IFR ECM Roundtable 2018: Part 2

IFR ECM Roundtable 2018
37 min read

Keith Mullin, KM Capital Markets: There’s a lot of stigma attached to deals that don’t work. That’s partially down to bankers’ competitive spirits running away with them. But is the stigma attached to a deal that doesn’t work overdone, and should we conclude that it’s quite reasonable to have deals that don’t work?

Luis Vaz Pinto, SG CIB: There’s definitely something about the way deals get done in Europe versus the US. It’s a truism that when you get to the end of the process in Europe and the deal hasn’t worked, you’re generally talking about something that needs to be repriced 20% down. That’s fairly traumatic and there’s negative press around it.

You have to think that’s because of the preparatory steps in Europe that you don’t have in the US. You’ve had the analysts running around with research, you’ve had early-looks, so you’ve got a lot of data. When you come to the end of that, you’ve somehow misread the data.

Either market conditions have changed dramatically in the two weeks or it might also be that some collective judgment has gone wrong. Either the company imposed pricing that was unrealistic versus what the market was asking, or the bankers didn’t have a good read. We’re all fallible.

When you get to the end of the two-plus-two period (two weeks of investor education, two weeks of roadshow) and you get it wrong, then you’ve really got it wrong. In that regard, it’s right that there should be some negative press.

In the US, since you have a more dynamic process, when you get to the end of the process and it doesn’t work, you say: “OK we’re just going to adjust the price and off we go”. There’s no negative headline attached to that and I think that’s right. If we change the process, maybe the headlines around changing the price range will change.

Audience question: Craig, you mentioned that the move from active to passive has an effect on how you do deals. Could you comment on that a little more?

Craig Coben, BAML: We need active funds to invest in our transactions and there’s almost an existential question around actively managed funds right now because passive funds over a cycle have been outperforming active, especially long-only funds. If that trend continues, it makes it more difficult for us to be able to price transactions. We can’t rely on passively managed funds.

We do have hedge funds but hedge funds come in a variety of shapes and sizes. Some are fundamentally driven but we have seen the emergence of a whole group of deal-orientated hedge funds. All of us work with them. We believe they’re necessary for transactions but they need to be sized appropriately and we cannot rely on them to complete transactions. We need to have active long-only fundamental money. If they aren’t getting inflows, it has an impact on our pricing.

It’s not always apparent so it’s very difficult for us to know what the exact impact is going to be. In fact, with some of the investors we get orders from, say, from the mutual fund complexes, it’s not always apparent which fund it’s coming from. It could be index money. It could be the hedge fund buried in it or it could be a long-only fund.

Often these are blue chip names and sometimes you get a surprise when, in the aftermarket, that blue-chip name has sold out of its position or they were a declarable stakeholder and then they’re no longer a declarable stakeholder. It just makes our lives much more difficult. We benefit from active fundamental money, people trying to derive alpha through traditional research and analysis. As we move away from that, the price discovery process is impaired and we find it more difficult.

Audience question: The Spotify direct listing attracted a lot of commentary. To what extent has this come up in discussions with prospective IPO clients and how worried are you that you might start to lose some business if more companies opt for the direct listing model?

Craig Coben, BAML: It hasn’t come up in a single conversation I’ve had. I’m not worried about it. It’s not an entirely unprecedented structure. There are certain specific aspects around Spotify that allow them to do a direct listing but I would be careful about extrapolating too much from one transaction. We’ve done demergers many times, the stock trades normally and they work out fairly well. That’s one of the arrows in our quiver.

Luis Vaz Pinto, SG CIB: Just to draw a parallel, there hasn’t been a lot of innovation in our market, let’s face it. One of the clear examples of innovation was Google in 2004. The company wanted to do things differently so they did a modified Dutch auction. They said, “let’s go out and canvas demand like it says in the economic textbooks; we’ll find the supply and the demand and we’ll just cross the line there”. It was an absolute failure. The price range at the time was US$108-$135.

They ended up pricing at US$85 and to add insult to injury, on the day they priced it, the shares closed at I think it was just over US$100. Clearly, even the economics of that weren’t working out. The market cap of the company at the time was US$20bn. It’s obviously gone on to great things but it’s more the fact that Google is a great company and whatever they did it was going to sort itself out.

I think Spotify might fall into the same camp but can we do a Spotify for every single company that’s out there? I don’t think so. I think it’s a one-off. We’ve seen demergers that have used the same method but it’s for very specific circumstances and very specific companies.

Suneel Hargunani, Citigroup: I agree it’s a one-off. It hasn’t really come up in conversation. Spotify is a large-cap, well-capitalised well-known brand so didn’t need to raise primary funds. They had a research following plus they had raised cash in the private market so there was a liquid private market that offered some valuation benchmarks. There are not a lot of companies that tick all those boxes that will lend themselves to that structure, hence why we don’t think it’s going to become too common.

Keith Mullin, KM Capital Markets: I want to talk about the emergence over the last few years of pre-IPO finance, which has been available in much greater quantities. Has the emergence of late-stage pre-IPO private money – not just private equity but fundamental equity funds too – impacted the process of going public? Are companies staying private for longer?

Christoph Stanger, Goldman Sachs: In the private equity world, there has been a clear trend of keeping companies private for longer, especially in the tech sector. It’s obviously good for owners to stick with them if they’re high growth and wait for the IPO, assuming the overall market tone is likely to stay positive. There are funds that support that and provide financing in the private world.

Beyond that, if you segment this into: is there a deal structure element coming out of seeking investors on the private side, whether you call it a cornerstone investor for an IPO or a pre-IPO private investment? There is certainly a rising tendency of that in Europe; we didn’t really see it 10 years ago. But even though it’s more frequent it still isn’t prevalent.

And you have to be careful and structured. Too often, buzzwords and chatter will fly (“you have to see all the sovereign wealth guys in the world and they will miraculously open their wallets and provide the best value”; that’s a dream that rarely plays out) and it can be a big waste of time from a seller’s perspective.

But there are situations – and technology is at the forefront of this – where taking in incremental money, either from private equity or from a strategic buyer or from an institutional investor who is minded to doing it, may work. Delivery Hero went public last year and had a big investment from Naspers about two months ahead of the IPO.

That company now is worth around €7bn and Naspers, over time, increased its position, actually helping to take out some of the other previous owners who wanted to sell even after it went public. That’s a symbiotic relationship that can work out over time and can have benefits for both parties.

These issues have to be analysed carefully and questions have to be discussed.

Does taking in private money just ahead of the IPO provide a ceiling to your pricing? Are you hurting yourself because you’re negotiating with one party rather than with the market? Does that provide you with less pricing power? Once you’ve done it, does it impact your ability to price the IPO higher than the price you agreed with that one party, especially if the timeline between the investment and the IPO is short?

The answer you’d normally have to give is ‘yes’. That is a risk. Why would the market pay you more than the private guy who just came in two months ahead of time? The only scenario where this is not the case is if the demand for the company is so high that people are willing to pay through it.

I used the example of Delivery Hero on purpose because that’s exactly what happened. The investment was made about two months prior to the IPO but the IPO priced through it because everybody wanted it. It’s a tough discussion if you are an owner of an asset as to whether you want to engage in this process, and you have to assess it carefully.

Silvia Viviano, JP Morgan: We need to differentiate the US market from the European market. In the US, it’s a much more consolidated practice. Private investors come into play well in advance of the IPO - I’m talking about a year to 18 months - so it doesn’t influence the IPO price. There is a big market around that. In Europe, it’s not so common. You need to be careful, as Christoph said, because you don’t want to fix the price in advance.

What we have seen recently, with Nippon Life coming in as an anchor investor in the DWS IPO, or the sale of Vivendi’s shares in UbiSoft, with Tencent and the Ontario Teachers’ Pension Plan acquiring stakes, is that these are strategic partners who are aware of deals wanting to put some skin in the game at IPO. It’s not a must-have but is something that has been super-appreciated by investors and that has sustained equity stories in the pricing of the deal.

Craig Coben, BAML: I’m surprised we haven’t seen more of this. Outside of tech and especially in the US, you would have thought with all these private pools of capital that there would have been more opportunities. Some of the investors we deal with have pockets for private investments because they want to get into an investment early, potentially at a better price. In practice, it’s been difficult to pull together a lot of these transactions.

Private pools of capital want very favourable terms, which vendors don’t see any need to give them. Also, it isn’t institutionalised and organised in a way that makes it very easy to distribute. Unless you have somebody coming to you or calling you saying they’re interested in an asset, it’s sometimes difficult to know where to start.

There are so many family offices, sovereign wealth funds, and private pockets within institutional investors that it’s very difficult to

know who to approach unless you’ve had some reverse enquiry. We haven’t seen it. The US tech situation is still, I think, sui generis. We can cite examples in Europe but they’re very anecdotal and I don’t think it has been an institutionalised development yet.

Keith Mullin, KM Capital Markets: I want to move on to deal management tactics and the strategies needed to get deals over the line, the benefits and disadvantages of syndicate size, and other factors. What are the key factors in this market environment?

Suneel Hargunani, Citigroup: De-risking is probably the key word in this environment as we think about deals. What’s the end goal? It’s getting an appropriate valuation with the broadest shareholder base. It’s about early engagement from fundamental investors, having investors understand the story, meeting them once or twice so at the point of IPO you’ve got confidence that you’ve got supportive institutions that will help validate the price.

The DWS example is a great one. It had been in the public domain for a while that Deutsche Bank was going to spin off that asset. Conversations with Nippon Life obviously started early and that resulted in an announcement. Likewise, they got Tikehau publicly disclosed as an anchor investor in the bookbuild.

I call it de-risking but we shouldn’t look at it as a bad thing. It actually provides validation, both from a price perspective but also confidence to the rest of the market that very smart investors or strategic partners are willing to buy the equity. We need to see more of that. It’s certainly easier in larger liquid situations.

What we’re seeing potentially in the UK, with FCA reforms requiring us to put out a document beforehand, will probably help the buyside understand the equity story ahead of time, will give them more content so enable the IPO process to be a true selling engagement process centred on trying to find the true price rather than just a one-way education process, which it is with some investors just because of the amount of time they look at it or their preparedness to look at it.

Keith Mullin, KM Capital Markets: Can you comment on syndicate size? Not a new subject but a recurring theme. Is it reciprocity at play? Can you have too many cooks?

Suneel Hargunani, Citigroup: Well you can and you can’t. Ultimately, regardless of how many banks you have, the issuer or the vendor is paying the same overall fee so it’s just cutting the pie into smaller or larger pieces. Ultimately, large syndicates have always been a theme of the IPO market and they continue to be. What we’ve seen over the last couple of years is title inflation where the global coordinators, if there are enough, are the real active bookrunners, and bookrunners are the old co-leads in terms of their influence or their access to the bookbuild.

Large syndicates are important if they’re complementary. There are a lot of banks with niche distribution or greater expertise in one region. If you think about an IPO, you want full education of the market and full distribution to the market as well. As any issuer looks to form its syndicate, typically it shouldn’t be based on reciprocity; it should be based on what is the best syndicate to enable the best distribution and education of my story.

That goes to the analyst community as well. We’ve had large syndicates for a long time and I think they’re here to stay because, ultimately, what each syndicate member does can be controlled.

Keith Mullin, KM Capital Markets: Luis, can you weigh in on this? The other element I wanted to bring in as part of this is what’s the optimal fee structure for an IPO? Not in the sense of the higher the better but what works? Are incentive fees a plus? What fee structure makes the underwriters come together and work for the benefit of the deal?

Luis Vaz Pinto, SG CIB: In terms of syndicate size, I agree it’s not about reciprocity because the seller, be that a corporate, a financial sponsor or another party, is taking the decision. When they take the decision, they take it based upon the capabilities of the various banks. Syndicates are not going to get smaller for the simple reason that the economics of the cash equity business with MiFID II are getting worse and, therefore, most banks have been lightening up their distribution.

To get the full coverage that Suneel is talking about, syndicates might actually have to get bigger. Not to the point, like 20 years ago, where you used to have a European syndicate and a US syndicate with all the regional banks and the real global coordinators sitting at the top. I don’t think we’re going to go back to that but we’re not going to get small syndicates from where we are now simply because these deals need to get distributed, and distribution is getting tougher.

In terms of fees, it’s not the higher the better but there’s always a real question about why they’re so high in the US versus Europe. The European market is very competitive, hence fees are more competitive and therefore lower.

As to the structure and your question about fixed fees versus the incentive, you need a fixed fee to cover the cost but you should incentivise banks, for example. When you have syndicate members that are doing a very good job, say, in a particular geography, issuers should have the discretion to reward that.

Keith Mullin, KM Capital Markets: But what does an incentive fee incentivise you to do that you wouldn’t normally do under a fixed fee structure?

Luis Vaz Pinto, SG CIB: When you have a syndicate structure where you have 10 banks – four global coordinators and six joint bookrunners – you may have a situation where the four glocos say they’re doing all the work and the joint bookrunners may conclude there’s little incentive to do anything. They’re just going to say, “well, if it goes wrong, the fault is at the top; we’re just in for the ride”.

If the issuer has more discretion in terms of who is rewarded then the bookrunners are probably going to motivate themselves to have more meetings with their analysts, to have their salespeople make more sales calls, to look at specific pools of demand that the glocos may have not targeted.

It’s not going to be Fidelity because everybody knows how to call Fidelity but it’s going to be some more niche, regional accounts, Tier 2s, Tier 3s, which will be allocated appropriately but will help provide momentum to the transaction. This is important, particularly given that some of the big Tier 1 long-only funds will only give you their order on the last day.

These funds want to benefit from that negotiating power. They’ll say: “I’m not going to give you the order that’s going to get the book covered on day one. If I can get away with it, I’d rather do it on the last day and influence the pricing because I’m showing you how powerful my order is vis-à-vis the book”. The faster you can get demand, be it through cornerstones or more diffuse distribution, the better for the transaction as a whole.

Keith Mullin, KM Capital Markets: How easy is it to get true book size where you get order inflation, particularly on hot deals?

Craig Coben, BAML: There’s no formula; you have to bring some judgment to bear. It depends on the investor; it depends on the environment; it depends on how attractive the IPO is. You can assess the amount of inflation, if any, in the book. Actually, except for the really hot IPOs, we don’t see a tremendous amount of inflation. I think the issue is slightly different; it’s the signalling effect of allocating a high percentage of an order to an investor.

In other words, if we’re allocating 90% of an order to an investor, that investor may infer that the transaction did not command a great reception and, therefore, that investor may decide to sell simply because of the deal dynamics irrespective of the fundamentals. That’s really the consideration that we have to take when we’re thinking about allocations.

It’s not just how much people have inflated or how much they want but also what inferences can be drawn. I’ve had IPOs that have been 1.7 times covered and which have traded well. I’ve had IPOs that have been 10 times covered that have traded poorly. There is no formula.

It’s harder because some investors are quite sophisticated about how equity capital market transactions work and they try to game the system, in sizing the order and when they put in their order, because they want to get a certain allocation. They want to get allocations on good deals and they want to avoid getting stuffed on bad ones, like everyone else. They play around with it and we’re reading the runes of this book and, sometimes, it’s not that apparent where the real interest lies.

Luis Vaz Pinto, SG CIB: That’s why, sometimes, when you have a slow deal, ie, a book that’s not covered on day one, it may trade better because everybody in the book knows why they’re in. They’ve sized their order appropriately and they’re not waiting for day one to go out and sell. The deal’s going to trade in a nice and steady way rather than a deal where there’s a lot of hype, everybody has put in big orders and it trades so-so and everybody is rushing for the exit.

Audience question: I’m interested in the panel’s thoughts on the value of IPO advisers. Is value actually added or does it just unnecessarily complicate the process?

Suneel Hargunani, Citigroup: One thing is clear: I think they are here to stay. Advisers have an important role to play, particularly as we talk about syndicate sizes. Often, the independent adviser is the one who directs the traffic and directs the noise to shield the issuer from 10 to 12 banks all going directly.

An independent adviser will be additive, clearly. A lot of advisers are aligned with the company, the issuer, the vendor way before the banks, for example; they understand the asset and can really help with their knowledge. They’re called independent advisers for a reason; it is deemed that they are looking out for the interests of the issuer.

The banks are clearly also looking out for the interests of the issuer as well but, ultimately, banks and advisers have done lots of IPOs together now; the majority of IPOs have an adviser, we work well together, and we’re all looking for a common goal of a successful IPO.

Craig Coben, BAML: If you look at the pension fund world, you have pension fund consultants who advise pension funds where to invest. They don’t go directly to a hedge fund or to an institutional investor and put their money; they need to have somebody independent to guide them and assess the various options.

We live in a world with a lot more audit and compliance and accountability for these decisions so it’s inevitable that when a company or a vendor is selecting banks for a mission-critical capital market transaction like an IPO, they’ll want to seek an outside consultant. That’s the role the IPO advisers play, in the first instance, to help guide them. What’s going to be interesting is the effect of the FCA reforms on the IPO advisers.

The FCA limits the ability of companies and their advisers to interview research analysts. Previously, a lot of advisers would organise meetings with analysts before the IPO pitch or right around the time of the IPO pitch. That practice was a key value-add of IPO advisers because they could do something that none of us at sellside banks could do. The regulators have now made that a lot more difficult so we’ll have to see how that plays out.

Christoph Stanger, Goldman Sachs: On syndicates, I disagree with what was said. You don’t need a huge syndicate to get a deal done. In fact, I think it creates risks rather than advantages: too many banks at the back of the bus taking a ride but not really steering. If it comes to the necessity of having to steer the bus, you suddenly look around and everybody points to the other guy and they figure out there’s no driver.

This notion of needing a large syndicate to get a deal done is wrong. If you have a large syndicate you need to ask yourself why. I don’t think you have it for distribution purposes. Every investor gives one order, whether there are 10 banks or 15 in a syndicate, it doesn’t change that. It’s one order. Therefore incremental banks will only add value from a distribution perspective if there was demand you felt could not be accessed with a smaller group of banks.

From my vantage point – and this might sound a little biased – I would say the top banks would definitely find 95% of all orders that are out there. If you have 10 banks, fine but it’s not going to change the distribution outcome.

Adding banks to syndicates may have other considerations like maintaining relationships, obtaining lending commitments or speciality research. These are valid purposes but are unlikely to improve the success of an IPO.

On IPO advisers, it’s really important to have clarity of responsibility and the value-add of different parties. The best adviser is an adviser who deals with complexities on the part of the seller or sellers. Think of a corporate with a supervisory board, shareholders and stakeholders with different interests; there’s value to be added. Or governments, where this role initially came from; governments want somebody on their side to help them because they don’t know how to do it themselves.

Once you start overstepping the line, going from your side to the other side, you start to blur the picture. Good advisers don’t do that because they know that. The bad ones do and it’s not a good outcome. Investors eventually interact with banks and they want their views to be reflected and heard.

Careful delineation is important. Not everybody chooses an adviser. It can be a very good and symbiotic relationship in situations where it’s complicated, but it’s not always like that. A differentiated picture is the right one.

Silvia Viviano, JP Morgan: I think what Christoph said will prove to be really important now. It’s such a busy pipeline and we will need to have conversations with some issuers and sellers in terms of valuation. It will be important to see how advisers will act; they can sometimes act a little like the enemy, facing off against the banks and pointing fingers when we have to have tough conversations. It will be very important for them to work alongside the banks to get deals done.

Keith Mullin, KM Capital Markets: We need to bring our conversation to a close so to conclude could you provide a forward view on expectations for the rest of the year?

Suneel Hargunani, Citigroup: The pipeline is strong. The markets might be challenging, but in terms of what the banks see looking out for the rest of the year and what we potentially could launch and price, it’s strong. We feel confident about the supply side. Last year’s volume was driven by bank recaps. Many of the banks raised capital, initially from a defensive perspective and then, towards the end of the year, we saw some from an offensive M&A perspective.

We won’t have as much as that this year but we hope a lot of that will be replaced by M&A financing. The M&A market was strong last year and it continues to be strong this year. In a rising rate environment, you may also see more equity issuance to support primary financing.

Finally, we’ve seen a number of carve-outs – we spoke about Healthineers and DWS – companies looking to crystallise value and find ways of realising value by spinning off some of their assets. This is a theme we’ve seen over the last year or two. We continue to see that and given where valuations are, we expect more of those types of transactions this year.

Luis Vaz Pinto, SG CIB: I agree, M&A is strong; we’re at a 10-year high in Europe. And four of the top five deals in Europe have been consolidations so we’ll eventually get some carve-outs. I think the macro environment is sound in terms of corporate earnings. That remains to be confirmed but I’m optimistic. The pipeline is there and investors are there.

One thing we haven’t talked about, which, for me, is quite encouraging is something that exists a lot in the US but not so much in Europe: SPACs. They’re a tough sell because you’re essentially handing a blank cheque to somebody to invest in deals. You’ve no idea what it’s going to be; you just rely on the reputation of the person, but these are getting done; I think the volume is about €1.5bn for the full year. This shows that there’s a lot of money waiting to get invested. That ultimately gives me confidence for the rest of the year.

Craig Coben, BAML: I think corporate action will definitely be a key part of the pipeline going forward. We have quite a few emerging market IPOs in the pipeline but I think it’s going to have to rebalance towards Western Europe.

One development we haven’t discussed is MiFID II. MiFID II comes into effect this summer and it is going to have an enormous effect on the secondary market and on cash equity franchises.

It will have a knock-on effect on the ECM business but it’s not really clear exactly how. You cannot have such a major change in the cash equity business without it eventually affecting what we do and how we do it. Whether we’re going to see that this year or next year I don’t know but I do expect that there will be various unforeseen consequences of MiFID II.

Silvia Viviano, JP Morgan: I agree it will be very important to see what happens with the emerging markets deals in the market. We didn’t really discuss the FCA reforms in the UK that will come into play this summer and will change the way IPOs have to be done. It will be interesting to see what’s going to happen after the summer with UK IPOs.

Christoph Stanger, Goldman Sachs: Activism, up. Corporate streamlining, up. Spin-offs, carve-outs, getting down to the core, up. M&A, up. The secondary market, I think down; and the IPO market, on a level of last year. Alternative financing is on the rise, either early investments, SPACs, private placements, funds, structures like that, all on the up.

Keith Mullin, KM Capital Markets: Thank you for some very frank and insightful comments.

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