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Wednesday, 22 November 2017

IFR US ECM Roundtable 2013: Part 3

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IFR: So do you have a number in terms of those that have filed confidentially? One of the things that is difficult for us is that we used to know all of the companies that were in the IPO backlog. Now, with confidential filing, it has become a lot more difficult.

Baird, Citigroup: It used to be a great thing about the market. You had 100% visibility on what was out there and what was coming. Again, all these threads keep finding themselves in the same place. Why do people come to the US markets? Because it’s the global standard of disclosure. Behind that, long story short, valuations are higher and liquidity is higher.

One of those benefits was, you used to have perfection of information about what was in the backlog – what was filed, how it was coming along, what those companies were doing, how they were performing.

Now, you pay no attention to that man behind the curtain for a while.

Morrison, Blackstone: I think there are several benefits to the JOBS Act, but certainly it allows a company to file confidentially and go through the preparation process. If their plans change over time, then the IPO filing wasn’t out in the public forum for everyone to know. That might be beneficial to a company.

Secondly, it can decrease the time to market – from when they decide they really want to go – because they’ve already done a lot of the prep work quietly, as a confidential filer. They can move incredibly efficiently from that point going forward.

So I think it’s a great mechanism for the capital markets.

Saacke, NYSE: It’s really helpful, especially because windows are becoming so much shorter. Overall the IPO window is generally open right now. But market conditions change – and windows can close really, really quickly. Being able to have everything ready – on file, through the SEC process, as much as you can – provides flexibility to go when the time is right. Companies have found that very beneficial.

IFR: Doug, can you talk about testing the waters, and when that comes into play?

Baird, Citigroup: One of the additional features of the JOBS Act – in addition to being able to file silently, which really does de-risk the process almost entirely for people who are thinking about it – is it creates a safe harbour for the company and underwriters to talk to investors ahead of an effective registration statement being declared with the SEC.

That used to be a huge no-no. If you think about the architecture of the Securities Act, it was built specifically to forbid that. The regulation wanted investors and issuers only talking with a full amount of legally required disclosure.

What testing the waters has done – also I think in the vein of attempting to de-risk the IPO process – is that investment banks and issuers can now go and talk to investors. And from that develop a view as to how much they might want to pay for it, whether they’d pay anything at all for it or not, and determine whether or not you’d be wasting your time with the process.

That used to be the risk. You file, you show the world everything about your business, and then the market closes or investors don’t care at the end of your roadshow. In that situation, you’ve undertaken a lot of time and expense, taken reputational risk, and have nothing to show for it.

Testing the waters is intended to allow people to take that bit of risk out of the process.

IFR: So when would you test the waters? In what situations?

Baird, Citigroup: We test the waters rarely, as one firm’s view. We tend to do it in the most early-stage companies, the most concept-orientated opportunity where financials are absent, for example. In cases where all the traditional tools of equity valuation are gone. It’s just judgement about the value of technology or the value of a patent or market position, or something like that.

But for the most part, we’re paid to know what this company is worth, and what investors are likely to think about it. We don’t necessarily need to be in the business of asking investors, “What are you going to pay?” and taking notes. I could send my kids out to do that part time

So that’s roughly the circumstance in which we would test the waters – when it’s really a coin toss as to how people think about the equity value of a business.

DeClark, Credit Suisse: You can also use it as a way to educate investors ahead of time, and limit it to five or 10 accounts that you go see. It’s not a broad marketing exercise.

I think something else that we’re seeing along those lines is that a lot more companies, particularly in the technology space, are attending private company conferences well in advance of even doing a bake-off. So it’s not uncommon to get to the IPO roadshow, and go to New York and Boston and have management teams who have already met with these accounts two or three times before the IPO roadshow, either through private company conferences or through the testing the waters process.

IFR: Clearly companies do have a lot more confidence when they come to the market, particularly biotechs. Doug, perhaps you can explain what’s going on with some of the recent biotech deals?

Baird, Citigroup: There’s been an evolution in the maturity and the quality of the companies over the years. So it reflects itself in how much capital they can raise, with a relatively higher level of precision around pricing. Biotech IPO pricings used to be: you’ve got a filing range out there that will be immediately ignored – just because – and then the deal will be sold to a small oligopoly of sophisticated investors who really set the price.

As that industry and its technology have evolved, they pursue bigger opportunities with more profitability. The investor base is growing. There is more vibrancy around the auction of the IPO. So there’s a precision in valuation that we just didn’t have a few years ago.

But you’re right – and again, you guys have written about this – it’s been a huge feature and a successful feature of the IPO market this year.

Morrison, Blackstone: I would also say it’s evidence that the market is seasoning. You’re basically going further out the risk spectrum in the IPO market. It’s almost like all types of companies are now included in what investors are willing to evaluate to get exposure to the economy, to equities broadly speaking.

It’s what I refer to as the further-out stories, juxtaposed to a right-now cashflowing business in a dependable sector. The market is now willing to look at the far end of the risk spectrum, which I think is where we are in the evolution of this cycle.

DeClark, Credit Suisse: Generalist investors, too, are willing to take on the risk. Biotechs are inherently, probably, the riskiest sector of IPOs. We’re seeing generalist participation there too.

IFR: At the same point, the total return phenomenon has really garnered a lot of investor interest. I’m thinking about recent IPOs from the likes of Phillips 66 Partners and NRG Yield. Doug, can you provide some perspective on the demand you’re seeing for these types of deals?

Baird, Citigroup: I like your description of total return. That sector of the new issue market is frequently talked about as the yield product. In fact there’s an enormous amount of capital gain that’s baked into these businesses as well. So you’ve just got the inherent growth of the business added together with its capacity to pay a big common dividend, and that’s what makes it attractive.

With interest rates very low and the reach for yield, there’s a lot of demand for any product that can do better than Treasuries in terms of yield. With technologies in the energy business, such as fracking, there is a need for pipelines to move all of this product to different parts of the country. There’s huge appetite for capital in that industry. Coupled with the nature of that industry, that lets these vehicles pay a lot of yield. This appeals to investors like my dad, who says, “How can I do better than 30 basis points in the bank account?” That all conspires to create a pretty healthy market.

Then at the other extreme, as Tom pointed out, in the risk-on, shoot the lights out, 30% a year returns against commensurate risk, there is that breed of cat out there that’s ready to take bets on technology and disruptive businesses.

IFR: I love how Doug has his entire family involved in the capital markets. He’s got his kids out pulling on equity valuations for on-risk companies and his dad at the other end of the spectrum, on the total return side.

Baird, Citigroup: And the cat. (Laughter)

IFR: Kristin could you provide some perspective on some of the other dominant themes in the IPO market this year? What are some of the hot trends you’re seeing in tech? Obviously software has been very bankable. How do you see the market developing over the next year or so?

DeClark, Credit Suisse: You’re absolutely right. In the first half of 2013 we saw 21 tech-related IPOs come out in a market that’s been the strongest IPO market we’ve had in a long time. Compare that to 2012 when there were 28 tech IPOs – and in 2011, there were 30. The first half of the year has definitely been relatively light, but I think things will pick up in the second half of the year. There are a lot of companies that have filed confidentially.

In terms of trends, software companies in particular are being valued on growth at the expense of profitability. We’ve seen that for a couple of years. It’s a sector that is valued, typically, on a revenue multiple basis. If you plot the forward-year revenue growth against the revenue multiple at pricing, for these software companies for the last couple of years, there’s an 85% correlation in terms of what investors are willing to pay for growth.

You are seeing that in some of the investor presentations. Tableau Software, for example, showed their historical quarterly numbers, and you see margins decline at the expense of growth. Investors love that story and others like it – such as construction software-as-a-service provider Textura – where there is very high, fast growth.

IFR: What about the internet, semiconductors and those sorts of areas? They’re obviously a bit quieter. Do you see those sectors picking up as well?

DeClark, Credit Suisse: I still think growth is a key theme. People, more on the internet side I think, are looking out at what steady-state Ebitda multiples would look like. Investors may be willing to ignore the next couple of years and look a little bit further out, provided there’s a good story to tell.

IFR: Tom, I don’t know if you’re best positioned for this, but if you might be able to give the outlook on real estate?

Morrison, Blackstone: We’ve been an investor in real estate and now we have some transactions on file to go public. We’re also in the monetisation cycle at the same time.

We continue to see with our portfolio companies very strong real estate pricing trends and occupancy trends. So I think we’re encouraged by the current state of the real estate market.

IFR: There are sectors of the real estate market, like homebuilding, that have been very active. And also there’s a lot of focus on the institutionalisation of single-family home ownership. Are those areas going to be a continual source for deals, or are there signs of fatigue?

Morrison, Blackstone: Well, I think those continue to be investment themes. As we look broadly across the real estate spectrum, obviously we’re contemplating where to put the marginal dollar. But we continue to invest across the broad spectrum, and will continue to evaluate monetising investments that we’ve made over time, where we’ve improved operations.

It’s the lifecycle of the investment that we focus on, in addition to the broader marketplace.

IFR: Bennett, what are your thoughts on the outlook for structured equity?

Schacter, Goldman Sachs: I’ll break it down between convertible bond issuance and then also share repurchases. But to bring it back full circle, the key driver for the convertible market will be interest rates. With the back-up in rates year-to-date, we’ve already seen new issue volumes for the year approach what was issued in all of 2012, and equal to 2011 and 2010.

This year we’re on pace for a market of about US$42bn from where we stand currently, which would put us back towards where we were prior to the financial crisis.

I think the outlook is buoyant. It’s driven by the combination of low interest rates but also lofty equity prices. We’re optimistic about 2013/14, and even arguably on to 2015, given our visibility currently.

I would say that within the various sectors right now, similar to Kristin’s commentary, a lot of the activity is driven by high-growth technology stories – 35% of the issuance year-to-date has come out of the tech space. A lot of our dialogue is definitely around those sectors.

In addition to growth, a lot of the tech names we have seen come to the convertible market have solid credit profiles and high volatility. That makes for an optimal convertible issuer. So we’re optimistic about tech issuance.

Lastly, I’ll say that the investor base is also very keen on seeing issuance. The technicals are very supportive. There is about US$50bn of paper going away this year, so there will be a lot of captive money that needs to be reinvested into the marketplace. That money has become more and more long-only.

In 2006/2007, convertible arbitrageurs made up about 65% of the investor base. Now they are about 30%–35% of the market, with the balance being equity income funds, high-yield funds and dedicated convertible money. A lot of that long-only interest is the type of money that issuers are very keen to see in their capital structures.

On the share repurchase side we continue to see a shift towards capital return. And within that are solutions where returns are enhanced with derivatives. There have been a number of very, very significant transactions – Johnson & Johnson last year and Merck this year – that have used accelerated share repurchases for strategic reasons. There have also been an unbelievable number of transactions that have been more tactical in nature.

Because of the trends we talked about earlier – the health of balance sheets, growing pressure to return capital to shareholders, and investor appetite for new paper – the business will also continue to be strong. Right now we’re exceeding where we were last year, and we think that will continue.

IFR: Mr Baird, any thoughts on the future?

Baird, Citigroup: Well my mum tells me stuff that… (Laughter)

IFR: What does your cat tell you?

Baird, Citigroup: He’s busy buying aggressive finance. That rounds out the Baird family’s participation. I would say I agree with Bennett that savvy issuers are going to increasingly find the convertible market. If you’re a CFO, and you’re of a view that rates are going to start ticking up directionally over the next bunch of years, it’s such a smart trade, at the current terms available, to return some of that capital that is on the balance sheet.

Some thoughts about what we’re seeing by sector: In technology, big data, cloud computing, and security are constant themes that we hear about. On the biotech side, I would highlight the notion of platform companies that have technologies that are applicable across a broad range of diseases and treatments, not just one. Again, that is part of that fundamental evolution of the sector.

The integrated energy company is really applicable only to the global behemoths. So I think, over time, we’ll see more and more of these spin-offs and carve-outs of businesses that have the ability to unlock value and generate lots of yield.

On the financial side, the wholesale funded specialty finance company is back. There’s a lot of these companies being formed, and the equity markets are interested in them. There are a lot of new payment technologies as well that straddle financials and tech.

On the retail side, there’s a lot of category-dominant retailers that seem to be crushing it, just gobbling up a lot of market share.

So my prognostication about the future is what’s going on right now. That’s what we’re going to see tomorrow, more of what we’ve seen.

Schacter, Goldman Sachs: If I could summarise one of the underlying themes, it’s that in a low-vol environment there’s just a lot of more stuff that is able to be done – whether it is blocks, disruptive technology companies, more levered IPO candidates, convertibles – there are just a lot of things that can happen.

Investment banks are evolving to be aggressive – and investors are evolving to be aggressive – because there are just so few ways to generate returns in such a low-vol, low-rate environment.

We got a little bit of a scare in June on interest rates, but the market’s come back. To the extent that we continue to see an accommodative rate environment, I think all the trends across the sectors will continue as long as we have that underlying phenomenon of low rates and low vol. I think that a significant, unexpected move in either rates or volatility is the only thing on the horizon that can really derail everything we’ve talked about.

Saacke, NYSE: It’s quite hard to be the last word following all these great views of the future. But from an IPO market perspective it’s going to continue, I think, to be very strong, based upon what we’re seeing currently in the pipeline and based on our visibility of the non-visible pipeline.

I would like to reiterate what Doug pointed out about branded retail companies. The reception has just been incredible for strong consumer brands.

We’re not seeing a lot of activity in the consumer technology space in terms of consumer internet or things like that. It is still hurting a little bit after last year, and that’s going to take a little bit more time to come back.

But so far, the companies that have been coming to market – and that have been successfully floated – are those with a growth story. For them the outlook looks great. But it’s not like every company can go public, and people still need to remember that. We’re not yet at the hangover stage, which is good. But 2013’s going to be quite lovely, I’d say.

IFR: Okay. Well thank you all so much.

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

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