t give orders until 15 minutes before the books shut is probably that they don’t know the company that well. They haven’t spent time looking at it, gone through the valuation process, and they may not have 100% conviction on the investment. So maybe they are looking for other investors to give them the confidence to go in.
Go back. Build the understanding of the management and the business early, build the relationships and the investor base from the bottom up. Have 10 guys who you can turn to, they might not all come in but at least they will give you a better steer on the valuation. It all goes back to building these early relationships.
NACHTIGALL: I think I can speak for all of us on this side of the table: we would be very happy to facilitate that. I don’t think any investment banker would want to deliberately hide things or bar access.
BENNETT: I think that wouldn’t have been the case two years ago. There has been a sea change in investment bankers’ attitudes towards this part of the process. The IPOs that have happened in the last 18 to 24 months are those which have never seen the light of day until they turned up two days or two weeks ahead of the launch of the IPO. Maybe going forward we will see the benefit of this change in how bankers and hopefully issuers view the process. But it has not borne fruit yet.
LEACH: Getting back to the point about the book being covered early. It loses relevance at the point you bring a high quality asset at a fair price. Then the demand comes automatically. You don’t have to game people into a book if you are bringing an attractive asset and an attractive price range.
Another thing that is really, really odd about Europe is the intransigence of issuers’ banks to change price ranges, either up or down. You can almost fix it at the start of the process with the analysts’ reports, and then officially fix it two weeks later. It doesn’t matter if the market moves up or down 10% in the meantime, everyone is transfixed on this range still. In certain countries there are laws relating to how much a range can change, but it is generally possible and the US does it very effectively. In Europe everyone seems to see it as losing face, it is impossible to go down 10%.
OAKES: Any down pricing seems to escalate a sense of negativity. It is not about losing face, it is because any signal which is not positive is interpreted so negatively. Down pricing is almost tantamount to admitting you will not clear the line.
And those fundamental investors are in the book because they believe in the company, irrespective of the coverage levels, and would be happy to receive an allocation at a fair price. What we have seen in IPO markets this year is high turnover in the first couple of days and weeks. That doesn’t inspire confidence that not coming out with a covered message would enhance the probability of success.
A lot of this is momentum driven and when we hear a coverage message it is really designed to get something completed, to overcome the lack of confidence we are seeing from investors in forming their own opinion on IPO stories. This plays out in the aftermarket, orders having been delivered and then filled, and then allocations churned.
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