IFR US ECM Roundtable 2013: Part 1
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IFR: Welcome to the IFR roundtable on the US equity capital markets. We have a lot to discuss. Leon Black of Apollo Group said in May that this is a fabulous environment to be selling into, and that the firm was selling everything that “wasn’t nailed down”. Would you agree with that assessment?
Tom Morrison, Blackstone Group: As a private equity firm what we do is, we work with our limited partners, who are investors in our various funds and businesses, and we manage capital on their behalf. We make investments, and with our operating teams and our investing teams, we work on improving the operations of the businesses.
Then, over time, we monetise those investments and return capital to limited partners. So we’re constantly investing and improving businesses, and monetising investments over time.
Interestingly, over the past several years, when you look back to the financial crisis and you work forward in time, there haven’t been as many open windows to sell equity and return capital to LPs. So I think private equity folks, venture capital folks, companies and issuers have been active participants in the equity capital markets. Whether it’s been IPOs with primary proceeds to pay down debt or use capital for growth, or secondary offerings to return capital to our investors, we’ve been an active participant in the capital markets.
Year to date, with our portfolio companies, we’ve completed 19 different equity transactions raising over US$8bn. So we’ve been incredibly active. We have several IPOs on file and we’ll continue to be an active participant in the capital markets going forward.
IFR: Let me just follow up on that. In a dual-track process, where M&A can present an alternative to an IPO, how does the open window of the current market environment affect the decision-making process?
Morrison, Blackstone: When we make an investment, from the beginning, we contemplate what the exit alternatives are, whether it looks like it will be an IPO or a strategic sale.
So we have a sense as to who might be an ultimate investor in the business. Over time that may evolve or it may be as we expect it. Markets, obviously, are constantly evolving and they present different opportunities. What may have looked initially like an IPO may become a sale to a strategic entity and vice versa, or a certain corporation may change a business strategy and decide to be an aggressive buyer of an asset.
I think we’re constantly evaluating multiples in the marketplace, where public stocks are trading – public comparable companies – as well as comparable companies in M&A transactions. So we’re evaluating multiples over time.
We try to be great stewards of the investment on behalf of our limited partners, and make the best decisions.
IFR: There’s been a lot of focus on central bank liquidity and what the Federal Reserve will do over time. Within the past month there has been a knee-jerk reaction and we have seen a snap back in the credit markets and a return of risk tolerance there. Doug, I’m curious if you can share some ideas in terms of whether we’ll continue to see equity fund inflows as incredibly strong as they have been for much of this year?
Doug Baird, Citigroup: Yes, well it starts with taking a look at the yield the 10-year Treasury rates going back 30 years. I won’t give you 30 years worth of perspective on that journey, but it’s really an astounding thing to look at. It’s sort of been a non-stop bull market, with a resulting decline in interest rates over three decades.
Almost two generations of Wall Street professionals advised clients when every day interest rates were a bit lower than in the past. So the question of the day is what the Fed said on July 10: will we see the end of 30 years of increasingly cheap debt, relative to equity? You’re right, actually. I think rates rallied back something in the range of 25bp.
With the prospect of bonds maybe going up, rates going up every day, people are starting to lay off their exposure to fixed income products and cycle in to equities. For a long time equities have seemed relatively cheap on a yield basis versus the money you can get in the fixed-income market.
I would describe that reversal of fund flows as a trickle. It’s directionally different than we’ve seen in a long time. It’s certainly directionally different than we’ve seen since the crisis with the flight to safety.
There is a tectonic plate shift yet to come, in terms of a risk-on appetite and a real tsunami of money in to equity mutual funds, but that has started. It’s followed a move in the S&P 500, it got down to as low as nine times forward earnings at the depths of the crisis and it’s climbed its way back to 15-ish times forward earnings. Back in the golden era of ECM it was 25 times forward earnings. So there’s plenty of money to be made buying equities and I hope we’re at the very front end of that as we speak.
IFR: One of the benefits of low interest rates, obviously, is a very buoyant market to refinance debt. Out of the financial crisis there was a tremendous amount of balance sheet reconstruction. Bennett, perhaps you could share your thoughts on the overall health of corporate balance sheets.
Bennett Schachter, Goldman Sachs: As you pointed out, a lot of the refinancing has taken place. Corporate balance sheets are in fantastic shape. Whereas coming out of the crisis in 2008/2009 the bulletproof nature of those balance sheets has proven to be a very, very valuable asset, and corporations placed a premium on security. That has started to shift as investors have become much more accustomed to a lower volatility environment, and a stronger view toward risk tolerance.
The fortification of the balance sheets is now shifting a little bit towards investors who are looking for a return of capital to shareholders. I think you should expect that to continue.
We’re starting to see a degree of agitation, not necessarily massive shareholder activism, but a degree of agitation if you will. That has stimulated some increased capital returns, and you see that in the corporate share buybacks in particular. Within the trend of share buybacks, we have seen more companies look at structured solutions to facilitate repurchases.
IFR: Can you walk us through the typical forms of structured share repurchases?
Schacter, Goldman Sachs: In its most basic form the structured share repurchase has really taken the shape of an accelerated share repurchase, which is an agreement between a company and a derivative counterparty to deliver the vast majority of the shares upfront, and the cash changes hands upfront. Then over time the company and the derivative counterparty engage in a make-up contract such that the company is allowed to buy stock at the average weighted share price over the course of the transaction, with some economic benefits in the issuer’s favour.
Typically the contracts are constructed such that there’s a variable maturity option. That optionality generates a premium for the issuer, and that premium can be expressed as a discount to the weighted average share price. So there is an economic benefit to companies that utilise an accelerated share repurchase.
In addition, they get to retire the shares upfront, so there’s qualitative and quantitative reasons for the trend towards accelerated share repurchase.
Also, in a low rate environment where corporations are looking for any bit of edge to create incremental value, the ability to extract value based on volatility, even in a low volatility environment, is still meaningful relative to buying back stock on the open market.
That being said, the vast majority of corporate share repurchases are still done via open market activity because of greater flexibility. But we’ve seen a noticeable trend towards a more tactical approach to share repurchases in the form of structured solutions.
IFR: Kristin, can you provide some perspective on how fund flows have affected your side of the business?
Kristin DeClark, Credit Suisse: On the technology, media, and telecoms side of the business, and other growth businesses, the IPOs we’ve seen have attracted not only traditional technology investors but a lot of generalists as well. Tech/media/telecoms IPOs for the year are up close to 50% on average. So that exceeds the broader indices.
In a time when a lot of the fund managers are trying to play catch-up just to reach the benchmark indices, growth IPOs, as an asset class, present a great opportunity for investors to really play catch-up.
That has, in turn, manifested itself in order books where we see multiple-times oversubscription – much higher than what we’ve even seen in the past. When you look at an order book that’s 10-times oversubscribed, you might be pricing it at the mid-point, the high-end of the range, or much higher than the range.
We’re seeing more investors play the growth stories as an asset class, versus coming in with really strong conviction on the story. So it takes a little bit more work on our part to really ferret out the long-term shareholders and who really understands the story.
IFR: I think that does represent a challenge for the process of syndicating deals. We have seen some situations where IPOs that are multiple-times covered but have not necessarily performed well in the aftermarket.
DeClark, Credit Suisse: We have investors that may not have as strong a conviction as what you’ve seen in the past, and people that may not know the story as well. If the stock doesn’t trade up at least 15% in the first day people start getting out. At that point in time you need to know how deep the benches are of buyers that are going to come in and support the stock in the aftermarket.
So we have to spend a lot more time with accounts – understanding how well they know the story, if they’ve built a model, where they’re willing to buy the stock in the aftermarket.
IFR: I would think that might make for some difficult discussions with issuers.
DeClark, Credit Suisse: Right, like trying to explain when they have an order book that’s 10-times oversubscribed, why that means a mid-point or high-end pricing, and why they can’t increase the price US$2 above the range. It does make for more difficult conversations, for sure.
IFR: Carolyn, how to do you interpret fund flows and the overall state of the market?
Carolyn Saacke, NYSE Euronext: This year’s IPOs have really been performing amazingly well. Part of the reason is investors really want to outperform the S&P. The performance of IPOs, starting really in the fourth quarter of last year, has been very, very good. It’s bringing a lot more investors into the market who do not necessarily have as much control over the pricing process.
It’s nice to see we’re talking about pricing in the middle to the upper end of the range, versus what we had a year or two ago when everyone was talking about pricing below or at the low end of the range. It’s a much better market from that perspective.
We’ve had about 100 IPOs this year in the US. Certainly the US continues to drive the capital markets globally, in terms of IPO capital raised, which is fantastic. The NYSE does lead the world from an exchange perspective there as well.
It’s interesting because it would seem this year that there are a lot more private equity-backed IPOs than we had last year. Last year was the story of venture-backed companies. This year, so far, it’s been a lot of private equity activity – companies that are seeing they are at the right place in their lifecycle to hit the public markets again. The climate is good for them to go out.
In the US market we have seen just over US$22bn raised in the IPO markets so far. We’re on track to hit basically what we did last year. So far we have fewer IPOs though than last year, but we have had much bigger deals than the smaller venture capital batch of last year.
What will be really interesting to see is what happens in the second half of the year. One of the things that we are seeing from the JOBS Act is that companies are filing confidentially, so it’s become more difficult to tell exactly what is in the pipeline.
So we’re on track for a great year. We hope, knock on wood, that continues.
IFR: We continue to see a large number of companies from abroad listing on the NYSE. What are some of the trends you are seeing there in terms of which regions are most interested in the US as a listing venue?
Saacke, NYSE: The US is still the centre of global capitalism. Most liquidity is here in the United States and the markets are the most advanced. So when there’s difficulty in the global economy, this is the place to list.
We’re seeing a lot of activity coming from Europe, a lot of which are private equity-backed deals. We’re seeing deals out of Russia on the tech side. We’re seeing a couple of things coming out of Israel for the first time in several years on the tech side.
But the story really is a European one at this particular point in time.
IFR: To what extent are issuers looking at dual listings using the Euronext platform?
Saacke, NYSE: It’s definitely interesting for companies to start looking at doing a listing here in the US and then also doing a listing on Euronext or another European platform. It’s very beneficial to do it on Euronext and the NYSE, so you can reach both investor bases. It allows for a bit more flexibility of whom you can market to from that perspective.
It’s certainly a trend that we hope to see more of going forward. Certainly, companies that are already listed have been using European platforms for dual listings as a benefit as well. So that they can get additional visibility in the marketplace, a bit more liquidity, and options in securities for their employees and customers, things like that.
IFR: There’s been a lot of discussion about China and how appropriate it is for Chinese companies to list on US exchanges. Do you see there being a revival in Asian companies looking to list in the US, or do you see them preferring to stay there?
Saacke, NYSE: Revival might be a strong term. Certainly the market has reopened with a recent IPO for LightInTheBox, which was the first Chinese company to list in the US in a long time. There is still a great interest in listing in the US, but the process has become a little bit more difficult for companies and investors alike. I think the attitudes are going to continue to improve. There are several companies looking at a listing in the US.
Latin America has certainly been a very strong marketplace in terms of companies that are in the IPO pipeline. There have been several large companies from the energy space, and the industrial space, and we’re expecting more out of Brazil. Brazil is a little bit difficult with some of their current issues, but certainly from South America and Mexico we’re expecting more deals.
IFR: Kristin, do you have some perspective from some of the foreign tech companies you have worked with?
DeClark, Credit Suisse: The last three foreign tech IPOs – Luxoft, LightInTheBox, and QIWI – have all performed very well. There are benefits to those companies listing in the US because they get access to the US technology investor base, which is typically more sophisticated than some of the other more generalist investor bases in Europe or other markets.
But there are certain benefits to listing in the US as a foreign, private issuer. There are less stringent requirements on Sarbanes-Oxley and board requirements. They don’t necessarily have to file quarterly reports. But for the most part we encourage companies, and I think investors require companies, to look as much like a US-domiciled company as they can from a marketing perspective when they go public.
It costs them a little bit more because we do encourage them to have quarterly filings, and they can’t fall back on the lowest common denominator of a foreign, private issuer standard. But they’re able to access the US technology investor base, and typically that translates in to a higher valuation.