IFR US ECM Roundtable 2014: Part 2
IFR: Just to switch gears a little bit, Matt, one of the big trends we’ve seen this year has been the increasingly prominent role of independent advisers in some high-profile ECM deals. It’s a concept that isn’t always entirely embraced by the Wall Street banks. Can you explain to us the role that independent advisers play and why there has been a bigger role for them to play, it seems, in the US recently?
MATTHEW SPERLING, ROTHSCHILD: Rothschild has had a full service platform on the ground in the US now for three years. But Rothschild has effectively been doing advisory services for seven or eight years globally, in part because the product really did develop outside of the US initially in the form of advisers such as ourselves sitting next to issuers like the British government taking British Gas public.
Those markets internationally were formed through privatisations in the first instance. So I think the broader set of market participants were more used to the notion of Rothschild or Lazard or folks like that sitting at the table advising the issuer, and the leap from privatisations to IPOs was not a leap, so to speak.
It was, to some degree, inevitable that as market barriers break down and capital formation converges in many ways that the role of an independent adviser would come to the US.
There are a number of reasons why this is a logical evolution of the market. But it’s not obvious that every situation is a perfect one for advisers to be involved; nor do we and others like us try to be involved in every situation.
In the US, we have the presence of a range of very sophisticated owners in terms of the financial sponsors and VCs who are responsible for much of the new issue product in this market. In the first instance, the advisory role was used I think to make things more efficient for such owners accessing the market with their portfolio companies, however, some then built up their own capital markets capacities. Even with this audience though, we continue to see situations where even sophisticated owners look to advisers for very specific types of improved outcomes, to run processes and keep them tight. For example, in a block bidding process, our counterparts on the other side [the Wall Street banks] are happy if everything’s tight if they’re bidding on a block in a matter of minutes or hours. If you talk to some of the lawyers in the room, here, if you remember the block process a number of years ago, it was often times a complete mess, with people going out to get bids and not even having yet called their lawyers.
So there’s an element whereby everything is made a little bit more sophisticated and smooth for parties on both sides of the table, and partly because of advisers. Also the broad acceleration of the capital markets has brought a lot of types of issuers into the markets. Some of them may be less traditional, less frequent issuers, where as owners they may be experts in building businesses, but they aren’t experts in capital markets.
In addition, there are a lot of trends that have driven all of us to a spot where there are now multiple bookrunners involved, economics are sliced and diced so many times, even though folks when pitching would love to be the guy who ends up sole book and running everything. Sole-book mandates have virtually disappeared – 7% of all IPOs these days are sole books; whereas if you go back 10 years ago it was the inverse.
In those types of situations where the capital market process is more complicated, we’ve seen a natural need for our services from non-traditional infrequent issuers – families bringing businesses public, companies doing cross-border deals, trusts that end up with stock positions they need to monetise, or even some of the more regular folks including sponsors and VCs who just aren’t at the level of a KKR or an Apollo – although actually we’ve done work for Apollo too – but who aren’t in the markets that frequently.
In such situations, the owner or issuer may already be talking with two, three, four, five banks. Hopefully that should be the case if you have got a great asset. But, sometimes, the issuer wants and needs to really have an understanding of the process and a desire to remain in control of the process, and they have the perspective of wanting someone to sit next to them saying, “Here’s how we are going to do all of this”. So, we’re happy and well-positioned to help since from our perspective as a real bank doing it (which we would say is fundamentally different than most of the other folks that do this), we can provide also full sector expertise, valuation work and positioning advice. So we’re often involved a year, year-and-a-half and sometimes longer with issuers before some of these assets come to IPO.
Finally, when you get to the point where you’re working with the banks in a more formal way, we like to think hopefully – tell me if you disagree – that part of our coming from the ECM world as well, from having been on the desk at CSFB back in the day, or UBS or Jefferies, we know what’s going on at the other side of the table, so we’re also trying to make it easier and more efficient for everyone to do their jobs, and to get better outcomes. We have worked with everyone for a long period of time now, and they know what we try to do, and everyone’s trying to work toward the ultimate goal.
Hopefully it’s a bit of a win-win. Yes, you will read in the press, and certainly in a recent large transaction, people saying, “Oh, it’s complicated, there’s an extra layer”. But that being said, I think we’ve all learned now to work well with each other, and frankly, in a situation where even on small deals there are multiple banks involved, sometimes even from the banks’ perspective – and certainly from the company’s perspective – it’s not a bad thing to have kind of a Switzerland in the middle to help forge consensus and to say, “Look, let’s decide what we’re willing to do right now, let’s have some fundamental perspective, let’s figure this out, and then let’s figure out what’s the right way to translate that for the client, who may not be as sophisticated.” That hopefully altogether produces a better outcome.
IFR: Ed, what’s KKR’s thoughts on that topic?
ED LAW, KKR CAPITAL MARKETS: To Matt’s point, we’re frequent issuers. We probably issued over US$40bn worth of equity in the last few years. Naturally, we have built up our own in-house expertise so we don’t use external advisers around execution of transactions. If we think about the topic of advisers, and if I think about it based on my experience both in Europe and the US, there are times when they can be extremely helpful to a transaction, that’s often why you have multiple parties. I’d say the deals where we have involved IPO advisers have been where there have been five sponsors, say, or multiple sponsors on a transaction, and to Matt’s point, building consensus, apart from anything, is something that can be very valuable.
What I’ve also seen in Europe is where there’s been an explosion in the use of IPO advisers, and with differing approaches, I’d say certain advisers out there, and Rothschild certainly does not fall into that category, tend to try to disintermediate the banks from the end investors, and from the clients. That’s where it starts to get extremely dangerous, because you’re kind of basing an advisery role on a lack of trust with your banks that you’re working with, which presumably if [you’re appointing banks around] execution of an IPO, it’s because you trust them and you value their advice, therefore why don’t you work with them in that process.
I’ve certainly seen – and I haven’t seen that in the US thankfully – but I’ve certainly seen, and Jonathan’s colleagues in Europe would probably also attest, a scenario where effectively the banks don’t feel secure in their own roles within the transaction to be able to pass on the real advice and the tough advice that you need to hear during execution of a deal. Investors get very frustrated because their views are not being accurately passed back to the management teams or the shareholders, and that can jeopardise the transaction.
I’ve seen situations where advisers have taken over the allocation of transactions as well, which invariably can lead to a poor aftermarket performance, because naturally the banks just tend to be more in the flow in the investor dialogues, and who’s active and who’s not, than an adviser that doesn’t generally have the same sales force, penetration and distribution as the banks.
To summarise, [the role of an independent adviser] is definitely an important role, and it can be a very useful role in certain transactions, it’s definitely not a one size fits all. We’re sophisticated users of the capital markets, so to have an in-house function is very valuable to our firm. I totally understand people who haven’t been to the market before could benefit from working with people they trust, whether that trust rests with an adviser or with the right banking line-up is the question.
IFR: Ed, in terms of KKR’s capital markets function and the ability of your group to work with middle market private equity firms or other third parties. Is that something that you might be able to speak to?
LAW, KRR: Within our capital markets business, the majority of our business is in relation to our portfolio. What we have recognised is that for financial sponsors that are smaller or middle market there is a benefit in having, sometimes, capital markets expertise that is sponsor focused, and we certainly do provide that to middle market firms.
Generally I’d say our focus has been more on the credit side than on the equity side in that regard, and a lot of that is about stepping into a bit of a void, particularly post-crisis, around provision of finance to the middle market sponsors. Generally we haven’t gone out there to do, for example, third-party equity advisory business, in part because it’s very time intensive.
There are plenty of people out there doing that. Certainly it’s an area, and it’s a focus area for us as a team, and increasingly a larger proportion of our overall revenues come from external capital markets services.
Coming back to that point on illiquid positions, where we do have a pretty differentiated set of relationships on the equities side is around private placement of equity. That’s obviously not surprising given the space we traffic in and the relationships we build across the alternative space, but we’re pretty active in placing private equity around KKR companies like the US$3.5bn raise for First Data Corporation earlier this year to also raising third party capital on a private placement basis.
IFR: Yes, one overriding theme here is the capital intensity that comes with investment banking. Whether it’s from human resource or from other resources, I think that’s one area where Rothschild may differentiate itself from some of the other independent advisers in terms of the breadth of advice that you’re able to provide.
SPERLING, ROTHSCHILD: Part of this is figuring out what the client wants in terms of an independent adviser. Rothschild is a global firm with 900 plus bankers, all advisory, 50 offices, 40 countries, full sector expertise. Sometimes clients want someone in the tent when they’re still also figuring out what’s the right corporate structure, and “How many guys do we need in accounting to make sure we can get to a point where…” It’s just frankly not as efficient for Credit Suisse or someone to spend all those resources for a year and half to ultimately get to a transaction where they still may end up among three bookrunners with the economics sliced and diced, and those teams could have been doing something else.
We have that ability, if that’s what the client wants, to provide not only product expertise, but also sector expertise in much the same way. We obviously don’t have the sales force, we don’t have the trading, so we are very careful not to stray into those areas. I agree on the notion that some folks have put forward, where it’s almost like some advisers are pitching themselves almost to the extent of saying ‘let’s go screw the banks’. To me, that is the absolute worst way of thinking about it, and not the way to build towards successful outcomes for your clients.
REECE, CREDIT SUISSE: When you think about it, the market’s changed, and I think JD mentioned this, Matt mentioned this. So 10 years ago, 12 years ago, it wouldn’t be uncommon to see a deal with one or two active bookrunners…
SPERLING, ROTHSCHILD: At Credit Suisse, when I was the director on Kraft in 2001, we had two bookrunners, and another 20 banks, raising US$8.7bn.
REECE, CREDIT SUISSE: …Those days are gone. Last year I think we did, excluding risk, 308 deals, and I can remember only a handful were sole active books. So Matt worked with most of us on this table on the IPO for Markit. There were 10 active banks. It had the potential to be enormously challenging.
When there are one or two actives, the role of an adviser is different, right? Then you may function more as a consigliere trying to give somebody independent advice, but if there are five or six bookrunners – by the way, it’s happening more and more, sadly, from all of our perspectives – quite frankly you’re a process traffic cop, and I don’t mean that in a derogatory fashion, it’s just the harsh reality.
We all are geniuses – just ask us – and we all want to tell the CEO or CFO what he or she needs to hear. But then it becomes: I’m whispering, JD’s whispering, Phil is whispering, and all of a sudden it’s like, they throw their hands up and go, “I don’t know what to believe. I trust them all, I know them all, but help us sort it out.”
So the market has sort of created this opportunity; it’s not like they woke up one day and said, “Oh, geez, this is a great opportunity,” it just sort of happened. Again, the days of having one and two actives on big jumbo deals, I don’t see the market going back to that, because of the need for financial capital, the need for geographic distribution, the need for big footprints. If I’m an issuer, I’m probably going to do the same thing that I hate right now. It’s like, “Well, I’ve got to have four actives, because I want to squeeze everybody. I want the best that everybody has to offer.” For these big deals that actually adds value.
SPERLING, ROTHSCHILD: What’s worse, four actives, equal, or four actives and us? You don’t have to answer truthfully…
MORIARTY, BofA MERRILL: Coming back to your opening comment: what type of transaction is it? There was an interesting comment when you said ‘side’; I don’t necessarily think of it as which side am I on. Some of the healthiest transactions that all of us have worked on the client doesn’t think of it that way either.
They want their deal done and, to be clear, our interest is a deal that works. It’s interesting; one of the things that’s happened with the evolution of this adviser market, and I’m sure you see this Matt, you just talked about a point of differentiation from a marketing perspective in terms of how you go to market with the resources of Rothschild. Everybody is trying to differentiate themselves. The one that I have found most laughable as a point of differentiation is it’s all about the allocations. That is probably a 1997 way of thinking about our business.
Allocations are really not the issue. A venture capital client once asked me, “Has there been any innovation in the IPO market?” I thought about it for a second, I said, “The innovation has been subtle. It’s actually evolved in one really significant way: it’s transparent.” And I think that is the key. If you, the issuer want to look at the book, you can look at the book. You want to set the allocations, you can set the allocations. My point being, at the end of the day, the thing that drives our allocation framework is the aftermarket.
You’ve got some advisers managing ‘the process’ – the Markit IPO is a great example. You’ve got some advisers who actually want to be drafting sessions with the company and preparing the roadshow deck, okay, interesting. Then you’ve got some advisers trying to play an IR role for the company afterwards. That can get a little hairy, because sometimes there are too many voices coming at the company in terms of how you manage to beat earnings and raise guidance, for instance, and the CFO is just confused.
Everybody is trying to come at it from a different angle, but effectively our market is evolving much like other markets have, right? We’ve all talked about the market in Europe, guess what, the fixed income market has dealt with this in terms of multiple parties being involved for years, right? We’re just evolving in much the same way.
ROSS, BLACKROCK: You’ve hit the nail on the head, at least from the buy-side perspective, on transparency. That is one of the mandates of our group. It’s not disintermediation.
The direct issuer dialogue is helpful, having the perspective of management matters. But at the end of the day our goal is to make sure that the banks, the advisers and the company know exactly what BlackRock thinks, and what BlackRock thinks may be a multitude of underlying perspectives, but developing a consensus perspective, because at the end of the day, it comes down to, “What’s the right price?” That’s obviously driven by what your objectives are from a secondary perspective, and ultimately what you want your shareholder group to look like. If we’re trying to hide the ball on our end, that does not serve the transaction well, and it doesn’t serve BlackRock well either, and it certainly doesn’t serve the company very well. So I think transparency is the right word, and that’s the critical focus we have throughout the process.
SPERLING, ROTHSCHILD: The only tweak I would make is that even though there’s been enormous leaps forward with respect to transparency – I agree with that 100% – to an infrequent issuer, the process is still very opaque and very non-linear, and there are a number of really critical touch points where they fear the most as to what’s going on.
One is certainly research, and I can tell you it’s even different across the different firms what you can do in terms of interacting with the analysts under the current rules, and if anything that’s also an area where we find the banks saying, “Great, help us get transparency,” because to do your job efficiently everyone can’t always know exactly what’s going on, even in their own shop, to the right degree. However, it needs to be done the right way – not these articles you read about advisers or owners pushing the analysts and everything else, that’s the wrong way – done the right way, this helps create transparency for the issuer and for the banks.
Another area, and this is probably where I think there is the most fear, is: What are the black arts practices at the very end of a deal that are being done by the syndicate guys? Some of that comes down just to the nature of the process, where in an IPO of whatever size, you’re going to be out on that plane in front of that issuer X months in advance as the ECM officer, winning that mandate. But the syndicate guys, the guys in the trenches at the very end pushing the salesforces saying, “Where’s my order from the guy at Fidelity or BlackRock?” The issuer doesn’t meet the syndicate guys until the end and doesn’t really understand their role.
SPERLING, ROTHSCHILD: That’s exactly right. Then you have the issuer going, “Okay, what deals are getting cut on the other side, because BlackRock went into a deal the other day that’s now trading down 10% and they’re getting blacklisted.” So we aren’t trying to sit there and say when we’re all in the trenches and if God forbid it’s hand-to-hand combat, which sometimes it is – we’re not trying to make anyone’s job more difficult, because everyone wants to get a good deal done, and the best deal done, knowing that you’re juggling two clients.
My client is sitting there going, “I have no idea what’s going on, and if I’m trusting you that you’re telling me that what these syndicate guys are doing, even though it may look like a sausage because at the very end there’s a bit more transparency, I’m trusting you that that’s okay,” I think that helps you get a better deal done and it helps the client get a better deal done.
Yes, sometimes there is tension, sometimes there is pushing, sometimes there’s, “Look, there’s 50 cents more here. Let’s go in a room, not in front of the client. Let’s honestly admit that you can allocate this book 50 cents higher than where it is.” Yes, that’s a little bit of capital that maybe stays in the hand of the issuer and doesn’t go to the buyside.
But there’s a point at which it’s like, “No, that’s not logical, that’s not reasonable,” and we all know that, and we can go back to the client and say, “We can move 25 cents, but 50 cents just doesn’t work, and I think this thing falls apart if we try to push it that hard, and everyone agrees and hopefully it trades right. We’re not going to try and allocate the book for someone.”
MORIARTY, BofA MERRILL: Interestingly, the biggest of institutions have figured out that transparency, meaning they may say, “Okay, here’s my 10% order, or in some cases I’m going to put in a 20% order, and it’s going to these three funds, and I’m not going to give you individual price targets, but here’s generally how we think about it.”
SPERLING, ROTHSCHILD: That’s great.
MORIARTY, BofA MERRILL: Right. I would say most of our companies only go public once, in terms of a management team, very much to your point; it is a process that is intimidating at first. Just that feedback alone puts the average issuer at ease, and actually is very much in your best interest, and the bigger institutions have figured that out.
Ultimately, our goal is to get to something that trades well. If we can put stock in the hands of the people that the company feels like they connected with in a concentrated way, that’s a really good outcome for us. So that’s what I mean in terms of that transparency. I take your point on research all day long, that is a challenging process for regulatory reasons, obviously, and we want the companies to have greater visibility there.
SPERLING, ROTHSCHILD: Well, the issuers don’t get that, actually; they sit there and go, “Hedge funds, hedge funds,” and you go, “No, Fidelity, Wellington, BlackRock”, but this is how it works, this is how much might get sold, this is how much they’ll end up with.
ROSS, BLACKROCK: If you have a three to five year time horizon, and raising your order 50 cents is going to get you a far bigger allocation for a name you fundamentally like, investors will do that all day long.
IFR: Jonathan; we discussed pre-IPO investing a little earlier. You’ve been quite active in that area, I think you’ve had some investments in some high profile companies, press reports indicate Mobileye and LendingClub, among others.
Can you take us through the philosophy that you take and how that works into your overall chase for alpha, if that’s the right expression?
ROSS, BLACKROCK: Yes. I’d like to think we’re not chasing returns per se, but I know what you mean. The driver for us in pre-IPO is a couple of things.
One, if you look at technology companies, they’re staying private much longer, for a combination of reasons. Part of it is because of firms like ours participating in pre-IPO rounds. They’re able to raise capital more efficiently, even while private, to enable that sort of evolution to the IPO to take a little bit longer. They’re able to provide liquidity to employees, to take a little bit of the pressure off of getting to the IPO quicker, so that’s helpful.
But for us, first and foremost, it really is about liquidity. So much of what we do and the reason my group was really born is all about liquidity. We all know there’s a declining amount of financial assets in the world. When you’re looking for size, if you wait for the IPO, in all likelihood, for most names, you’re going to wait for two to four years after the IPO before it’s truly investable from that standpoint. Going in earlier in the pre-IPO round allows you to establish a position, such that when the time comes for the IPO, you’re adding to an already existing, sizeable, position, as opposed to trying to build a position right out of the gate. So it just makes the process much easier.
Certainly without a doubt there is, we think, in the names we’re investing in, an asymmetric skew on the risk-reward profile as well. So certainly we find it attractive from that standpoint.
I think the one thing we aren’t doing, though, is taking a basket approach. We’re sort of bouncing around, and I think the one theme hopefully that plays itself out is that we’ve been fortunate enough to pick the companies that will be winning, or relative winners, in whatever vertical it is they’re operating in.
When I first started about two and a half years ago, my first private deal was about four or five months after I started, and that was one team. And then we executed a few more deals with that same team. Then, as you saw public events happen, other teams became more and more interested. Other teams became more comfortable with owning an illiquid asset in a mutual fund context.
Living in a world of daily NAV marks makes illiquids a little bit more challenging, but we’ve been able to refine our operational processes internally. So it makes the process much easier from a back-end perspective, and what we’ve seen over time is that the number of teams exploring pre-IPO has continued to grow.
REECE, CREDIT SUISSE: You give a good explanation of it, but it’s sort of mandate creep; it has to be.
ROSS, BLACKROCK: Yes, without a doubt.
REECE, CREDIT SUISSE: I won’t call them out, but I got an email last week from one of your largest competitors. They’re starting a minimum billion dollar fund managed by the liquid guys to invest in illiquids.
ROSS, BLACKROCK: Well, two of our competitors now have one; one’s not quite a billion, one is targeting a billion. There is a view that we’re an effective bridge to a public event, and that we’re a good long term capital provider for these companies, and so it does put us in, I think, a reasonably unique position. So you do have dedicated capital in that regard. You have the ability to invest those assets reasonably well.
DRURY, CITIGROUP: Does it get to a point where you start to cannibalise interest in the IPO? So is capital formation just occurring at an earlier stage and the players are changing?
ROSS, BLACKROCK: Great question. When we’ve had a team that’s invested pre-IPO, it’s created interest in the IPO where there otherwise wouldn’t have been as much. Had teams at BlackRock not made certain investments they would not have bought in the IPO because they simply could not have gotten the amount of liquidity that they needed for the position to make sense inside the fund.
REECE, CREDIT SUISSE: But you’re doing it – and I don’t think it’s a bad idea – with a view that these companies are going public 12 months out.
ROSS, BLACKROCK: You know, every story [is different]. I’d say our time horizon is ideally 18–24 months.
REECE, CREDIT SUISSE: So what happens when correlation and vol spike in the market shuts down, year long, and the price is wrong and you can’t move it; you’re not going to be so happy, maybe, right?
ROSS, BLACKROCK: Every case is different, in some cases we might be, it depends on the individual funds that participated.
REECE, CREDIT SUISSE: Because it’s easy – Phil said earlier, and JD said, “Oh look, the last two and a half years, everything has worked.”
LAW, KRR: I guess you won’t have a daily mark though, and a security, so you’ll be alright.
ROSS, BLACKROCK: We’ve looked at investments where we know we’re going to be illiquid for probably at least three years, maybe pushing five. We looked at a deal recently we didn’t do, it wasn’t because of the time frame to IPO, but you’re looking at literally a zero revenue business, so you’re stepping up the numbers and saying, “For this company to really be worth even what we’re paying now, you’re looking at, at least three to four years of revenue growth to get there.”
I’d like to think that we’ve been thoughtful enough going in.
APTHORPE, RBC: Joe, I think it actually dovetails back to the comment around rates in general, as you think about the last two or three years there has certainly been a reach for yield, and a willingness to go down the yield curve and search for that asset, taking on greater risk as a whole. So as you think about pre-IPOs and the illiquidity that you potentially suffer, and the lack of IPO exit, you are taking risk. You talk about [cannibalisation], in many instances people will use alternative instruments as opposed to just discount equity to offset some of that concern about the incremental risks that you’re taking; there’s certainly been an uptake in the amount of pre-IPO convertible bonds that are being used as a way to get liquidity.
If you think about the cannibalisation of the equity demand, this is tapping a different buyer base, ultimately, it’s a yield buyer, with downside protection, so to the extent that there isn’t an exit through the IPO, they’ve still got a fixed income instrument with yield that will help them through that period of time of uncertainty.
IFR: We’d like to switch the topic a little bit to blocks, and round out the conversation on this.
REECE, CREDIT SUISSE: I have to go. (Laughter).