IFR ECM Roundtable 2018: Part 1

IFR ECM Roundtable 2018
35 min read

Keith Mullin, KM Capital Markets: This year we’ve seen bouts of volatility in equities and there’s been talk not just of continued volatility but of market corrections, bubbles bursting and a tech sell-off. But despite the negative nuances, equity markets have tended to snap back relatively quickly, suggesting a degree of resilience to the news flow where pullbacks are invariably seen as opportunities to lay back in again.

I wanted to talk about the general macro environment to kick off and we’ll get into the deal-making environment: a review of Q1 and then a look forward to the rest of the year focusing on deal flow and deal management tactics that underwriters need to employ to make sure that deals fly in the more uncertain market environment. Christoph: could you kick us off?

Christoph Stanger, Goldman Sachs: Markets should react to facts, such as corporate earnings and the earnings environment. If you look at that in itself, the environment we are dealing with right now is very good. Global growth rates are as good as they’ve been in the last 10 years. We have economies performing in Europe as well as in the US (which has passed significant tax reform), and we’ve got corporate earnings that are solid. If you just took that, you’d say we were in the best of all worlds, the best we’ve been in a long time.

But, there are issues beyond economics that are hard to value: the US presidency, Syria, North Korea, trade wars etc. The recent earnings season was very strong and the market reacted to it. On the macro-flow question, the reality is that even though interest rates are going up, the debt asset class is tricky because making money is really difficult so I don’t think there’s going to be a sucking sound out of equities, at least not yet. The risk environment favours equities.

If you ask me, “what would turn the equity market?” I would say if you take politics out of it, the thing that will turn an equity market for sure is if on a 12 to 18-month horizon, market participants were to expect a recessionary environment. Nobody sees that right now but a lot of people are watching out for it.

Keith Mullin, KM Capital Markets: What Christoph said was interesting because there doesn’t always seem to be a lot of rationality in how markets are behaving but there are negative overtones creeping into the language and the narrative. Craig, do you share Christoph’s fairly benign view or do you think there are things out there that we should be concerned about?

Craig Coben, Bank of America Merrill Lynch: I agree that the macroeconomic environment is relatively favourable for investors. The political environment is very different. We have a lot of tough talk on trade. We have threats of competitive devaluations. You have the asymmetric risks around emerging markets as we’ve seen most recently with the announcement of US sanctions against various Russian oligarchs. As a result, I think investors are finding it a little bit difficult to gauge risk.

I think there are also broader structural factors that are affecting the way markets are behaving. Looking at the flow of funds; cash is coming into equities. The problem is it’s not coming in to active equities, it’s coming in to passive funds and that does change behaviour in the markets. It changes the way we do deals and it affects the ability to price transactions in ways that are not always very apparent to the naked eye.

Overall, the secondary market looks relatively stable. We’ve had bouts of volatility but I think it has been relatively stable and we’re still at very high levels. But the underlying tone is more negative because of these broader structural factors.

Keith Mullin, KM Capital Markets: European politics has also been weighing on markets. Luis, there been a lot of stress around election outcomes for some considerable time, most recently the Italian election. While the US political scenario is being played out on Twitter, the interplay in Europe is a little more nuanced.

Luis Vaz Pinto, SG CIB: There is a positive mood, certainly in France with Macron and the renaissance that we’re seeing there and elsewhere. But when, objectively, you look at the numbers, the environment is very difficult. If you look at stock indices around the world, you have trouble finding significant markets that are up for the year.

That’s certainly the case in Europe where, as of today’s discussion [April 11], they’re all down with the exception, ironically, of Italy for reasons that have very little to do with the elections but with investors trying to play the recovery, notably on the financial side now that it’s being cleaned up. There’s a lot of positive news out there but it’s a very difficult environment in which to operate because people are having to manage their portfolios and every day it’s a struggle because of volatility etc.

But it’s not a European phenomenon; it’s a worldwide phenomenon. If you look at investment banking revenues globally this quarter, they’re down 14%. Equity capital markets revenues for the quarter are down 22% in Europe but they’re also down in the Americas and in Asia-Pacific.

It’s a classic ‘glass half-full, glass half-empty’ scenario. I tend to see the glass as being more half-empty at the moment and the environment is not really conducive to doing deals. When you look at where the patterns of activity have been in Europe, I see one bright spot, which is Germany. German ECM activity is up by 25%, albeit largely due to a couple of big IPOs.

But if you look at the top five regions in EMEA, Germany is number one and is up but the next four are down. It’s a tough environment and we really need to think about some of the topics you mentioned at the beginning: about how to best structure deals and how to assess investor appetite to get deals done successfully.

Keith Mullin, KM Capital Markets: In terms of getting deals done, Silvia, the task of underwriters is to take the factors we’ve mentioned and satisfy two poles: issuers and investors. Getting the right price is always an art but when markets are so difficult, doesn’t it all become more complicated?

Silvia Viviano, JP Morgan: JP Morgan hosted a big global markets conference in Paris less than a month ago and we ran a survey that more than 100 top investors responded to. Everyone has their eyes wide open to all the issues we’re facing that we’ve already mentioned.

Still, around 70% of the people we interviewed told us that they are still planning to stay long equities and are planning to do that at least for the coming six months. So yes, everyone is aware of what’s going on but there is still cash available that is coming to play in equity markets, which is positive considering the pipeline.

Coming to valuations, it’s a tricky market so volatility is playing a very important role in the pricing of our deals. What is becoming even more important now is defining the right bottom of the pricing range. We need to do a better job in educating our clients to understand that the bottom of the range needs to be an insurance against any volatility spikes.

You have big deals, like the €4.2bn IPO of Siemens Healthineers where all the right boxes were ticked. You still need to be careful with the valuation range even if you know it will get done because it’s a must-have stock.

Then there are other stories where the equity story is still strong, it’s a very good asset and market feedback is positive, but where one of the boxes has not been ticked. It’s at that point where setting the valuation range becomes fundamental. We have seen mixed post-IPO performances lately. This is mainly driven by the absence of creating and building momentum during bookbuilding.

The only way to get this right is to fix the right bottom price in order to hook investors and try to create consensus around the story and the valuation. A lot of work has to be done by banks and advisers to get the valuation right.

Keith Mullin, KM Capital Markets: Feel free to comment on the macro topics, Suneel, but could you talk about valuation, and fixing a pricing range that’s going to work in tougher markets with volatility never far away?

Suneel Hargunani, Citigroup: On the macro points, I agree with a lot that has been raised. The reality is that we believe we’re still in an environment with synchronised global growth and strong underlying fundamentals. The upcoming earnings seasons will be closely watched to reinforce that view and I think that’s the view of most investors.

Having said that, from a primary market perspective, the volatility associated with other factors is clearly impacting decision-making and it isn’t necessarily just fundamentals and macro that’s driving market movements or driving interest in our transactions. It’s a challenging environment for dealmakers but fundamental investors are still very receptive to transactions where they feel there’s value.

The question is – and it goes to the point about passive money – are there enough fundamental investors that have a medium-term outlook in this market to support a deal? From my perspective, how deals trade or how deals are structured should be based on how we engage early with fundamental investors who will be price leaders.

There is a slight concern that the process is becoming a bit commoditised from an IPO perspective. Europe has always been criticised for having a process that’s too long; not only the public process of investor education and the roadshow but the early-look process, where management teams go and meet investors early.

That’s critical but what’s happening now is that the process is becoming elongated and we’re meeting too many investors. What we need to do in a volatile environment, I believe, is meet fewer investors overall but more fundamental investors to get a true grip on where valuation and sensitivity is. You can then anchor your public process with the knowledge that you’ve got fundamental support behind it. That will help navigate the volatility, navigate the windows and provide a benchmark on which to build a book and create momentum.

Keith Mullin, KM Capital Markets: So if the real art is creating momentum and a situation where fundamental investors feel there’s value, is the tendency in today’s market to take a more defensive approach to pricing and valuation?

Christoph Stanger, Goldman Sachs: I would make a few comments on the process and how it’s changed. We had a situation some years ago when investors were telling us, “we hate the fact that you come and see us for the first time on the roadshow and then you give us half an hour. That’s not enough to assess the company; you need to come and see us earlier”.

The pendulum swung too far and everybody started visiting investors earlier and several times. We then reached a point where investors started saying, “you’re wasting my time. Don’t come to see me unless you’re serious”.

The pendulum is swinging again, probably in the right direction. Now we’re giving investors early but targeted access. If somebody wants more access, we can certainly provide it but we’re not forcing it on them. This is a good process.

On pricing, if you come from a 10% vol environment last year to a 20% vol environment today, it doesn’t take a lot to recognise that this has to have an impact. If you don’t recognise that, you will have a failed deal. It’s very simple. I personally think a lot of the deals in the wave that came out after Easter will fail, particularly companies whose business models aren’t necessarily in the right place, companies that are not necessarily coming out of the right geographies or with price expectations that are way beyond what the market will take. I am bracing myself for a lot of failures in the next month or so.

But that can be seen as a good thing. I’d rather have a deal fail at the outset than limp through and fail for investors afterwards; that really kills markets. If a deal gets taken off because people didn’t like it, that’s OK. If a deal gets stuffed down people’s throats and it’s down 10%, that’s really bad. Natural selection is a good thing.

What the market has told us in the first three months is that you can get a good company floated very successfully with a good aftermarket but you have to recognise which waters you’re in and what kind of reaction is needed to get you into safe territory. In a seller’s market, you’ve got to take care of things one way; if it’s not, you have to do it another way. Things can still get done successfully but deals will fail if they don’t adjust to the environment.

Keith Mullin, KM Capital Markets: So by the law of probability, some of the deals that you’re all working on are going to fail. But that’s clearly not the intention and investors will always choose the stories at the valuations they like and be selective. In a tough market, doesn’t that put a lot of pressure on sell-side dealmakers to avoid failed deals, whether that’s failed in the approach to getting the deal done or in the aftermarket?

Suneel Hargunani, Citigroup: To the failure point, I agree it’s going to be a challenging environment. There are a lot of deals out there. The second quarter, straight after Easter, is always the busiest period. But let’s define what failure is.

The market will put pressure on pricing for a couple of reasons. First, it’s a more volatile environment. If we compare this year to last year, it was easier to provide liquidity where the majority of market participants felt the market was going up. If you’ve got liquidity, you’re going to make a return if the broader market is going to carry you upwards. When you’re not sure about the market direction and you’ve got volatility, there is going to be greater pressure to apply an IPO discount.

We all talk about the IPO discount but it’s difficult to quantify. It’s effectively what fundamental institutions would like as a discount to fair value to compensate for market volatility. In time, that fundamental discount narrows and that’s the return they get in a market that’s going sideways or that is volatile.

Once we’ve gone through the education process, the price that the market is willing to pay for the asset may not necessarily be what the seller wants. The vendor has to decide whether to proceed to bookbuilding and at what price, on the basis of this information. The advisers need to ensure the vendor is provided with as much market intelligence and judgment as possible to make this decision.

They may decide to postpone their transaction, but I question whether this is a failed deal, given the deal never formally launched. If they get into the bookbuilding process and it’s potentially at the wrong range and the deal doesn’t get covered, then the onus is back on the advisers to provide the vendor with options and advice on potential next steps.

I agree it’s going to be challenging but, once again, as we saw in Q1, good transactions will get done if clients’ expectations are managed on value because there is definitely still appetite for primary equity.

Craig Coben, BAML: Back in 2009/2010/2011 when the IPO market was very difficult, that’s when we started to do all these early-look meetings to try to de-risk the execution around IPOs and, as Christoph was saying, also to respond to investor complaints that they weren’t being given enough exposure to the company to make an investment decision.

With the benefit of hindsight we should reconsider our practice here. We took those investor comments at face value and now we have a lot of early-look meetings, we have a lot of pilot-fishing meetings yet it’s not de-risking the process very much. It’s not even giving us all that much visibility. As a result, what we’ve created is a very laborious process with less output than we would like.

The pricing environment is more difficult now because of higher volatility, because of more flows into passive and so forth but I would say the market is open and several IPOs have traded well. Part of the problem is that some of the IPOs that have come out have had less-than-inspiring equity stories. They’ve come from geographies that are more difficult and so, as a result, the quality of pipeline is perceived, fairly or not, as being weaker than as in past years.

That is one of the reasons why some deals have attracted a lot less interest than the issuers or the vendors would have liked. Overall, I have to say, every investor I speak to is open for business. They are open for deals. They’re just not going to be indiscriminate about it.

Silvia Viviano, JP Morgan: Taking Christoph’s more pessimistic view and Craig’s more benign view, I’m in the middle. We’ve had 14 companies issue intentions to float over the past week. Probably not all of them will price; it’s just too many. That said, investor money is still available so if we have another couple of weeks where markets are up and US and China trade tensions retreat, IPOs timed to price will still happen, but several factors need to be kept in consideration and some deals will be driven by specific situations in the market.

Keith Mullin, KM Capital Markets: Luis, it’s not just investors who demand certain valuations; so do issuers or vendors and there’s tension between the two. I guess your job is to find a middle ground. Run us through the conversation that takes place. I’m curious about this notion of deals that don’t have a particularly good equity story finding their way into the pipeline – which is what investment bankers ultimately define – particularly if equity sellers or the company itself have unrealistic expectations of the price they think they can get at execution. This idea is intriguing that banks are aware that not all deals they put into the pipeline will work.

Luis Vaz Pinto, SG CIB: Some companies are clearly too early-stage to come to the market. There’s a problem associated with that: what are the seller’s expectations in terms of what they’re worth versus what the market thinks they’re worth?

If you look at the Siemens Healthineers IPO, which was quickly covered, traded up and was a stunning success, when you look at the way that was priced versus the comps, it came at a reasonable valuation. Investors saw it as such, saw it as a great company at a great value so everyone jumped in and bought it.

There’s going to have to be a similar thought process for a number of companies. As Suneel was saying, what is failure? Sometimes the seller wants a price for something but the buyers don’t want that price so the deal either goes away, maybe comes later or goes to a trade sale because financial sponsors have raised large funds and gone through a period of selling a lot of portfolio companies, so there’s going to be a new investing cycle.

But it’s not just whether companies want to come to market too early; it’s what valuation the market is demanding. Investors are in a very difficult environment. When your year-to-date performance is down – and let’s remember that most investors measure the year on a January-to-December basis – and the screens are showing red, you’ve really got to make sure that the big investments you put in your portfolio trade up. That is far from a foregone conclusion at the moment.

Some IPOs will fail because we haven’t got the right balance between what sellers want and what buyers want in terms of valuation. Part of the problem with the early-look process is people got used to going through the motions and not looking at the feedback that was provided. Bankers are sometimes guilty of engaging with processes where accounts have given very clear feedback about where they thought there was value but then sellers had a higher view of themselves. In a way, we’ve wasted that early-look feedback process because we haven’t paid attention to the data points we were given.

Could we do it faster? Yes, I think we could. The US model, which we keep talking about, is more agile, more flexible, people change price ranges more easily without the drama that happens in Europe. That’s something to talk about.

Christoph Stanger, Goldman Sachs: There’s been a lot of reference to Siemens and I would say one thing, which transpires through everything that happens out there: it takes a vendor who structures the best possible process but is also willing listen carefully to the market. In that transaction, the buyside was very disciplined. What do I mean by that? I mean that large investors on a very large situation held back on giving real indications on price and value for as long as they could, with the expectation that, given that it was such a large deal, they had the power to price it.

They did have pricing power, of course, but the vendor had a globally successful process that created significant buying pressure, and the vendor was engaged and listened to the market, which eventually led to a highly successful transaction.

That holds true for every deal. The pricing power of investors in a more difficult environment is only going to go up and investors have to use that power; it’s their job. If you then have a vendor that isn’t willing to engage, you either have to take the deal out or it will fail.

It’s the obligation of the bank to have the tough conversation early rather than late. Too many times the tough conversation take place too late because it’s easier. Having the tough conversation early is the key to success, especially if you deal with complicated organisations where certain expectations are ingrained.

If you don’t have the tough conversation early, you end up with a mess because you get the wrong range, you get disappointment, and then you get pressure and it ends badly. The tough early conversation is often missing. It’s partly also because syndicates are too large and people don’t say what they really think.

We all have to say what we think if we want a success. That’s the one message that applies even more in a difficult environment. Riding people to the very end and then taking the seller down on the last day isn’t a good strategy. Not exposing your thoughts is the wrong strategy; it’s a cop-out. This market will, I hope, teach every banker that they should have the tough conversation early because the likelihood of failure will go up if they don’t.

Suneel Hargunani, Citigroup: That’s key. When you asked what our jobs are and how can we let these deals come to market, from an issuer’s perspective, we need to give them frank advice. We’re their advisers. We need to be able to judge and read the market, make sure their eyes are wide open, act as the screen and the filter and then mobilise a full global distribution platform to sell the equity story as well and as appropriately as we can, taking into account our obligations to the buyside investor as well.

What we shouldn’t be doing is using the market as an excuse as to why their deal isn’t working or why they aren’t getting the value they were expecting. I agree: those tough conversations need to happen early and clients need to make decisions on the base of that. The only incremental point I would make on the lack of visibility, maybe, is some of these deals will not work because it’s a crowded market and, in addition, to the price discipline we’re seeing from the buyside, we’re seeing selectivity as well. That may be the challenge over the next few weeks.

Keith Mullin, KM Capital Markets: On the basis that there are a lot of deals in the market at the moment, that investors are going to be selective and it’s an art to get them to work, the key related point is how does the deal timing piece work, in terms of lining up deals so you have a clear market? Why do we have so many deals being shoved into the market now? Was it because Q1 was light versus expectations? I’m curious.

Silvia Viviano, JP Morgan: We came out of 2017, which was perceived as the IPO year. The year ended with equity indices at all-time highs, the volatility index at an all-time low, and we had a lot of supply from funds. Towards the end of last year, all the companies that wanted to get assets into the public market started to get ready.

We had private equity funds planning to exit, family-owned businesses looking to engage with the public market, carve-outs, … what has fuelled the IPO market is the result of a very positive 2017. IPO windows are driven by financial results and some specific windows have to be taken. The reality is you either do it before Easter or now. All of them have to come in the same period so it’s also the result of a very positive market environment.

Keith Mullin, KM Capital Markets: OK but back to the point about having the tough conversations early, surely that includes timing.

Silvia Viviano, JP Morgan: It’s not a flexible system. The IPO process is not a flexible process; once you start working on a specific timetable and with specific financial results, you can push as much as you can but, unfortunately, you are looking at specific window. Once you’re working on it, it’s difficult to track back.

One key point here, and where we can start to do better, is to try and maximise flexibility. Shortening the marketing period or whatever you can do to minimise volatility risk will help. Again, time is of the essence.

Christoph Stanger, Goldman Sachs: I don’t think there are too many deals coming to market but I do believe that we have too many deals that are not “must-own”. The market can absorb the volume of deals that are out there, as we’ve seen in other periods when the market is good. We had a lot more flow in 2014-2015 than we have right now and they worked. I don’t think it’s a function of capacity. We’re putting €300bn or so of European equity issuance through the market every year. It’s a big number.

When you look back, European market volume has increased massively over time in a global context with Asia and the US. That’s no surprise. There are 500m people in Europe. Why shouldn’t Europe have as deep a capital market as the rest of the world? It’s not a function of capacity; it’s a function of whether people like what they’re seeing.

In 2008, post-crisis we started with an empty book on the IPO front. The European IPO window only really opened up in 2011-2012 so 2013-2015 were the busiest years as there was a need to catch up. You had private equity portfolios that had been sitting there for 10 years, so everybody went and offloaded in 2014 and 2015. It was good quality, there was huge volume, it worked and everything was fine.

As we head into a broader new-issue environment late cycle with deals coming from all corners of the world, we need to be mindful of crafting the right equity stories and matching them with what investors are looking for. Market capacity per se is not an issue,

Craig Coben, BAML: I don’t think the quality of the pipeline is as good now as it was, for example, in 2014. The first half of 2014 was unbelievably busy. Some of the companies that are being IPO’d now are perfectly good but you can’t just sell companies; you have to sell narrative, you have to sell stories. It’s not enough that a company is investable; if there isn’t a story behind it of growth, of margin improvement, of cash delivery, cash return, you’re going to struggle to achieve a premium valuation.

What we’ve had in many cases are perfectly fine companies being IPO’d that don’t excite the market and, as a result, investors who have various choices but who may not have that much in the way of inflows are being quite selective about where they’re going to invest in demanding price concessions.

I don’t think it’s a problem that we have 14 IPOs coming up in the market necessarily but, actually, when you look at them on an individual basis, the wow factor isn’t all that high across all 14. It is true that we have difficulty in controlling the timing of IPOs because we can only launch them off the back of results. It is very difficult to pull back or delay a process by more than a couple of weeks because your numbers go stale, you reach a holiday period or there’s some other factor.

We do get stuck into these timetables and it may not be the optimal time to IPO but I don’t think these deals are failing because of timing. They’re failing because they aren’t exciting the markets, and the valuations that had been pitched to them by the banks are far higher than what ended up being achievable and the expectations weren’t managed down.

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