IFR: Welcome everyone to IFR’s ECM Roundtable. We have heard a lot of discussion from the SEC, and elsewhere, about how access to private capital negatively affects IPO activity. Anna, with IPO issuance up more than 20% for the year on volume, and by one-third on number of listings, do you think the pendulum has finally swung from private capital into public equity markets?
Anna Pinedo: Oh no, not by any stretch. We are certainly seeing a healthy IPO market, and while that’s something that all of the panellists are very happy about, there is no shortage of private capital. We’re seeing enormous amounts of private capital being raised, particularly for tech companies.
The dynamic that has caused so much consternation for the SEC, regarding the overall decline in the number of US public companies, I don’t think that that’s changed or that it’s changing anytime soon.
So long as there’s private capital available, at attractive valuations, a lot of household names are going to stay private for as long as they can.
IFR: Thinking about how private market valuations extend into the public markets, software companies have been an important source of outperformance in the public markets. Craig, can provide some perspective on valuations for technology and software companies?
Craig DeDomenico: Obviously, investors want to buy IPOs at an attractive valuation. They’re hoping to get performance in the aftermarket.
If we look at the IPO asset class year-to-date, it’s up around 20% and we are on pace for something like US$60bn and potentially as many as 200 IPOs. That is obviously a pretty healthy market. But in order for that to be sustainable, the asset class needs to outperform the broader markets.
Nasdaq is up 17%. A good portion of that performance is coming from the technology universe. Ultimately, a portion of that universe that is driving performance has been software.
Four to five-time revenue multiples on software deals feels like a tough entry point. But the reality is the quality of the software IPOs that have come to the market this year is very high, and deals have performed well.
It reminds me of what we saw in 2014, where you had a very high-quality group of software companies become public. Again, similar valuations, and investors ultimately made a lot of money.
Whenever you’re buying an IPO, you’re taking risk on those projections and meeting expectations, as is the case with all newly public companies. Software companies help de-risk some of that volatility because they have predictable business models.
There is also an M&A floor underpinning software and that provides some downside protection to operational missteps. A larger average deal size [for software] also results in improved trading liquidity.
Overall, the IPO market has benefited from a wider variety of industries going public. The only industry that is tracking down year-over-year, in terms of number of IPOs, is consumer. We all realise why that is.
So it is a pretty good backdrop overall. As long as the asset class continues to outperform, we will continue to see a pretty healthy IPO market moving forward.
IFR: There are times when companies fail to achieve a valuation on their IPOs that they did on their last private raise, a so-called down-round. Akram, how challenging are down-round IPOs?
Akram Zaman: If a company is simply looking to raise capital, the private markets are obviously there, and very accessible, particularly for the higher quality companies.
But it’s important to consider that there are other reasons to go public: creating currency for acquisitions, incentivising employees, raising the company’s profile. Maybe the management team just wants to go public. There are a number of different factors.
Having said all that, generally there is a valuation concession required to go public, an IPO discount.
Nevertheless, there have not been too many IPOs of late that have been a down-round [to their last private valuation]. We’ve had a very healthy backdrop in US equity capital markets.
There are cases where there will be down-round IPOs, but again that may be because there are other motivations for going public.
When we speak to potential issuers, most want to go public at the valuation they got on their last round at least, ideally above that.
If the market were to roll over a bit and valuations come in, we could see the dynamic of down-rounds become more common.
James Dunning: The bigger test could happen next year, when we see some of the brand name tech companies that are bringing billion-dollar-plus deals at US$10bn-plus valuations.
This year, we have seen smaller-sized IPOs in the software and tech spaces.
There have not really been the big brand name private companies that have raised capital at super-rich valuations. Some of those could be forced to accept a discount. We are all in a bit of wait-and-see mode.
IFR: James, are you concerned about software valuations right now?
James Dunning: In general, no. We are in a market where investors are differentiating.
Some software companies are truly disrupters that are growing extremely fast. Those that have demonstrated a path to profitability trade at very high valuations – seven or eight times forward revenue.
It makes sense for those companies, if they are not going to get acquired, to access the capital markets.
Some software companies that are growing revenue at 20%, 25% annually trade at around five times. That is a historically high multiple for software companies.
Overall, we think investors are doing a good job of differentiating high-growth, premier software companies such as Zscaler and DocuSign from others that do not have the same level of growth or market opportunity but are still well run.
IFR: Craig, how have we seen those opportunities play out in the convertible bond market? Why does it make sense for investors to consider a CB and is that market overheating a bit?
Craig DeDomenico: Convert originators have been waiting years for this rally. A big reason for accelerating deal flow is companies terming out floating-rate debt exposure as we have seen interest rates rise. That accounts for about half of what we have seen in terms of new issues.
The other half is really coming from the technology universe, many of which went public in the 2014-2015 timeframe. A lot of those companies are funding in the convert market.
A lot of these companies don’t really need the money. They are locking in funding at 1% or sub-1% rates. That low-cost capital is supportive to their valuations.
Convertibles are a great way to pre-fund balance sheets for M&A. A lot of the big banks have been pressing that theme: Instead of straight debt and bank debt, which carry covenants, load up the balance sheet by issuing a CB.
If you can go to the board and tell them, “Rates are rising but we can get funding at a sub-1% coupon, which we can carry and earn more on interest earned from cash, with stock dilution at a 30% premium to a stock that is trading at five, six times revenue”, that is a pretty good funding tool.
A lot of what we are seeing in the convert market is related to that pre-funding theme.
IFR: 2014 was a memorable year in the IPO market. Biotech was a significant portion of deal flow then and remains an important source of investor outperformance and deal flow in 2018.
Steven, what is driving the level of issuance we have seen and is it sustainable?
Steven Tuch: The last time we had a downturn in the life science market was in November 2015 and January 2016, when Hillary Clinton tweeted that she was going to legislate lower drug prices.
[The threat of lower drug prices] had nothing to do with the quality of the companies and returns investors were making on IPOs. That threat did impact investor perceptions of the economics of drug development.
It took the market a long time to get out of that rut.
The positive shift in investor psyche happened well before President Donald Trump was elected [in November 2016].
Investors started to become more comfortable before then that it was not going to be easy to legislate lower drug prices.
Biotechnology is a little bit different than, let’s say, the software market, because there are macro issues.
The saying about biotech is that the second pill costs 10 cents and takes one minute to make, but the first pill costs US$600m-$1bn and takes 20 years to make.
There is always going to be a need for capital. The question is, “Will you get it from the public markets or will you get it from the private markets?” You prefer to get it publicly, because it’s a cheaper form of capital.
Access ebbs and flows on science. And it ebbs and flows on investors’ appetites for later stage versus earlier stage.
I cannot predict what is going to happen after the midterm elections [in November]. I also cannot predict the investor appetite will be after the JP Morgan healthcare conference in January.
Biotech is a sustainable market because it is so capital-intensive, and it has been performing. Overall, biotech IPOs are up about 20% on average from pricing. That compares with a 10.5% gain for the [Nasdaq Biotechnology Index] and an 8.6% return for the S&P 500.
If you played every single biotech IPO, you are outperforming the market significantly. It is not that way every year, but it is this year.
I would like to think that the markets will remain receptive to biotech IPOs. But I can assure you if the public markets aren’t there, there will still be biotechs that need to raise money.
James Dunning: Think about both tech and biotech. Investors are generally predisposed towards growth and companies with technologies that are disruptive. That is the type of IPO product that investment banks are bringing to market right now. Some of the biotechs are trying to develop cures for certain types of cancers. In the tech space, companies are changing the way business is transacted. That’s the new economy investors want exposure to.
Tech and biotech have outperformed the broader markets. That is the type of alpha-generation you can get from IPOs.
Banks have also done a great job at mitigating risk for biotech companies that are coming to market.
On a US$75m-$100m biotech IPO, typically US$25m-$35m is spoken for by insiders when they launch.
The ability to test the waters as part of the JOBS Act has helped issuers get comfortable before they launch IPOs. That is a big deal.
Everyone, from bankers to corporates and investors, is on the same page by the time a biotech wants to go public. And everyone is aligned in terms of exposure that a company is asking us to absorb.
Steven Tuch: I agree. An important part of the success of the biotech IPOs is the JOBS Act.
The JOBS Act has been really instrumental in allowing companies to educate investors. It was not meant to pre-sell an IPO. There is no jumping the gun. It is about really educating investors.
If an investor is meeting with a biotech for the first time on the IPO roadshow, they are not investing. I firmly believe that.
We have had corporate clients that have done 15 testing-the-water meetings, and we’ve had clients who have done 80. And the ones who do 80 end up having better results.
By the way, I’m not recommending a company do 80 meetings. Maybe 25-30; 80 takes a lot of time.
Investor education is an important factor of the success of the biotech market that is not going to go away.
Matthew Sperling: There is a little bit of a ‘mafia’ element to the pre-IPO biotech funding rounds. Public investors want to see those pre-IPO investors participate in the IPO. It’s a stamp of approval.
Steven Tuch: There are definitely the A-list private investors. From an origination perspective, we do get a lot of pressure from new investors. “Why are we not seeing X, Y and Z investor? Why are we not seeing A, B, C investor?”
The number one reason is that there might be five biotech IPOs and seven follow-on offerings pricing in a week. The last thing they want to do is take a testing-the-waters meeting when they are going to see you in four weeks anyway.
It is a valid point that we do have certain brand name investors that invest in biotech. We have had them for a good 10, 12, 15 years. Some have been spun out [of larger institutions] or start their own shops.
Biotech really has the benefitted from a strong, dedicated investor base. Even in down markets, they know what they know, where they want to be invested and where they don’t. They are not playing a schedule.
They know biotech. Frankly, I believe that during the next downturn they will still be in the market and will make money. If anything, [a hot market] drives them crazy because even inexperienced investors make money.
Matthew Sperling: The quality of biotech companies coming to market is important. In general, we are seeing companies that are in Phase II development or later. If we start to see pre-clinical or Phase I companies, that is where we could see potential pushback from the public markets.
There is a similar screen for tech or software companies that have sub-scale revenue profile, call it US$100m or less.
As soon as we start pushing the envelope, the IPO market could become very fragile.
IFR: Akram, how does the participation of crossover investors impact syndication of biotech IPOs? Are you seeing generalist investors participate?
Akram Zaman: We have talked a lot about biotechs, but crossover investment extends to tech, fintech, and high-growth consumer retail as part of a broader investor bid for growth. Those are the industries where we see most of the pre-IPO crossover investments, much more so than industrial, and energy and power.
That could change if there were a rotation out of growth and into value or if there were a greater emphasis on cashflow and total return. But for now, it is all about growth.
Once an investor knows that there’s a strong growth profile, the second question is: “Who are their pre-IPO investors?’”
A lot more traditional, public market institutions are moving into earlier stages of investment. That pre-IPO investment comes six to 12 months prior to an IPO. They are taking on more liquidity risk by investing earlier in a company’s lifecycle in an effort to generate alpha.
Any time you have a number of these pre-IPO investors on the cover, whether they are household brand names, specialist healthcare or specialist tech, that are willing to add to their positions is extremely powerful.
First of all, these investors are some of the smartest in a particular space, so their endorsement is important. Rather than selling at the IPO, they are adding to positions and are willing to own for a longer period of time.
Also, crossover participation takes away some of the supply being sold on a deal. If you have a US$200m deal and US$75-$100m is spoken for, there is just a lot less to go around. That is going to help out pricing.
We always try to have some of these pre-IPO investors involved in the IPO to provide support. Then we try to right-size the float, because one of things from an investor standpoint is the liquidity profile after the IPO listing and how will that grow.
Institutional investors want to know how much a stock will trade after an IPO. Obviously there are smaller, biotech and tech deals where there are limitations, but in general you want to right-size the deal to have a decent size float so that there is a good amount of stock being traded down the road.
IFR: We have seen a large number of foreign companies listing on US stock exchanges this year, despite trade tensions and tariffs. Carolyn, can you help us understand what is driving that deal flow?
Carolyn Saacke: Traffic has been particularly strong from China. We are seeing so many deals coming out of Asia. In 2017, we had 17 IPOs in the US out of China, raising US$3.3bn. So far this year, we have had 19 IPOs raising US$6.7bn.
There have been three US$1bn-plus IPOs this year, including [electric carmaker] Nio, the Tesla of China, which listed on NYSE yesterday [September 12].
You would not have seen this pace of foreign listings in the past. One of the big reasons we are seeing companies from China list in the US is liquidity. There is more trading liquidity on US exchanges than anywhere else in the world.
Some of that may be going to change that a little bit. The Hong Kong stock exchange recently passed rules to allow listings by companies with dual-class stock, which was part of the reason Alibaba chose to list on the NYSE in 2014. We have already seen companies like Xiaomi take advantage of that rule change to list in Hong Kong.
Another recent change implemented by the Hong Kong exchange is to allow listings by biotechs that are not yet profitable. That wasn’t possible before.
We are going to see a lot more companies, including biotechs, list simultaneously in both the US and Asia. There has been some news about one of the largest US biotechs doing just that at some point this year.
So there are some changes in the market for international listings. I still think from a liquidity perspective, because the US markets are so deep, US exchanges will continue to get their fair share of Chinese IPOs.
We have also seen some European companies list in the US, but not that much. The European stock markets have gotten stronger, so a lot of the new listings are remaining there. You look at a company like Adyen, the Dutch fintech payments company that listed on Euronext in June. In the past, they would have listed on NYSE. But there was enough liquidity [on Euronext], Adyen is a big enough company, and there were enough investors that wanted to invest. Investors were going to buy the IPO whether the listing was in Europe or in the US, so why not keep it in the home market?
We were hoping to see a lot more deals from Latin America this year. We started off the year really strong, with another fintech company [PagSeguro Digital] that listed with NYSE in January. Brazil can’t stop getting in its own way, right? We are not seeing as much out of Brazil. And Argentina is having its own problems.
But when companies need to raise capital, they do so here in the US. Hopefully, we are going to continue to see that for some time longer.
IFR: To be fair, the IPO market has been quite active in Asia as well.
Carolyn Saacke: Oh, absolutely.
IFR: Akram, we are hoping to call upon your international experience, given that you have had stints in Asia-Pacific, EMEA and the US. How does syndication of Asian deals differ from US deals?
Akram Zaman: Both regions have their pros and cons. In all honesty, it is really interesting. There are a lot of different factors that go into where a company wants to list. We have seen that process evolve over the last couple of years, and we are going to see it continue to evolve over the next couple of years.
I’ll focus on China because Carolyn mentioned it.
Let’s take Tencent, for example. They have been active in monetising stakes. We did a Hong Kong IPO last year for China Literature, which was one of their portfolio companies. They decided to list in Hong Kong. Tencent themselves are listed in Hong Kong. Then you would have seen in the press that Tencent Music is a potential IPO that will likely list in the US.
Often, many of these companies gravitate to their home market, but they also think about the peers. So, Spotify could be a potential peer for Tencent Music.
They also think about what the rationale is. Do they want to acquire companies potentially listed in the US? Do they want an even stronger US institutional shareholder base? Investors are becoming more listing-agnostic.
It is also important for companies to consider where their ecosystem resides. Alibaba and JD.com are listed in the US, for example. There are a number of very high-quality Chinese companies listed in the US, both on NYSE and Nasdaq.
There are a lot of different factors that determine where a company lists.
One final point I would make, and it’s arguably the most important, is where a company can get the best valuation. At various times, valuation arbitrage can vary between regions. We have seen take-privates of US-listed Chinese companies, and we have seen Chinese companies list in the US.
Every situation is very different, and the decision is very personal and based on a company’s chairman and its backers. Honestly, I don’t think we’ve really seen a trend established. We have seen really good companies list over here and perform and trade well, and others that have not traded as well. We have seen exactly the same thing in Hong Kong.
It will be interesting to see how the new regulations in Hong Kong impact whether those companies stay at home or whether they come here.
We still think that the highest quality buyside institutions in the world are here in the US. I’m obviously saying that because I work at Bank of America Merrill Lynch, but we really truly think that [US institutions] are the highest quality capital, and generally believe US listings allow for the best, overall global institutional participation.
The final thing I would talk about is retail. Obviously, you have US retail that participate in US stock listings, and then you have Hong Kong retail. There is a clawback mechanism in Hong Kong that has to be taken into consideration by issuers and investment banks in the pricing and syndication of a new deal. How that retail behaves in the aftermarket; how much they do contribute to the process?
The short answer is that there are a lot of different factors that need to be considered as to when and where a company gets listed.
IFR: Moving onto one of our favourite topics: cannabis. Tilray went public in July and is the top performing IPO of the year [up 605% from offer at the time of the roundtable]. Canopy Growth is another Canadian grower that listed on NYSE in February and followed up with a convertible bond in June.
Steven, do you see anything in common here in terms of those financings?
Steven Tuch: We can add cannabis to the list of growth industries. I find myself in a unique situation here, because BMO is a bank. In the US, cannabis is still illegal under federal law.
BMO did a deal in Canada for a cannabis company that I was not involved with, I could not be involved with, nor could anybody in the US. Any institution that has a banking licence in the US, could not be involved. While I work on BMO’s US equity capital markets desk, I could not even tell you when the roadshow was. The process was completely ring-fenced out of Canada.
And by the way, one of my lawyers is in the room so I am waiting for her to shake her head violently one way or the other!
But cannabis is a growth industry. And it’s becoming legal state by state. But until federal laws change, investment banks that are chartered with the Federal Reserve cannot participate in underwriting securities for cannabis companies. There are investment banks that are not regulated as banks in the US that can.
Do I think cannabis is a good industry? In countries where it’s legal, such as Uruguay and Canada, it is a very good business. In the US, it is a business that US banks cannot participate in today, until the laws change. So ring-fenced is the only word I can use.
IFR: Carolyn, can you talk a little bit about the NYSE’s listing rules as they relate to cannabis?
Carolyn Saacke: Absolutely. We get calls every day from cannabis companies that want to list. They want to know how the rules have changed and how our approach has changed.
In 2017 we listed a company called Innovative Industrial Properties, a triple-net lease REIT that has customers that grow cannabis in states where it is legal to buy and sell cannabis for medicinal purposes.
There was something known as the “Cole Memo” [issued in 2013 by US deputy AG James Cole] that basically said that the US attorney general would not get involved in matters if cannabis is legal within a state and as long as it is not distributed. Even though cannabis is illegal on a federal level, we were able to get comfortable on very select situations where companies are not buying, selling or marketing in jurisdictions where cannabis is illegal.
Jeff Sessions [appointed as US attorney general in January 2017] later came in and said the Cole Memo no longer applies, so we are now a little bit more concerned. NYSE is very much on the same path as Nasdaq, by the way. You’re not going to see one exchange go one way legally and another exchange go the other.
Right now, if a company is doing business in the US, where cannabis is illegal, we will not list you. Full stop. Canadian companies [the federal government legalises cannabis on October 17 2018] are absolutely fine. Each of the exchanges then looks at it from a reputational perspective and what that really means. All exchanges have some discretion whether or not they are going to list a company for any reason. We are just looking at it day by day.
We are getting a lot of calls from clients in the US talking about how they believe cannabis is going to become more legal within 12 months, 18 months, depending on how aggressive that particular management team is. We are also hearing from more institutional investors and investment banks in the US that are taking meetings with these companies.
It is going to be a really interesting to watch how cannabis evolves as an industry.
Matthew Sperling: Just to back you up on that, since Labor Day [September 3], we have been inundated from investors looking for cannabis opportunities, whether that is in the private market, companies that are listed in Canada that are considering a potential US listing, or even just conferences to educate themselves on the industry.
It is interesting. From the buyside, cannabis is a sector that has never been covered. Where does it fall? Is it a special situation? Is the asset class here to stay? Maybe it falls into consumer staples.
There are a lot consumer staples companies at conferences talking about the effect of cannabis to their industry, their bottom line, and whether they are trying to partner with the industry. There is a view that cannabis is definitely here to stay and I can tell, just from the opportunities I have seen over the last year and a half, that there are a lot more investment opportunities than there’s ever been.
The breadth of investors that are looking at the industry now is not only hedge funds and not only high-net-worth private individuals. Cannabis has definitely become topical among mutual funds, if not already an investment.
James Dunning: Obviously, Tilray has garnered an unbelievable amount of attention from investors. But I would point out that Charlotte’s Web, a Canadian company, went public before Labor Day and has been well received by the investment community.
I believe the cannabis industry definitely has legs to it, despite the comparisons to cryptocurrency. I can’t make that connection.
I agree with the others, it will be interesting to see how cannabis is covered from the perspective of research and trading.
IFR: I would like to move on to Spotify and its direct listing in April. Carolyn, can you walk us through the direct listing process and the regulatory approvals that it made it possible?
Carolyn Saacke: The process actually started a couple of years ago with three bulge-bracket investment banks calling me within 48 hours, asking “can we do a direct listing of a really cool company without any IPO?”
On the first call, you tell them what the rules are and you’re like, okay. The second call hits and you’re like, interesting. Then by the third call, you realise something is up.
It took a couple of years for us to work through the regulatory process. We worked with both the SEC and Spotify for quite a long time.
We looked at the rules that we had in place: you can list an IPO this way, you can transfer a listing this way, and this is how other types of securities can be listed. But we didn’t have anything in place that would allow a direct listing like Spotify.
We spent many, many months working through multiple drafts before the SEC approved the direct listing processes in February 2018.
The rule allows a company with a market cap greater than US$250m, with at least 400 shareholders, and 1.1m shares outstanding to directly list. A company also is required to have an independent financial adviser.
The direct listing rules are very similar to what are required for a traditional IPO, with similar protections such as for retail investors.
Just looking at the public filings and the media coverage, it appeared that there was a clear track being followed once the direct listing process was approved.
But there was a lot of work being done behind the scenes. There were three financial advisers that were working with Spotify. Citadel Securities was hired as the designated market maker and floor specialist. Spotify was working with its financial advisers for three months.
There were a lot of complexities. Multiple shareholders, both institutional and retail, that did not actually own a tradable security, so all of them needed to be set up with accounts.
You need to make sure that there are enough shares that you can actually short the stock, if investors wanted to, after the listing. There were so many steps along the way that made this possible.
The good news is that all of the regulatory steps for a direct listing are in place. The next one is going to be much easier. As a side note, the SEC direct listing rules can be used on both NYSE and Nasdaq.
James Dunning: Carolyn, a quick question. How much of the success do you believe was based on the fact that it was Spotify?
I mean everyone knows Spotify, even my parents. I can walk through Times Square and ask who knows Spotify, and every single hand will go up.
Some of the unicorns, even the tech unicorns, are not as well-known as Spotify.
The plumbing and infrastructure for a direct listing are in place, I get that. But how easy will it really be for the next company to directly list?
Carolyn Saacke: You are absolutely right. There are a few things that made Spotify special and that made its direct listing work. They had breadth of investors, many of whom had been there for a long time.
There was a lot of marketing by the financial advisers to gauge interest from those investors; whether they were going to stay put and that not everyone would sell on day one. That everyone was able to sell was a big concern. On the other hand, you do want some selling by existing investors to create liquidity, because there is not an actual offering [of new stock].
From a research perspective, Spotify already had coverage before their listing; they are such a big company that has been around for a while. They also provided a lot of financial forecasts as part of the direct listing.
You also have to remember that there was an active grey market in Spotify shares ahead of the direct listing on NYSE. In the first 10 days of March, the average daily trading volume in the grey market was 500,000 shares, which is huge for a private company. The average price on those grey market trades was about US$132.50.
The night before the direct listing, the financial advisor put out a reference price of US$132. Yes, the reference price was influenced by trading in the grey market, so there was a little bit more certainty around valuation.
Matthew Sperling: One other key to Spotify that is unique, well relatively unique, is that it is still growing despite being such a large company. They did not need to raise primary capital. If they did, Spotify would have been in regular IPO land.
Rothschild advised one of the major corporate owners on Spotify. We also advised another consortium of independent record labels.
I do believe that Spotify will end up being a relatively unique set of circumstances that will not apply to as many situations as the news headlines would suggest.
Having said that, kudos to Spotify and the financial advisers for pulling off the direct listing. The press and everyone was ready to write their “Facebook trading debacle story” if it didn’t go well. It did go quite well.
It is important to compare the direct listing process to a traditional IPO. While a traditional IPO is not perfect, we spend a lot of time talking about ways to improve the process, and how to make the process more transparent.
A traditional IPO bookbuild has a cadence whereby some of the variables are fixed up front in terms of supply, an approximate notion of value, and then an orderly process that investors can choose whether they want to invest and at what price.
There is a negotiation between investors and a company’s owners and management. “I’m willing to accept your offer and buy at your price or here is my counteroffer.”
Of course, there are all sorts of dynamics around those negotiations and the process is fairly opaque to begin with. But one of the things that made Spotify particularly complicated, and again, they pulled off the direct listing, is that what normally is a week-and-a-half long process was mashed into three hours in an open outcry auction process.
There was no feedback loop and no variables fixed.
Essentially you had owners sitting there saying, “I have a grid in my mind, I’m willing to sell X at this price, maybe Y if it’s at that price”. And you had the buyside looking at this, saying, “I’m willing to buy X at this price, and Y at that price”.
Ultimately, somehow, they needed to meet in the middle. Having spent hundreds of hours on this, I think the success of Spotify’s direct listing is best evaluated when compared to a more traditional billion-dollar-plus tech IPO.
And, even though the stock has since obviously performed, the near term was a little bit more dicey. You had a stock that opened very high and traded down 15% on day one.
Everyone talks about retail and that everyone knew Spotify. The reality was retail participated very little in that transaction. Why?
Most of the banks turned their retail systems off because the argument was we don’t have the information as to what’s actually going on and so we’re not going to let our financial advisers loose and put grandmas and other clients into this deal.
So, Spotify ended up with only USS$1bn of liquidity on the initial trade, whereas the hope was that there would be more. And, that liquidity dried up pretty quickly.
Carolyn Saacke: Actually, I have to disagree with that. The opening was very similar to what you would see on a traditional IPO. On a traditional IPO, a stock opens based on indications that come in throughout the morning. That opening price is not likely to be the price that was set on the IPO the night before.
There is an iterative process based on conversations between banks involved in the underwriting syndicate, the designated market maker or floor specialist, and all of the traders involved. Based on those conversations, the bid-ask indication moves, and narrows over time.
In the case of Spotify, it took about an hour for that first range of indication to be published. The first indication was a US$10 spread, which for a US$132 stock is not too shabby.
There were eight more indications; the last one was a spread of US$3, which signalled to the market that we are ready to go, that the opening was going to be within this range.
There were certainly some that suspected some of the sellers, were like, “Well, we’re just going to wait and see how high the stock goes on the open”. They started selling a little bit when the stock hit their targets.
Matthew Sperling: I agree. The whole objective was to get that initial float large enough to balance buying and selling. But if you look at Alibaba, who Rothschild also advised, there was US$25bn of float trade in the first day.
Frankly, one of the biggest challenges for Spotify would have been if some of the large shareholders decided to sell less in a way that no one anticipated. There is, obviously, human emotion involved throughout all of this.
We were in the frontlines. You could have had a situation where the first-day volume was double what it was; or where it was one-quarter, say only US$250m. If it were the latter, a lot of people would have been writing, “Oh my God, the deal failed”.
Arguably, that is a risk that some companies and owners may not want to take.
I completely agree that the plumbing has been fixed. There are a lot of elements to the Spotify listing that are positive. If you look at what Spotify management have said about the process, they certainly achieved some of the objectives they had hoped for from the direct listing.
Spotify’s direct listing certainly affects the conversations that issuers can have with investment banks on a traditional IPO. “Look, we are going to get covered by as many people because of who we are. We are going public through a syndicate of four bookrunners but we expect another 25 will cover us.”
Then there is the concept of an IPO discount – Spotify talked about how they did not like the notion. One could argue the discount is not the same for every transaction. Certainly, larger IPOs tend to have smaller discounts. If you are an issuer and you have that size dynamic on your side, that’s a positive. Pricing above range obviously narrows the discount.
Going one step further, a company could approach the underwriting banks and say, “We are not giving this away. We are going to price our IPO where the market is”.
There will be a more open dialogue going forward between issuers and their underwriting banks around valuation. Investment banks may not like it, but the discount may smaller.
IFR: Certainly, there was an element of democratisation of capital behind Spotify’s decision to directly list. Google had a similar motivation when it went public through a Dutch auction bookbuild all the way back in 2004. Google’s IPO process was flawed in many ways, and we really haven’t seen companies go public via an auction since then. I think we can all agree there are growing pains with such innovations.
Matthew Sperling: The market doesn’t like uncertainty. And in the context of pricing deals, the market likes to think things through in an orderly process. What is the valuation discount? What does the book of demand look like? Where is this stock going to trade in the aftermarket?
The notion of having a lock-up in place is, arguably, an important tool to bring investors to the party. Basically, the investor understands that if I’m buying this I know that I have got 180 days. Obviously, if the stock performs, the company or its shareholders may go to the underwriting banks and request to be released from the lock-up.
But there are norms. In the case of Spotify, there were uncertainties surrounding how the book of demand was being built and how much supply there would be at any given price in such a short period. Again, it worked, there is no doubt.
Personally, I do not believe [a direct listing] is going to be replicated in as many situations as others believe.
I can only speculate that the buyside institutions that bought on that US$1bn of liquidity on the open were not happy to see the stock trade down 15% on the first day. Obviously there had to be sellers on that opening trade.
Carolyn Saacke: There is a reason why the IPO process really has not changed that much in 30 years: because it works.
The NYSE does like that there are companies exploring alternatives ways to go public. We do need more public companies in the US. There are a lot of advantages to being public.
The direct listing was an interesting way for this one company to go public. Maybe we’ll see some more companies look to directly list, or maybe just borrow different elements from Spotify’s process.
IFR: One element that allowed Spotify to directly list was that there was already a deep, liquid private market in their shares to facilitate liquidity. The SEC has recently discussed broadening access to private capital to a greater number of investors. Anna, what is the latest you are hearing out of the SEC?
Anna Pinedo: At a recent speech in Nashville, SEC chairman Jay Clayton talked about looking at ways more retail investors could be brought into the private markets.
This is a theme that we’ve heard over and over from the SEC - too few public companies, an over-reliance on private capital, and private companies experiencing significant growth while private. Their preference would be for companies to go public and allow the general public to participate in or benefit from that very significant growth.
Clayton’s point is that the vast majority of investors are unable to participate in private placements because they are generally limited to large institutions and accredited investors.
It becomes a line in terms of loosening regulatory burdens surrounding private capital or making it more appealing for companies to go public.
Is that initiative ultimately going to go anywhere in terms of not having an accredited investor standard? Unlikely; I don’t see that changing.
The SEC came out with a study on the accredited investor definition. Congress, at least on the House side, passed what’s referred to as JOBS Act 3.0, though the legislation has yet to be considered by the Senate.
JOBS Act 3.0 has a provision that would modify the definition of an accredited investor to broaden the scope. It would not broaden the definition in really significant ways that would be impactful, in my opinion. The provision would allow individuals, regardless of net worth and net assets, who have certain accreditation, such as CFAs, CPAs, or certain brokerage licences, to qualify as an accredited investor.
At the periphery, that could make a difference expanding participation in private placements.
But fundamentally, you have to question whether there’s really a problem. I would argue that a lot of crossover funds – and we have already heard that crossover funds are very actively investing in promising growth companies – provide retail access to private capital.
Even if that access is disintermediated through a crossover fund, retail can still participate in those growth opportunities.
IFR: What other aspects of JOBS Act 3.0 should we think about?
Anna Pinedo: JOBS Act 3.0 would generally be quite positive for the market. For example, it would expand the ability of pre-IPO companies to test the waters beyond emerging growth companies (EGCs). So, all companies would be able to test the waters.
I think everyone on the panel believes that testing the waters is a useful process.
The legislation would also extend exemptions for smaller companies with lower revenues to Section 404(b) attestation under Sarbanes-Oxley. [Editor’s note: Section 404(b) obligates management to attest to internal controls over financial reporting].
Life sciences companies, which Mayer Brown frequently represent, would fit within that low-revenue issuer category. They would not have to dedicate valuable resources to the 404(b) attestation and could defer that obligation for a significant period of time.
Fundamentally, I think that is very useful.
Another significant point contained in JOBS Act 3.0 is quarterly reporting. A long time before President Trump’s tweet about abandoning 10-Qs, the legislation had put measures in place that would require the SEC to conduct a study to evaluate the merits of quarterly reporting for EGCs.
The SEC would also be required to carry out a study on research coverage and how to promote additional research for smaller companies.
We have not really talked about research today. For many smaller companies, going public is a very expensive process that provides little assurance that they are going be covered from a research perspective. That weighs heavily on management.
IFR: Craig, do you have thoughts on research coverage for smaller companies?
Craig DeDomenico: If you look at the traditional IPO process, underwriting syndicates have gotten larger, not smaller. I would argue fees have gotten lower, not higher.
But there is no doubt that an IPO is a material, expensive event, between fees paid to lawyers, auditors and investment banks. And, frankly, going public takes a lot of time. It is a high-cost event.
There are reasons that companies raise money privately, and one of those reasons is that they need money to go public.
Whether a company goes public through a traditional IPO process, through an up-listing, through a bankruptcy reorganisation, or by a SPAC merger, it comes down to the same blocking and tackling.
Management teams need to make sure that they have the processes in place to be a public company, that they are comfortable with quarterly earnings, guiding investors, and accountability to their board of directors; that they’re ready to be a reporting company, that they practice being IPO-ready, that they treat projections and the board and their quarterly reports that way.
I think smaller companies can get public in the current market backdrop, as long as there is a story and there is growth. If you look at a US$60bn IPO market this year, there are about 200 companies, so it is not only mega-caps.
Middle-market companies continue to dominate the IPO calendar. Those are our clients and, ultimately, there is a lot of time spent by investment banks and lawyers to help them stage and prepare for going public.
I do believe it healthy to think about the process going forward. At one time, testing the waters used to be a bogeyman for some firms. Now, all firms see it as valuable.
We could see roadshows shrink in size by a day or two, depending on the type of company and objectives but I do think the current process is relatively efficient.
Ultimately, the hard part of our job is picking the right companies [to go public] and turning down the ones that should wait. But there’s nothing like pricing a successful IPO in terms of a relationship with a company.
IFR: Matthew, what is your outlook for the rest of the year and into 2019?
Matthew Sperling: Clearly, we are off to a strong start after the Labor Day holiday, as everyone expected. It will be interesting to see if and when the midterm Congressional elections [in November] start to affect the calendar.
Arguably, the post-Labor Day start would have been stronger, but the physical calendar in terms the holidays has made it a little bit more complicated. There is a lot of high-quality product. There is also a lot of cross-border activity.
Flavours come in waves. The question, of course, starts to become whether the third, fourth or fifth similar transaction is digested as easily as the first. I believe that we could see some indigestion and that some of that could be driven by volatility in and around the midterm elections. If conditions aren’t disrupted in November, then we should see a strong finish to the year, which would set up 2019 very well.
Predicting what will happen in November is pretty impossible to do. There are certainly lots of prognosticators talking about, “If you have split congress or if you have one branch this way and the other that way and then the presidency that way, what could that mean more generally?” We will see.
IFR: Carolyn, what is the NYSE seeing in its pipeline?
Carolyn Saacke: I completely agree with Matthew about the midterm elections. If you look at our calendar, September and October are extremely busy. Everyone wants to get out before the elections.
Typically, at this time of year, there would be companies saying, “I’m aiming to go in December”. This year, everyone wants to go beforehand and give themselves that extra bit of cushion.
It is going to be a very strong end to the year. Obviously small transactions are getting done, but there are also some big deals, some bigger brands, some names in industries that we haven’t seen in a little bit.
It should be a really good year and hopefully, knock on wood, that will lead us into a really good 2019 as well.
IFR:Excellent. I would like to open it up for questions from the audience.
Audience: Diving a little deeper into cross-border listings, particularly out of China. What is really driving that deal flow? How do you differentiate between all of the investment alternatives?
James Dunning: You’re right. We have seen a ton of new paper coming out China, and our understanding is there is a lot more in the backlog.
For J Goldman, we really do look at those companies on a case-by-case basis.
We want to make sure that a company is sizeable enough that it is not going to become a public orphan. That it will have research coverage from Asian or US analysts, so that it will have the right investment community following the story.
There are going to be some big deals coming down the pike that we believe will be very well received, assuming the valuation makes sense.
There is a bifurcation at the smaller, sub-US$500m market cap Chinese companies, where investors are a little bit more discerning.
If you look at Pinduoduo [US$28.5bn market cap Chinese e-commerce platform], Nio [US$8.3bn market cap], or iQiyi [US$19.6bn market cap Chinese social media platform], they are well above their IPO price.
But some of the sub-US$500m, or maybe even US$1bn, market cap companies have been left as public orphans.
There are a lot of education companies that are going public that can be hard to differentiate. The fourth, fifth lookalike might not be as well received as the first or second, especially if the first or second is trading below where they went public.
Craig DeDomenico: It only takes one or two to earnings misses out of the gate for investors to lose confidence. Scrutiny to meet earnings expectations is more intense for foreign companies. That puts pressure on investment banks to ensure we are bringing the right type of companies to market.
Investors can lose patience really quickly, particularly with small-cap companies.
James Dunning: Cross-border transactions are always going to be trickier. But I do believe companies and underwriting banks are doing the best they can to minimise risks.
There are a lot of high-quality cornerstone investors that are putting real money behind some of these companies. And they are not the same cornerstone investors over and over again on every deal. There is a nice breadth, whether it’s strategic out of Asia, US long-only mutual funds, reputable global hedge funds, or sovereign wealth funds.
Just like with smaller-cap or biotechs, it really helps to have dedicated industry expertise that participate. Having a deal insulated with insider buying helps, going back to supply-demand dynamics that are important on every IPO.
Audience: My question is about private markets. What role do investment banks play in facilitating liquidity? Are there specific exchanges that make a market in private stock?
Anna Pinedo: Yes, there are organised markets. Nasdaq, obviously, through the Nasdaq Private Market, sponsors trading in pre-IPO companies. Those are generally company-sponsored liquidity programmes.
There are smaller venues, such as EquityZen, that will facilitate trading and will post pricing for transactions that are executed in privately held companies. Some of that information is publicly available, particularly to accredited investors.
Away from organised venues, there are negotiated transactions that broker-dealers will facilitate, particularly if they have agented a private placement for some of those companies. They will facilitate trading off-exchange, not through a Nasdaq Private Market or through any other vehicle, to find buyers.
For a lot of the large private companies, there is significant trading.
Matthew Sperling: In the case of Spotify, there were a number of investment banks that were making a market in the stock before the direct listing. They were deliberately speaking with all of the potential sources of supply. Those discussions helped create transparency among the advisory group as to when and how trades were happening.
Akram Zaman: Many of what you would consider public market institutions, mutual funds that buy our IPOs in size, were all holders of this grey market or private security. That was very, very interesting, and it allowed this facilitation to happen.
Matthew Sperling: That is a very good point. When you talk to the key banks that were advising, there was a lot of uncertainty as to what the aftermarket buying would be because a lot of the funds that would be traditionally buyers in the aftermarket already owned stock.
Audience: What type of activity are we seeing from private equity firms?
IFR: Sponsor-backed IPO volumes are down about 50% so far this year.
Matthew Sperling: There was a period of time with [Apollo Global’s] Leon Black talking about, “We’re selling everything that’s not nailed down”. Some of the lower issuance we have seen is the natural cycle of many firms monetising everything that was monetisable. Other IPOs that were in the works ran a dual-track process and chose to be acquired rather than go public.
ADT was certainly one IPO that a lot of investors were clearly not happy about. But I’m not sure that investors hold grudges against a particular private equity owner.
If there is a high-quality company, with a great investment story that is priced right, rarely would you see an investor say, “But it was brought to the market by X, Y, Z and I don’t like X, Y, Z”.
They might ask tougher questions, they might poke the underwriting syndicate more strongly around other areas to gain leverage to move pricing down on an IPO.
The slowdown in sponsor-backed IPOs is also a function of the current cycle.
If you look at the breadth of the IPO market, tech and healthcare are an enormous chunk of it, with more growth equity and deals away from traditional sponsor-backed companies.
Carolyn Saacke: The same sponsor [Apollo] behind ADT did another transaction [PlayAGS] just one week later that performed really, really well. Everything is going dual-track, and so we had sponsor-backed companies that were lined up to go public that have since been sold.
IFR:Thank you everybody for coming today and thank you to Stifel and Mayer Brown for sponsoring the roundtable.
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