IFR Equity Capital Markets 2007

What a difference a year makes. After a frenzied 2006, Japan equity issuance is down almost 60% in 2007, global convertible issuance is down 60% and moving strike convertible bond (MSCB) issuance is down a staggering 95%. A sea change in conditions has battered public market issuance but has also resulted in a bonanza for private structured deals.One after another, banks have announced complicated and highly tailored deals including Resona Holdings’ ¥350bn (US$2.93bn) preference offering, Liberty Global’s ¥86.4bn block trade, Goodwill Group’s ¥15bn warrant offering and Fujitsu’s ¥200bn of convertible bonds. The string of high profile deals have generated headlines and, more importantly, large profits for the banks involved, making them the must-have deals of 2007.“These types of deals certainly have become a more important part of the business in Japan,” said Alex Large, head of Japan ECM for JPMorgan, “In a quiet year for traditional issuance, they have been especially significant”The deals have also dominated the league tables with Morgan Stanley representing the only one of the five overseas firms in the top ten that has not delivered a structured trade.Recent interest in structured solutions has emerged as a result of a deeper currents within the Japanese equity markets. Perhaps the most important trend has been the development of shareholder activism in Japan.A number of overseas investors led by Steel Partners, Perry Capital and the Children’s Investment Fund, as well as powerful domestic institutions such as the Japan Pension Fund Association, have increasingly pushed for greater influence over the corporate agenda.Their aggressive dividend demands and return on equity requirements concentrated minds across Japan’s corporate landscape on the importance of shareholder voting rights, dilution and the danger of takeovers.Nearly 10% of Japan’s listed companies, or 378 firms, announced measures to fend off unfriendly buyout bids by June this year. Against that backdrop, corporate managers have started looking for financing structures that target well-defined financing aims and provide greater control. “Japan’s corporates like certainty and investor control, and priate deals are ideal for meeting these aims,” noted Alex Woodthorpe, head of Asia Pacific ECM at Merrill Lynch. Merrill was able to provide Resona with that certainty by buying all of the ¥350bn preference shares that the bank issued to help pay back government funds. Merrill also took responsibility for dealing with the investors, something that Japanese corporates still prefer to avoid.Another factor that is clearly subduing equity issuance is the exceptional health of Japanese corporate balance sheets following successive years of record profits. With capex financing tailing off and M&A needs still muted, Japanese corporates have been content to focus on their more prosaic financing requirements. The ¥200bn convertible bond refinancing from Fujitsu in August may have come earlier than expected but it seems to reinforce the argument that the agenda is no longer being pushed by market impetus.One final trend that may be driving the structured boom is the complete disintegration of the MSCB market, which has fallen 95% this year. Worries about the share price impact of such deals forced the government to introduce new MSCB regulations in July, but for many issuers the structure was tainted long before the government took action.The correlation between the fall in MSCB issuance and the growth in structured deals is striking but may not be directly linked as there seems to be a clear migration in the quality of issuer considering structured products.“MSCBs were primarily for distressed companies, the story of the last 12 months is the move of highly structured products to investment grade, blue chip firms,” Large noted.Minimising dilutionDespite the interest surrounding these structured deals, some bankers are quick to warn that the distinctiveness of each trade means

When the qualified institutions placement (QIP) was introduced to Indian equity markets in May 2006, many market participants expected it to spell the demise of the depositary receipt. So far this year, however, a whopping 62% of the US$18.2bn raised by Indian issuers in equity markets has come from offshore. The sheer volume of equity issuance year-to-date – the largest amount in the past decade – is a sign that Indian capital markets have arrived. Buoyant offshore issuance this year has been underpinned by a handful of large-scale ADS follow-ons by issuers that already have an established ADS program. These include ICICI Bank’s US$2.15bn ADS and HDFC Bank’s US$700m ADS. Two exceptions are Sterlite Industries’ NYSE listing, which raised close to US$2bn including the shoe and Genpact’s IPO, which raised close to US$500m. These four deals alone accounted for close to half of the US$11.4bn raised offshore year-to-date. By comparison, GDR issuance remains fairly muted this year as issuance is largely being supplanted by the QIP format. “There has been a slowdown in GDRs. Aside from Indiabulls Real Estate and UTI Bank, we have not seen too many GDRs getting done,” said Ravi Kapoor, head of Indian equity capital markets at Citi. “ADRs are different ballgame because you can get into many liquidity pools such as POWLS (public offers without listing) and there are still premiums for ADRs,” he added. Like companies elsewhere, Indian issuers generally seek out listing destinations where they are likely to get the highest value for their stock. It was for this reason that in March 2006, Birla Copper became the first Indian issuer to list on the Australian Stock Exchange. The deal, which priced at the top of the range, proved a great success and provided the company with a decent valuation because Australian investors understand mining companies better than investors in many other markets. Similarly, Indian IT companies have usually been able to get better valuations in the US for their equity, with ADRs issued by tech firms such as WNS and Infosys trading at significant premiums to underlying domestic shares. For many of these IT companies, their customer base is in the US and they choose to list there because it gives them a higher profile among investors. There are deterrents to Indian issuers aspiring towards a US listing, however. For one, it is far more expensive and there is the presence of the Sarbanes-Oxley. “It’s probably 50% more expensive to do an ADR…you also have a longer process if you have to deal with the SEC. If it’s a GDR, it depends on what market you list it on, but the local regulators aren’t as difficult there,” said Michael Sturrock, a partner in the Singapore office of Latham & Watkins. ADR deals generally require two sets of legal counsel – which leads to higher costs – and the issuer is faced with strict liability issues as US investors are more litigious. A fast-tracked ADR deal takes about 120–180 days from kick-off to finish, whereas a GDR takes about 60–90 days due to faster clearances from the exchanges, said Sturrock. GDRs to die a natural death? The long listing time in the US has led some Indian issuers to head to Luxembourg or London’s AIM, where the process of listing is much faster and the regulatory environment much more relaxed. AIM, for example, has attracted a slew of Indian real estate listings, though it remains to be seen if it is a passing fad. However, GDR issuance in markets like London and Luxembourg are hampered by issues such as a lack of liquidity and flow back to domestic shares. Since a major motivation of going down the DR route is to get to get a better premium, it makes little sense of Indian issuers to go through the expense and listing requirements of a GDR if trading is then illiquid and they are unable to get a premium. According to a banker, potential issuers who are looking to issue a combination of equity together with a foreign currency convertible bond (FCCB) may prefer to

The revival of the Chinese domestic market over the last 12 months has caught global spotlight. The terrific economic growth, high-flying corporate earnings and tremendous liquidity have constituted a rocketing A-share market. Since January 2006, the Shanghai A-share Index soared 314% and closed at a historical high of 5,060.19 on August 13.The flying Shanghai index is now acting as a driver for movements in other markets. The A-share market, which in the past did not have much impact on the Hong Kong stock market, is now influencing the ups and downs of the benchmark Hang Seng Index and H-share index.And the Hong Kong market is not the only one to come under the spell of the A-share market. An 8.8% slide in the Shanghai market on February 27, triggered by the fears of monetary policies to cool the overheated market, led to a global market corrections of 2% to 3%.The A-share market rebounded quickly after the deep correction, emerging from the turmoil even more prosperous than before. To cool the red-hot market, the Chinese government raised interest rates five times consecutively, and lifted banks’ required reserve ratios nine times in the past year.In a series of unexpected measures, the government tripled the stamp duty on share trading in May, and a further relaxation in the Qualified Domestic Institutional Investor (QDII) programme, should help to drain about US$7bn of liquidity.All the implemented measures, however, only had a temporary impact on the mainland stock market and in all cases, it bounced back faster than anyone expected. The soaring market lures more and more citizens to put their money into the stock market, with the latest figures showing that China currently has about 100m retail investors, the highest number in the world.In addition to its attempts to regulate demand in the stock market, the Chinese government also aggressively increased the supply of good quality listed companies to cope with that excess demand.After intensive encouragement by the mainland regulators, Hong Kong-listed H-share companies such as China Life Insurance, Ping An Insurance and Bank of Communications all went back home to list in the Shanghai market. Other H-share companies lining up for a home listing in the next two months include the Rmb50bn (US$6.59bn) float of China Construction Bank and the Rmb40bn (US$5.28bn) A-share IPO of PetroChina.Chinese regulators are also eager to bring red chips (companies which operate in China but are registered outside China) home. Currently, China only allows domestically registered companies to list in the A-share market, but new rules are being drafted that will open the door for red chips. Red-chip entities such as China Mobile and the PC maker Lenovo have been looking at spin-off listings in Shanghai that could raise renminbi-billions.Bringing giant mainland companies home is not enough from the mainland regulator’s point of view. Early this year, it began blocking corporate attempts to go for overseas listings.In September 2006, the China Securities Regulatory Commission (CSRC) announced a moratorium on offshore SPVs that makes red-chip overseas listing difficult. And beginning this year, the regulator also put its foot down to prevent companies that raise less than US$1bn from listing in Hong Kong.The measures are effective. The mainland IPO market raised US$20.6bn as of mid-August this year, almost matching up the US$21.6bn raised in the whole of 2006. The staggering sum amply demonstrates the depth of PRC liquidity and the Chinese market’s capacity to digest IPO deals. The bourse is also expected to beat Hong Kong on IPO fundraising this year.While China is opening its market door, its heavy interference remains. The control of the QDII and the qualified foreign institutional investor (QFII) scheme is arguably necessary given the non-convertible nature of the currency. But the bizarre interference in other financial areas inevitably raised eyebrows in the market.To protect its recover

There is no disputing the success of AIM since inception in 1995. The real growth, however, began in 2004 when admissions leapt from 162 to 355. The amount of money raised, both from IPOs and follow-on offerings, has also grown substantially. In 1995 flotations raised £514m, rising to £9.9bn for 2006. Secondary offerings, which are possibly a greater demonstration of the faith that investors have in a market, grew from £302m to £5.7bn over the same period.Overseas companies have played a large part in that growth, particularly over the past three years. Just 16 overseas companies were listed in 2003, rising to 124 in 2006. So far this year, a further 39 have joined the market, meaning that 24% of its members now come from outside the UK. Much of this is down to a growing awareness of AIM around the world, helped by the LSE’s decision to set up teams focusing on different regions. The recent takeover of Italian exchange Borsa Italiana should also give a welcome boost to AIM’s visibility in continental Europe. Lower listing fees are a big part of the attraction, with added benefits of no minimum freefloat required and no minimum track record rule. Another big attraction is the location. London has long been regarded as the ideal place to list, because of the size of the investor base and the number of investors with knowledge of the small-to-mid-cap sector in the UK. And small to mid-caps can gain the sort of visibility on AIM that would be difficult on a senior market.“Companies with a market capitalisation of less than US$1bn find it hard to generate interest from institutional investors and analysts”. Tracey Pierce, head of global business development at the LSE.The tightening of US market regulations, following Sarbanes-Oxley, and the US requirement for quarterly reporting has also driven an increasing number of North American firms to London’s AIM.The number of admissions by US companies grew 39% last year to 25, and 13 more have joined the market so far this year. US securities laws require that their shares trade in certificate form for the first two years. That has naturally led to settlement and liquidity problems for some companies. The huge growth in international admissions, and criticism from oversease exchange operators, particularly in the US, led the LSE to review AIM’s regulatory structure. The LSE’s main market is regulated by the UK Listing Authority. By contrast, AIM is regulated by its own in-house team. The FSA officially supervises the regulation of AIM, but day-to-day management is left in-house.The review resulted in the introduction of stricter procedures for companies with a market capitalisation above £300m and those listing GDRs. Another outcome was the adoption of a formal rule book for nominated advisers (nomads). Alongside the new nomad rulebook, regulations have also been introduced this year requiring companies to maintain a website and disclose information in areas such as corporate governance. Some of AIM’s success, however, comes down to the fact that many of its members simply did not qualify for a listing elsewhere. It has been described as “dangerous” by US billionaire financier Wilbur Ross, who highlighted that a number of companies had fallen far short of the business performance they had been forecasting when they floated on AIM. However, other bankers say that investors are aware that AIM is intended for small, early stage growth companies that do not meet the requirements of the main market, and the level of risk is bound to be greater. “Ultimately, the proof of the pudding has been in the eating. An ever increasing number of institutional investors have been prepared to put their clients’ money into AIM,” said Marcus Stuttard, the deputy head of AIM.Alternext and First North, the junior markets of Euronext and OMX respectively, are much smaller than AIM but have also grown rapidly. Alternext recently celebrated its 100th listing, raising over €1bn from IPOs and follow-on deals

The lines between public and private equity have blurred in recent years. The advent of alternative listing venues targeted at institutional investors have further obscured those lines by enabling private-equity firms and alternative asset managers to sell stakes in themselves without the headache of a traditional public listing. The importance of trading platforms developed by Goldman Sachs, Nasdaq and others, have arguably been enhanced by regulatory scrutiny of the industry and recent market volatility.While private companies have been able to raise capital in the private equity markets for decades, the process has been unappealing to both issuers and investors because of a lack of transparency and antiquated technologies used to trade stock. Under Portal, a platform launched by Nasdaq in 1990 to facilitate trading of 144a securities, both debt and equity, investors were required to contact broker-dealers directly to buy and sell securities.“It was a great place to raise money but a terrible place to trade securities,” says John Jacobs, executive VP at Nasdaq, which operates Portal. Nasdaq enhanced the liquidity of the system, where both equity and debt are sold, with the launch of a centralised trading platform on August 15 this year.With registration rightsIn the late 1990s, Friedman Billings Ramsey Group (FBR), a regional investment bank, helped change the way that institutional investors thought about private equity. One concept that would gain popularity was simply to offer registration rights on private stock sales. This enabled companies to raise capital in the private markets by selling stock and, within 180–270 days, allow initial investors to realise a return through a public listing, either a marketed IPO or simply registering the shares with the SEC.This became a favoured strategy for investment firms looking for start-up capital that, once deployed, would enable them to achieve the higher valuation in the public markets. KKR Financial, a mortgage REIT formed by its namesake, marked the height of the private-to-public equity format in June 2005 through a US$800m IPO that featured six bookrunners led by Citi and that included FBR. The listing satisfied registration requirements as part of a US$775m private placement the previous August.A shortcoming of the private-to-public model is that fees eat into the amount of capital that can be deployed. The large number of copycat financings also made it difficult to attract new investors in a marketed public sale, which at times resulted in a disorderly distribution of shares upon registration. More importantly, such private stock sales failed to address the fundamental problem, the lack of a centralised, electronic exchange.FBR provided one answer when it unveiled FBR PLUS (Private Link to Unregistered Securities), an electronic trading platform that provides qualified institutional buyers (QIBs) access to trading information, in June 2007. At launch the system displayed transaction volumes, latest pricing, indications of interest, and trading history on 14 144a securities where the firm acted as placement agent. It currently supports 17 securities.“We’ve had this system in place since 2002,” notes Lauren Burk, a spokesperson for FBR Capital Markets, a majority-owned subsidiary of Friedman Billings Ramsey Group. “FBR PLUS represents the latest upgrade to the platform by providing additional information about each trading security and using Bloomberg as the distribution platform.”Tracking shareholdersGoldman Sachs provided a competing solution when it launched its GSTrUE (Goldman Sachs Tradable Unregistered Equity) trading platform in May. A subtle, but critical feature of Goldman Sachs’ solution is the ability to track the specific number of shareholders, something that at the time was not possible through existing systems. The bank worked with American Stock Transfer & Trust Company, a shareholder services firm, to develop a proprietary mechanism to settle trades.T

Since stock exchanges began to float 20 years ago, the issue of consolidation has never been far away. The need to satisfy their shareholders, as well as their users, has made life much more complicated for exchange managers. The major exchanges have always had a regular dialogue, and recent years have seen more cooperation agreements as a response to globalisation.The first significant merger in the sector, the tie-up between NYSE and Euronext in 2006, has led to many exchanges scrambling to find partners in a bid not to be left behind.US technology exchange Nasdaq, was again rebuffed by the LSE earlier this year, and then consoled itself with the purchase of Nordic exchange group OMX. The London Stock Exchange (LSE) is to acquire the Italian group Borsa Italiana, and the Chicago Mercantile Exchange and the Chicago Board of Trade have just completed a merger. In Australia, the Sydney Futures Exchange and ASX, the Australian Securities Exchange, also merged this year.The desire to grow and raise their profiles is common to all exchanges, but those in the US have also been influenced by the impact of recent legislation, such as Sarbanes–Oxley, which has discouraged some overseas companies from listing in the US.The complexity of exchange mergers means that successful deals are generally agreed by both parties, but that was certainly not the case with Nasdaq’s bid for the LSE last November. The ferocity of the language used by the boards of both companies was remarkable, and probably did little to help Nasdaq’s case. Its offer duly failed, and in August, the US exchange mandated JPMorgan and UBS to advise on strategic options for the the disposal of the 31% stake in the LSE that it had amassed.The LSE’s recent €1.6bn takeover of Italian exchange group Borsa Italiana is expected to give it a market capitalisation of £4bn and all-important admission to the FTSE100 index. That could allow the LSE to demand an even higher price from any prospective buyer.The LSE’s move for Borsa has as much to do with preventing NYSE Euronext or OMX from acquiring it as it does to do with establishing a firm base in continental Europe. A surge in new listings and an increase in interest from investors in the Italian market also played a significant role, but Borsa had been considering its own flotation, and that would clearly have made it more vulnerable to a bid from elsewhere.“Exchanges know that their visibility and profile is a function of their size, the larger the exchange the better the visibility of its listed companies,” said Jukka Ruuska, head of Nordic Markets at OMX and president of the federation of European securities exchanges. Increased visibility is seen as a positive for the big players in the sector and although a listing can boost the profile of smaller exchanges, it can also attract unwelcome attention from larger peers.New York’s decision to merge with Euronext last year brought with it a number of complications due to the potential problems of regulation and cultural differences. But there are obvious benefits. Euronext and NYSE have horizontal business structures and they both generate most of their income from trading activities on a simple trading platform. Growth comes purely by adding extra asset classes to the platform.Other exchanges such as Deutsche Boerse have silo structures, generating most of their income from post-trading activities such as clearing and settlement. Combining companies with different structures is much more difficult and costly.Most ECM bankers are comfortable that exchange consolidation will have little impact their business. “The choice of listing venue is unlikely to be materially affected by consolidation in the exchange sector,” said Jeroen Berns, head of European ECM at ABN AMRO Rothschild. “The decision about which exchange to list on is much more influenced by other factors, including tax treatment, the company’s domicile and whether its home market has any peers. Getting onto a specific in

Brazil was always referred to as the “country of the future.” For Bovespa, the Brazilian stock market, that future is now. In just four years, Bovespa has made it from the sidelines into a pre-eminent listing venue and is quickly becoming one of the hottest targets for growth capital in the world.It is staggering to consider how rapidly the exchange has grown. In July 2003, a mere US$3.7bn in stock trades were completed on Bovespa and the exchange had a total market capitalisation of US$161bn at the time. The total value of listings now stands at US$1.1trn, with monthly trading volume reaching a record US$45.4bn in July 2006.A developing capital markets industry and the adoption of world-class corporate governance standards have been a significant driver behind that maturity. Ahead of the traditional summer slowdown in late July, a record-high 54 companies raised R$41.2bn, about US$22.4bn, through new stock listings. That compares with R$8.8bn (US$2.8bn) and 15 sales of equity in 2004.“We are in a unique point in the history of our stock market,” says Carlos Antonio Magalhaes, technical vice-president of Apimec, a capital market professionals’ association in Brazil. “The huge world liquidity is also coming to our shores and our interest rates are at record lows.”Domestic retail investors also are becoming more comfortable with the concept of ownership. A good example was the vast R$4.1bn (US$2bn) IPO of card processor Redecard in July, which drew a record 30,000 retail investors.The advent of the Novo Mercado, a sub-segment of the Bovespa that imparted a higher standard of corporate governance, was a big reason behind the boost in investor confidence. Novo Mercado was created in 2000 to fight back a sharp decline in the number of listed companies and trading volume in the end of the 1990s. Among other requirements, companies listed in Novo Mercado sell only voting stock, with full tag-along rights, and have to float at least 25% of their shares.A new law creating a clear framework of rules designed to protect minority shareholders in 2001 and later, the smooth handover of power to left-winged Luiz Inácio Lula da Silva, helped to reassure investors. The stability coupled with steady growth catered to foreign investors, but it also helped attract Brazilians into stocks, which partly explains the recent bout of activity. According to the national investment-banks association Anbid, while fixed-income funds recorded net outflows of R$12.2bn in 2006, stock funds received R$8.4bn. Plus, local liquidity has never been so high. In 2006, open investment funds took in a net R$68.8bn, 213% more than the previous year.The moderation of interest rates, which were historically maintained at high levels to fight inflation, helped draw investors to equities. The benchmark rate in Brazil currently stands at 11.5%, a historical low. And, despite a recent up-tick in inflation, market consensus is that the central bank will cut rates at least another 0.5% before stopping. The central bank started a long series of rate cuts in September 2005, when it lowered the benchmark from 19.75% to 19.5%. Building blocksReal estate is probably the sector that benefited most from the declining costs of borrowing. Just two years ago there was not a single company from the sector listed in Novo Mercado. Currently, the sector boasts the largest number of listed companies.Cyrela, the first homebuilder to be listed in Novo Mercado, began trading in 2005. Since then, the number of real-estate related companies on the Novo Mercado has surpassed 25, with 15 initial public offerings from the sector this year alone. Results were mixed in all these IPOs. Still, the fact that almost all of them managed to price within range suggests investors are betting that lower interest rates will unleash the huge contained housing demand in the country, currently estimated at 8 million units. “The key to this sector’s growth is the possibility that banks will move more heavily into

After living with the threat, US companies with net-share settle convertibles have come to the realisation that they will most likely have to account for both the debt and equity portions of the bond separately beginning January 1 2008. While bifurcation was largely expected and adoption will bring US accounting standards in line with those of the rest of the world, the short-term impact is dramatic and will challenge originators to come up with alternative solutions.Net-share settled convertibles, or cash-par settle, allows issuers to account for earnings dilution for shares that would be issued only for levels above the conversion price. Because of their favourable accounting treatment, the net-share settle bonds proved a popular way for companies to undertake leveraged recapitalisations or to repurchase stock in a way that was friendly to existing stockholders.Since the beginning of 2005, when the provision gained popularity, 220 of the 390 convertibles issued have been structured with net-share settle provisions. That represents about US$120bn principal of the US$170.9bn raised over that time period. “The rule change may very well kill the use of net-share settle,” said Dana Trier, a partner at Davis Polk & Wardell, of the Financial Accounting Standards Board (FASB) decision to bifurcate net-share settle bonds.The proposal, which was approved in principle by the accounting board’s board of directors at a meeting on July 25, would obligate companies with net-share settle converts to account for the debt and call options as distinct securities. The board was expected to put out a proposed staff position formalising the proposal by late August; followed by a 45-day comment period, making ratification likely by early December.If approved, bifurcation would require issuers to account for the value of the bond at what an issuer would pay for a similarly structured straight debt instrument. Any residual value is attributable to the call option, or vice versa – the actual interpretation has not been determined.A company that issued a US$100m, 10-year net-share settle convertible with a 2% coupon, for example, initially would be bifurcated as US$64.5m of debt and US$35.5m of equity. The value of the debt would accrete toward par at the issuer’s ordinary cost of debt, requiring adjustments over the life of the security.The change would result in higher interest expense flowing through the income statement, though the accreted value is non-cash, “phantom” interest. Instead of US$2m, annual cash interest expense for the 2% convert, the expense would rise to US$4.6m, a 127.8% increase, in the first year, increasing to US$6.7m in the final year, according to a recent report by Bear Stearns.Phantom menaceOverall, the “phantom” interest expense would depress net earnings of net-share settle issuers by 9.0% and 9.2% in 2007 and 2008, respectively, estimates Venu Krishna, head of US equity-linked strategies at Lehman Brothers. The FASB proposal does not currently envisage a grandfather provision, obligating companies to retroactively restate earnings back to the date the net-share convertible was issued. “It’s not so straight forward to restate the earnings data to account for the security on a bifurcated basis,” says Krishna.Indeed, the restatement would be a significant burden. Even if issuers redeem net-share settle converts prior to approval, they would still need to restate earnings. Krishna estimates that bifurcation would result in an additional US$12.4bn of interest expenses, reducing net earnings by a similar amount. Instead of an average coupon of 2.6% for the net-share universe, interest expense would increase to about 4.7%.Bifurcation would also result in the elimination of about US$30bn from corporate balance sheets. The counterbalance is a similarly sized increase in stockholders’ equity to reflect the value of the call option. It is unclear what impact, if any, the restatement would have individual companies’ leverage tests o

Property has been an increasing component of ECM volume since 2004. At that point deals such as the IPO of Fadesa Immobiliaria in Spain and the emerging market offerings of Globe Trade Center in Poland and Open Investments in Russia gained a very positive response from investors. Real estate has since grown rapidly with banks bringing a steady stream of offerings, mostly from Western Europe.In 2006, real estate accounted for 11% of EMEA equity issuance over US$50m. In the first half of 2007 it increased further to total 15% and solidifies its position as the second largest sector in the region. And volume would be even larger if all deals that launched actually completed. Over the past two years, many IPOs, generally for fund structured vehicles, have soft-launched but never got as far as pricing. Often these deals have not even reached a bookbuilding period.Due to the limited number of real estate specialist funds in EMEA, many of the investors participating in early deals were generalists. Consequently, the buyside was not always clued up on the sector, which eventually led to the listing of blind pools that often lacked a significant portfolio of assets and were completed at a fixed price. Investors were buying purely on the basis of management and what they thought could be achieved. One banker describes the success of these deals as the property sector’s dotcom bubble. In a similar fashion, demand for these vehicles collapsed in 2006.Having learned from their earlier mistakes, investors now need to see a portfolio of assets as well as a pipeline of planned acquisitions to be made with the funds raised at IPO. Marketing sees investors study management’s track record and the portfolio. It is not just what is in the portfolio that is important, but also how the assets are managed and how management has maximised returns. It is for this reason that follow-ons have been better supported than IPOs as investors can see how management has delivered on what was promised.Many bankers now believe that there has to be a pipeline of acquisitions to justify capital increases. In the case of German firm Alstria Office, which completed its IPO in April through Deutsche Bank and JPMorgan, the company was actually using the proceeds to refinance the acquisition of assets from Daimler.While the asset pool has become more important, there is still substantial variety in the structure of the companies listing. Bankers and lawyers agree that both externally managed and internally managed structures will continue to co-exist with the success really depending on the assets themselves and management’s track record.One particular issue for investors with externally managed funds is that the manager will earn a fee every time the fund successfully raises new equity. However, it is through those funds that investors can get access to successful management teams in which they trust. The result is multiple funds listed by advisers such as Dawnay Day that have met with success due to the firm’s record of delivering on its promises.Dawnay Day completed the IPO of its third fund in May 2007, raising the maximum proceeds target of €300m. Dawnay Day Sirius offered exposure to German commercial property but differed from alternatives in this space by showing some initial success with developments. For example, Dawnay Day Carpathian was up 28% from IPO at the time of Sirius’ listing, and Dawnay Day Treveria, up 40%.Ultimately, it seems that externally managed funds and internally managed companies can both succeed if they have the right assets, trusted management, and are offered at the right price. Structure can also be crucial.Several REITs has listed successfully in the UK this year, led by Local Shopping REIT in April. But the largest test of the REIT market, Vector Hospitality, failed to price. Many investors thought the structure to be too complicated and in this case, an external management group with the conflict of interests associated, was not seen

Annual consumption of ethanol in the US has increased by 2bn gallons to 6.5bn since the US government introduced favourable legislation in 2005 in an effort to induce production. Demand is expected to increase further with the implementation of standardised blends for the fuel additive, with a stated target of producing 36bn gallons by 2022. It was this promise that drove enthusiasm for a wave of initial public offerings in the summer of 2006.VeraSun Energy, the second-largest producer behind Archer Daniels Midland, had little trouble attracting interest to its US$419m IPO in June 2006. Morgan Stanley and Lehman Brothers were able to increase both the size and targeted pricing, from 17.25m shares at US$18–$20 to 18.25m shares at US$21–$22, before pricing at US$23. The shares gained 30% to close first-day trading at US$30.“Ethanol companies are hard to value because most are mostly green-field operators,” noted one investment banker. In other words, they are early stage companies that are valued upon profitability far into the future. A major element in evaluating that potential profitability, aside from prices of corn, oil and ethanol itself, is the future capacity of individual operators.The relevant valuation metric was, and still is, enterprise value to forward production. Based on proposed production of 340m gallons in 2007, VeraSun initially was valued at US$4.81 per gallon. With ethanol prices at record-high levels, the rationale was to raise as much capital as quickly as possible, to achieve the highest valuation.Aventine Renewable Fuels took advantage of the phenomena by providing investors what essentially amounted to a call option on future production through a US$389.5m IPO, also in June 2006. The results were even more impressive. Banc of America, Friedman Billings Ramsey and Goldman Sachs placed 9.1m shares at US$43, versus targeted 8.1m share offering at US$39–$41.The offering valued Aventine at an enterprise value of US$8.10 per gallon based on 206.5m gallons of production by the end of 2007. The company offered the potential to more than triple that production to 756.5m gallons by 2009 through the construction of new facilities and by entering into non-binding agreements. Metalmark Capital, a private-equity firm founded by former principals of Morgan Stanley, took advantage of the rising valuations by purchasing a 40% stake for US$260m (US$13 per share) in a December 2005 private placement.Thomas H Lee, another private-equity firm, attempted to exploit a similar private-to-public arbitrage by purchasing an 80% stake in Hawkeye Holdings in May 2006 for US$736m, only US$390m in equity and the remainder funded with debt. Three weeks later, the private-equity firm filed to take the company public in an offering that would value its new investment at US$893.8m, more than double its initial equity investment.By the time Hawkeye hit the road in September 2006, however, the economics of ethanol had softened dramatically. Credit Suisse, Morgan Stanley and Banc of America were targeting a valuation of US$4.03 per gallon, which was far above spot-market prices for the commodity. After peaking at US$3.92 in June 2006, spot prices plunged to US$2.04 by September and currently stand at US$1.83.The rationale for the run-up of ethanol prices was only partially attributable to higher demand. Technical factors, specifically the phasing out of MTBE, a fuel additive that ethanol replaced, and an underdeveloped infrastructure gave ethanol producers leverage to set prices. The price of corn, the primary feedstock, also spiked above US$4, its highest level since the mid-1990s, as farmers were unprepared to meet the new demand.Prior to 2005, when President George Bush spearheaded ratification of the US Energy Policy Act of 2005 that provided the industry with incentives, ethanol was a low-growth fuel alternative. With subsidies of US$0.51/gallon and tariffs on imports, the legislation made it a high-growth priority seemingly overnight

More than a year after the groundbreaking Amsterdam listing of KKR Private Equity Investors (KKR PEI), permanent capital has come into question for a variety of reasons including poor aftermarket performance and difficult primary execution. Many have traded at discounts to NAV, some have been forced to buy back shares, and one has been wound up, highlighting the sometimes temporary nature of so-called permanent capital.Many that were queuing up for access to permanent capital in KKR's wake, are now reconsidering given the high costs and added reputational issues of coming under intense public scrutiny, with regular NAV reporting."For fund managers, the concept of permanent capital is fantastic, but it isn't a free lunch. Many have found it much harder going than they imagined and people have now realised that it isn't as easy as KKR made it look," said Louise Wilson, head of ECM at UBS.As a consequence of the sub-prime turmoil, London-listed Caliber Global Investment has closed its London-listed fund, while Cheyne Capital Management's Queen's Walk reported US$91m losses and the stock languishes at less than half of the €10 IPO price. Caliber shares traded at a discount of more than 40% to NAV as US residential mortgage-backed securities represented around half of the fund's US$900m of assets. Far from a permanent source of capital, Caliber's decision to return all capital to shareholders came just two years after flotation.Away from the difficult credit backdrop, failure can also be attributed to structuring errors and over-ambitious targets. "Some deals have been unsuccessful because they were structured solely with the asset manager in mind rather than the end-investor. A few deals have had unattractive structures, suggesting a naïvely optimistic assessment of investor appetite on the part of their sponsors," said Craig Coben, a managing director in Merrill Lynch’s ECM team.Many have been forced to rethink their size targets during marketing. Brevan Howard's LSE listing of feeder fund BH Macro fell short of its €1bn target, raising just €770m after more than a month of bookbuilding, but at the smaller size, the fund has performed well and continues to trade above NAV.With an increasing number of permanent capital vehicles (PCVs) to choose from, some strategies for success are beginning to emerge. "Funds need to offer a genuinely differentiated investment proposition and offer something that investors do not otherwise have access to," said Coben.Fees have been a sticking point in which investors appear to have won the battle. "Fund managers must be prepared to bear the cost of setting up. Investors don't like having to pay set-up fees as it eats into NAV. Those funds that have found another way of financing the set-up have performed better," said WilsonStructure, quality and differentiation are all important determining factors governing where a fund will trade in relation to NAV, but there is also an element of equity risk involved. "Ultimately, the share price is a function of demand and supply. The NAV provides a reference point, but with a listed fund, you tend to be at the mercy of the market. Where you have a very compelling story and the manager is clearly adding value and delivering on the performance objective, there is no reason to trade at a discount to NAV," said Mark James, executive director, alternative investments at ABN AMRO.Although there has been some increased institutional interest, participation generally remains limited to private banking networks and high net worth. The primary investment decision rests on the ability of the fund manager to add value, and the opportunity to buy illiquid assets in liquid form. But for most funds, liquidity is low, which is adding to the share price pressure."Liquidity has always been an argument for buying these vehicles, and although they are in principle liquid, in reality they don’t really trade as they are yield instruments. That means to build a position costs more

Since 2005, Russian and CIS equity capital markets have developed beyond recognition. Bankers concede that while the pipeline has always been reasonably visible for the largest deals, none would have dreamed that activity could grow at the rate it has. More importantly none had expected buyside appetite to grow at a commensurate rate. Yet demand has supported the huge growth in activity with sectoral investors piling into Russian deals alongside emerging market specialists, to the point where banks find it difficult to identify which fund types are buyers of its deals.This, however, creates a challenge in that while emerging market investors would never stop putting their money to work in Russia, they are being asked to ignore ‘Russian risk’ and are seeing pricing at bullish levels against Western European peers. Such a dramatic change in the risk/reward profile has forced some to seek out those markets where the rewards are more reflective of the ensuing risks.“Over the past few years returns from investing in Russian IPOs have been terrific for many, but not all deals,” said Charles Lucas, head of CEEMEA ECM at ABN AMRO Rothschild. “Investing in the principal components of the indices has been a more reliable strategy particularly recently.”A squeeze on pricing is not surprising when Russia has grown into such an important market in EMEA with an ever increasing audience of investors as well as increasing funds under management for emerging market funds.“Some issuers have been aggressive on pricing, but as some deals have been crowded during bookbuilding so they can push pricing,” said an emerging market ECM head at one US house. “But in some cases the incremental buyer in the bookbuild has not been there in the aftermarket”In the first half of 2007 Russian ECM volume totalled US$22.3bn through 17 issues. This put Russia into second place in Europe between the UK, which totalled US$37.8bn, and France, which had issuance of US$17bn. Russian volume represents more than 15% of total European issuance.For IPOs, Russia has become the single most important market in EMEA, eclipsing all other countries, including the UK, by several percentage points. Russia has also been the source of the two largest deals of the first half with the US$8.9bn follow-on for Sberbank in February and the US$7.99bn IPO of Vneshtorgbank (VTB) in May. However, aftermarket performance has been no match for primary volume. At the end of the first half there was not a single Russian issue among the 10 top performing IPOs of the year, yet there were four from the UK.A changing dynamicEmerging market investors have for many years become accustomed to a ‘Russian risk’ discount, to reflect the impact of political interference in markets and companies. Over the past two years concerns, at least over ownership, have diminished and vendors have become more aggressive.“Some issuers have argued that there should be a “Russian premium” as opposed to an emerging markets discount, due to the superior returns available in the Russian market compared to developed markets,” said Alasdair Warren at Goldman Sachs.While it is logical that the greater potential for growth should encourage higher pricing, investors are well aware that companies can struggle to deliver the sensational growth they promise at IPO. In some cases it can be a very short period of time before those promises are shattered by grim realisation in the form of first results.Sitronics, which completed its IPO in early February this year, is a case in point. The technology firm was floated by parent Sistema in a US$414m offering of GDRs in London by Credit Suisse, Goldman Sachs and Renaissance Capital. The deal came when there was some nervousness over heavy supply thanks to a pipeline that included Sberbank and VTB. Price was clearly an issue throughout, leading to the adoption of the decoupled bookbuild, despite a clear dislike of the process by some of the bankers involved.The deal size was only set on the