IFR: We often hear bankers say there is a lack of conviction in investment decisions, which is demonstrated by the discrepancy between the book at pricing versus the performance in the aftermarket, and where the turnover has been.
LAW: That might be an allocation issue.
LEACH:: There are thousands of investors in IPOs and lots of them are only interested in momentum. But I think the target shareholders that you want in an IPO for a growth company will not care about the momentum in a book if they see a deal they like in a quality asset at a good price. They want to own the assets.
NACHTIGALL: I completely agree, but all sides, the banks and the investors, should come a little bit closer together than they are at the moment.
I concede that in certain cases there has been a little bit too much finessing with the messages that banks have given out. But at the same time, all too often in the bookbuilding process some very large investors come very, very late in the process. If they are not in the book I, as a banker, can’t provide the transparency.
I understand that investors want to get to know the company as well as they can to make an informed decision. There is no question they will want to have had the roadshow meeting and maybe another couple of days to plough through the material and make as informed a decision as they can. But at the same time I would like to believe if there is a positive fundamental attitude towards the company, that the order is not withheld artificially. It might help me in the momentum game and it might help me not to push up the price. If the transparency is there bankers and advisers can do a better job steering the process, and not rely so much on the hot money that sometimes comes in.
Once the deal is subscribed once or twice, all of a sudden the floodgates open and it goes to three or four times covered in no time. All that demand coming in at that point is usually not fundamental demand, it is coming in because somebody thinks this deal is going to go up by 10% or 15%.
IFR: That is the challenge then? Those 15 to 20 key guys you desperately want to be in there at present are not enough to cover the deal and that is why you have to have half an eye on the coverage message and getting the momentum.
Is this where the US model is better? Would you rather see the deal scaled to a more sensible size that would bring in just your key guys? So the IPO isn’t the exit, it is the introduction. Then you see the larger sales in the follow on.
LEACH: If the big 15 to 20 guys are in then it is going to be a blow out and everyone is going to follow.
BENNETT: There is some truth in that. But equally, if the 15–20 guys don’t cover the deal and there aren’t other people coming in there, then the deal is the wrong structure. It is demonstrably the wrong size.
There is a real opportunity to create more flexibility around the deal size. Starting off with smaller deal sizes with upsize options – not just the greenshoe – but an upsize option. If the deal is going well and it looks like there is the demand to increase the size of the transaction then we should be looking to address that.
From our perspective a lot of the companies that come to market are growth companies. That is typically why companies IPO. There are a few yield plays that do come through too, but they are mainly growth companies.
As an investor, we want to give those companies the money to carry on growing or to allow them to grow at a faster rate where the opportunity is there. We want to provide growth capital. So we are keen to see companies focus their IPO issue size on the primary side, not the secondary.
As has been said, the IPO is the start of a new life, a new part of the company’s lifecycle. It is not an end in itself, it is a start. KKR have shown us there are multiple exit points. So let’s focus the IPO on a primary. Let’s get the company growing and give it the capital to do that. Let’s get a properly covered deal from the leading investors who can then support the company going forward.
That is a bit more US style but I don’t think we should be adopting the US model wholesale. There are certain things we can change.
LEACH: One word of warning for the smaller free-floats: the US market is much more liquid than the European market. So Groupon and Linkedin can get away with it. But the smaller European company might suffer.
KOOPMANS: It goes exactly against where the market is going. The focus on size and liquidity in order to get attention in the first place is tremendous.
GERBAULET: When we launch mid-cap deals, if you reduce the deal size it has an impact on liquidity. That is the feedback we get. So there is a balance.
LAW: If you look at the way things are done in the US, typically the IPO is primary and is smaller in size. The valuation at which it is done, establishes a benchmark, provides us with liquidity and allows us to monetise over time, which is helpful.
The US process is obviously very different to what you have in Europe. There is a completely different price discovery process. So when we talk about flexibility to move ranges, maybe part of the reason why Europe is so inflexible is because you have had research out there. One has two weeks of pre-marketing and extensive dialogue with the investors before the range is published. Therefore there is a belief that you have got the range right from the outset. Whereas in the US you haven’t had that level of interaction.
KOOPMANS: Ed and I used to work at Deutsche Bank which tried to adapt to this with a de-coupled process. It never caught on in the entire market but I always thought it worked pretty well.
I don’t see what the problem is in doing the roadshow in the last three days, building the book around the price range that is realistic and therefore having less market exposure and the benefit of real feedback.
LEACH: Then you do rely heavily on getting very, very good accurate feedback and there is still a block in the communication process, clearly.
If the syndicates aren’t doing their job well enough, or investors are not communicating well enough what deal we want, that is a communication breakdown. There is confusion between fair value and the price at which you buy a stock, that comes up repeatedly. You get distortion, I say something to one bank and it gets written up and repeated back to me differently – incorrectly. From the sales person to the syndicate person to the originator to the advisers to the company – that is a big daisy chain of information.
NACHTIGALL: And the obvious thing to fix.
LEACH: I think Ed’s approach of going to investors, especially the more important ones, is very sensible. As investors we should be going straight to the issuers and talking to them.
IFR: In Germany the de-coupled process was used much more. Did it really make much difference?
GERBAULET: We didn’t do that on the last transactions, but we used it sometimes. I wouldn’t say it is the standard.
NACHTIGALL: It seems to be used in cases where price discovery is, for whatever reason, extraordinarily difficult. Something like biotech, where the numbers can move so much that you need more feedback from the bookbuilding process. But I agree with Ute, I don’t think it has become market standard.
IFR: There seem to be two opposing forces – a desire to know where a deal is likely to come in advance, from analyst research, or to do the price discovery once in the market.
LAW: There are two elements of the debate. One is, as an issuer, if you are going to launch the process you want comfort on where it is likely to come out. That comes back to whether expectations are being managed appropriately throughout the process and whether you are getting a clear and accurate judgement from ECM desks around what is achievable in the market.
The other element is to what extent investors want to know a price range that is out there before spending time looking at a deal. I think de-coupled processes show it isn’t that important to them.
BENNETT: I agree. We don’t rely on the price range to be there before we start to look at the deal. If the company is fundamentally interesting we will look at it and tell you what we think.
LAW: It is even arguably easier to have the debate without a price range.
IFR: It has been a high volatility environment this year, and that doesn’t look like it will change any time soon. Is there a question in terms of the four-week process that it is just too long? Or is it just that people need to be more flexible and move ranges and adapt to the environment?
BENNETT: There is no question that four-week market exposure does not help the IPO process. It cannot be an advantage to have that kind of exposure. The issue is not so much what some commentators have assumed, which is that we should not do research. It is more a question about the research blackout period, which is a legal fallacy made up by lawyers and perpetuated deal after deal. It has absolutely no foundation in law whatsoever and it seems to be acting as a real barrier to helping the IPO process speed up and become more successful.
If we can achieve one thing, I would like to push back on this IPO research blackout. Has any institutional investor ever sued an investment bank claiming to have relied on their research? Of course not. We have got to try to push back on these things, these are the things we can achieve, things we can do to improve the process.
LEACH: I agree entirely. In terms of the bookbuilding process, there should be a range of 20%–25% and that should be enough to get through two weeks in most market conditions. The problem is that the bottom of the range that has been set has recently been pretty much the highest price a company could to achieve. So there is no margin for error and as soon as the market comes under pressure it is impossible. The old adage of trying to price a deal two thirds of the way up the range seems to have been completely ignored.
IFR: What are the prospects for retail?
OAKES: In Europe we really lack an exuberant retail element and a collection of funds that could become cornerstones. Not just sovereign wealth funds but equally high-net worth individuals, private families or private wealth money. That gives some sort of non-price sensitive, early momentum.
There was a time in the German ECM market of the 2000s when retail investment was a significant plus, but generally sentiment in Europe and bookbuilding structures tend to push retail to the margins. So it is less about negativity around retail or other sentiment around the deal, but that we are not accommodating areas of natural demand that could be helpful in a book filling process.
Recent Spanish examples have demonstrated quite a cynical approach to retail, which is “we can’t sell it to the institutions so let’s see if we can get the deal over the line with the local retail investors who don’t know any better”.
KOOPMANS: It really depends what market you are in. For example, Turkey is the opposite. But generally you can count on local support for an issue, though there are differentiations.
LEACH: Retail is just not in the market, there isn’t the depth in the market you have in the US or in Asia. Retail comprises a small proportion of flows in Europe.
OAKES: Although when you talk to the UK retail brokers at Charles Stanley, Killik and others they have a certain amount of money to play with, but they know they will never be allocated. They are not the customers of the banks running the deals, so there is no incentive for them to spend any time in the early process educating themselves on the deals. There is no stock for them.
I do wonder whether retail processes can become more effective in Europe.
LAW: There is quite a lot of regulation around retail across Europe, which varies depending on the country, in terms of price ranges and marketing material, so that is an added cost. To some extent, retail in Europe has tended to be a momentum investor, so you see them in deals that are strong, but not otherwise. In which case you have to ask, can you rely on them?
One of the differences between Asia and Europe is that in Asia it is much more of an equity finance culture, generally. As a consequence of that and the high growth on offer there, and with the companies coming to market, allocation is scarce.
So that allows deals to get meaningful cornerstones, early on in the process. That is a way to get an allocation in a deal. In Europe we don’t have all those dynamics.
OAKES: This goes back to the performance issue. If you are expecting to lose money you are likely to be hesitant. We referred to Germany earlier: there was a general expectation that investing was a one-way ticket, which hasn’t been the case in Europe for a while. But that is the situation to some extent in Asia, hence the demand. Maybe that is quite cyclical too.
LEACH: Asia is actually not functioning that well at the moment, either, it is pretty much shut, the same as Europe. It is a fickle investor base. Several times in the last few years they have opened and shut the gates, there have been periods of months without deals, particularly when they start to run the price up as is happening in Europe. It isn‘t the golden opportunity everyone thinks it is. People lose money as they did on Samsonite they won’t keep coming back, they will close the doors.
NACHTIGALL: Retail is ultimately a complimentary element. In Germany direct equity ownership has gone down among private individuals quite significantly over the last few years. In terms of orchestrating a deal, it depends on the size of the transaction. In big deals that we feel might resonate with retail investors, it can make sense to add a modest retail tranche. But this is not the answer to the problems we have been discussing. It could offer an incremental increase of demand that might help.
OAKES: There was plenty of momentum in the Nordic transactions, where you get consistent retail participation…
GERBAULET: But for European transactions there is a major challenge for the syndicate is to find the right mix of investors. It would be a mistake to only approach the 15 biggest institutions in Europe, all based in London. You need to find the right mix of local investors that have known the company for longer, and know the region and the economic environment, combined with the bigger funds that are either sector specialists, or are more liquid or are trading oriented funds. The bank needs to find the mix that will make the difference in the after market.
That is the difference with the US market. There you don’t have predominantly regional expertise. This is why they can also do without IPO research, because they are very sector oriented. Here and in Europe we have a lot of very different investors with different experiences: some investors are starting from scratch with a business case, and others that are already familiar with that specific sector who are able to jump in very deep.
OAKES: That is why we tend to find more success overall with syndicates that match an international bank with a local bank. The syndicates made of five, six or even more international banks cannot help identify and educate the right mix of investors for the deal. It is otherwise just the same narrow investor group that every deal gets sent to.
IFR: So looking to the start of 2012, what can you say to investors? What is going to excite investors?
LEACH: I don’t mind about sector. I am looking for high-quality companies at reasonable prices. It can be a yield play, it can be a stable play, it can be growth play. I just want the right quality and also the right structure and the right pricing. At those points the money comes up.
BENNETT: We are looking for a compelling investment thesis, a compelling management and a compelling valuation. There is a fundamental asymmetry of information between buying and selling an IPO, as we have discussed today. So when we invest in an IPO we want to have a high level of conviction that what we are doing is the right thing. That is as true at the bottom of the bear market as it is at the top of the bull market.
IFR: Next year even if the market is improving are problems going to remain because of an expected wall of new issues?
LEACH: We look at every deal on the same basis, no matter how many of them there are. But unfortunately for the issuers and the bankers there will remain a high degree of cynicism because of the sheer lack of profitability in the recent transactions. It will be hard for the first few deals and they need to be of a high quality and priced correctly. Otherwise the window will close again.
BENNETT: It is also worth considering institutional equity flows. Equities are not seeing inflows. Look at the Investment Management Association data for last month [October], it shows, yet again, another month of outflows in Western European equities. So we have a finite pool of capital to invest.
Look back at 2009 when the whole of the European corporate sector seemed to be recapitalising, particularly the UK, there was a big call on funds in terms of existing listed companies and hardly any IPOs. So you have got to look at what are the calls on our capital. How much capital do we have to invest? Generally we have to sell something in order to buy something and until we start seeing material inflows coming in to Western European equities that will carry on being the case.
LEACH: But it won’t be an impediment to getting good deals done.
BENNETT: There will always be room for good deals.
LEACH: We will always find capital for good deals.
BENNETT: Always room for good deals. We just have to manage our situation.
IFR: It comes down to trust essentially doesn’t it? That is what has got to be rebuilt. We can point fingers at each part of the market to ascertain where they failed or where they were considered by someone else to have failed. But we won‘t move forward until some trust is rebuilt between all the partners.
LEACH: There is a massive impasse. There are too many spoons in the pot, it just isn’t working. The messages don’t get through either way from the issuer down to the investor.
BENNETT: It is the same in any transaction. Whether it is buying a house, or buying a car or buying an IPO. Both sides want to walk away from that transaction happy and that is especially important with an IPO which is not a one-off transaction.
IFR: So it starts with the issuers because you are responsible for picking syndicates.
LEACH: What advice does an adviser give to an issuer about syndicate size these days?
NACHTIGALL: It depends on the size of the transaction, but to generalise: the sweet spot is probably two to three bookrunners. That strikes a balance between having a sufficient number of bookrunners in terms of selling power and each of them still feeling completely responsible for the transaction. With regard to the junior syndicate, we often find that co-lead managers and co-managers don’t really put all their full force into a transaction, many just sit alongside the bookrunners, leaving it to them to move the transaction forward.
Anything beyond that, with very few exceptions, becomes increasingly difficult to work with. Sometimes investment banks pitch to their corporate clients to get themselves added as the third or fourth or fifth bookrunner, as the case may be. Sometimes they offer certain sweeteners to the corporates to get on the deal. There needs to be more discipline.
IFR: Is that where advisers need to be stronger? Ralf’s colleagues on Loterias had 20 plus people through the door to see them and in the end appointed nine bookrunners.
GERBAULET: But you can easily sort them into active and passive bookrunners, as we did on our own transactions. Even with a big transaction like ours, of €11bn, it is easier to do it with three banks than six or seven, sure. But you need a certain level of underwriting too, so you have active ones and passive ones. This resolves the situation.
NACHTIGALL: We are saying the same thing. In my mind a passive bookrunner is a bit like a glorified co lead manager. They get the league table credit, which is something that investment banks obviously care about.
KOOPMANS: But it is not only about the numbers, it is also about making sure they complement each other. You see some syndicates where you have two American banks in there as global co-ordinators and they take a third American bank.
GERBAULET: … Which doesn’t make any sense.
KOOPMANS: So you say, come on guys, look at some of the regional dimensions, look at some of the sectors I mentioned. You need to grow both brackets, you need to make sure they are complementary. By the way, in the example I referenced it was an independent adviser that suggested a third US bank be added to the syndicate.
LEACH: No one is turning to us and asking us what we want as investors. Do we want to be marketed to by six people or eight people, or ten people? I can only speak for myself but I don’t. We don’t. We want to talk to one person or two maximum.
BENNETT: You talk about passive and active bookrunners. That is fine. But someone has got to tell them that their job is to sit there and do nothing…
LEACH: We don’t care if there are 20 as long as we can talk to one or two people.
BENNETT: …It is clear that those are the two people that matter, there is no argument about it. You don‘t want someone else phoning up and saying they are also a bookrunner and you have to talk to them. Which is what we get.
LEACH: In the US they don’t talk. In Groupon they had one guy who was in charge, who did all the marketing. The other eight just did nothing. They have still got the bookrunner title and their league table and their money and so on. But we don’t care about that.
BENNETT: One thing that hasn’t come up throughout today is corporate governance. That is so important for us. We have seen situations where, for example, the independent non-execs or the chairmen seem to us to be very much an afterthought. We see non-execs who are appointed hours before the prospectus goes to print. This is a very important issue for us, we do take it into account. We want to see a company that is coming to list acting like a public company for months in advance.
We want non-execs of the board that actually understand the business. You need a balance between your non-execs, it needs to be thought about in advance. Obviously the sponsors have to ensure that the board is suitable. You may end up with a board that is not ideal for a private company, but in terms of wanting to present the best face to the market, corporate governance does matter to us.
KOOPMANS: I appreciate that. But I guess it will be reflected in the price, right? If it is not in place then it has to come at a discount, or maybe you decide not to participate. That is fair. But to claim that any transaction can only come to the market if all those boxes have been ticked is taking it too far the other way I think.
LEACH: If the question is how to get investors comfortable with IPOs again then that is a core point. If there is a perception that you are losing too many deals, this is something that would make us more comfortable.
BENNETT: Do you as a bank feel comfortable with putting an IPO in front of investors where the board is not properly constituted and where there is not any proper corporate governance?
LEACH: This brings it back to the core impression and how important is it to banks? Is the responsibility disseminated amongst so many parties that no one really knows what the trades are? It doesn’t help the image of IPOs. It is not constructive.
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