ECM 2005 - Great expectations

IFR Equity Capital Markets 2005
11 min read

With secondary markets picking up across the world, and M&A activity returning to the fore, bankers expect global ECM volumes to surpass those recorded in 2004. Europe was the stand-out region, with more volume and more variety of business than last year. Mark Baker, Jasper Moiseiwitsch and Stephen Lacey report.

Global ECM volumes in 2005 look set to surpass last year's total of US$417.5bn, even though US activity is markedly down. As of early September, Asian volumes are level with the same point in 2004, at US$79.5bn, while EMEA activity is comfortably ahead of last year, on US$112.2bn compared to US$96.8bn.

Total global activity currently stands at around US$263bn, almost exactly what had been recorded at this point in 2004, but with a much more significant pipeline of business to come.

Across most regions, the return to consistent positive secondary market performance spelled the return of the full variety of ECM business – from IPOs to rights issues, and from overnight block trades to fully marketed follow-on offerings. The other factor, although it follows on logically from better market conditions, was the return of M&A activity, which was also boosted by continued low financing costs in the credit markets.

Nevertheless, across the world primary ECM deals coming to market in the first half often had to get by without a crucial part of the investor base – hedge funds. With these typically buying about around one third of the average deal, and generally being the second most important constituency after Tier 1 accounts, the hammering of their performance in the spring had a huge impact on sentiment.

"There has been a move to value investing across the board. Where the hedge funds are active, they are doing as much work assessing the fundamentals as the long-only funds," said Danny Palmer, HSBC's global head of equity and equity-linked capital markets.

The full-scale return of IPOs in Europe – as compared to the tentative signs in 2004 – was a major feature of business in the region. Whether they be examples of innovation, such as the hard-underwritten £611m IPO of RHM in the UK through CSFB, or experimental and controversial efforts in a new sector, such as Dresdner KW's sole-led £1bn IPO of online poker giant PartyGaming, new stories were generally multiple times oversubscribed by investors.

However, even novel stories such as PartyGaming were keen to satisfy one overwhelming investor demand that still exists in current markets – yield. While a good proportion of the business in 2005 was from very defensive sectors which could be expected to pay decent dividends – often around 6%-7% – even a company such as PartyGaming offered a yield of just over 4%.

IPOs of utilities such as Gaz de France and Elia, as well as the follow-on of Enel and the massive €10bn IPO of EdF expected by the end of the year, all emphasised the focus on yield. The London bomb attacks on July 7 and the second attempts two weeks later provided timely reminders of why investors still prefer defensive stocks.

The recovery of the German IPO market was another notable aspect, led by the €1.18bn IPO of Premiere in March and continuing with the €651m IPO of engine manufacturer MTU Aero Engines in June. The second half also promises to be busy, although aside from large financials such as HCI Capital it is the relatively untested sector of renewable energy that will provide a good proportion of IPOs.

Accelerated deals, with or without backstops, continued to be a feature of the European market as banks take it in turns to pick up quick – if costly – league table credit. Difficult deals have included the €2.08bn sale of Mediaset by JP Morgan in April; the €3.42bn government sale in France Telecom spread across Goldman Sachs, SG, Deutsche Bank, ABN AMRO Rothschild and BNP Paribas; and most recently the €224m sale of Commerzbank by Citigroup. On the flipside the German government successfully disposed of €2.4bn of Deutsche Post in a deal through Deutsche Bank, Goldman Sachs and UBS.

Asia still strong

The Asian bull market is two years old and counting, and is showing no signs of slowing down. The real beauty of Asian ECM has been the ability of markets in one region or sector to compensate for slowdowns in other sectors. For example, as Taiwan equity-linked has entered a prolonged stagnant period, Indian CB issuance has stepped up and more than filled that void.

Items on the agenda included old candidates such as Minsheng Bank (mandated two years back) and large deals such as Shenhua Coal. Bank of Communications was a blow-out and Shenhua raised US$2.95bn on solid, if unexciting, demand. But the leads were forced to pull Minsheng, while China Cosco was a terrible struggle all the way through.

In Japanese markets, primary activity continues to be dominated by the flood of issuance from J-REITs. Elsewhere, the mega-deals were few, the most notable being Shinsei Bank's US$2.9bn February follow-on and Jupiter Telecom's US$1bn IPO. The pricing of the follow-on privatisation of JR Central Railway – a US$4.26bn deal in July – was a significant event, being the last of the large government deals and the biggest Japanese ECM deal since 1999.

After a slow period in spring, largely following the GM/Ford credit downgrades which took a terrible toll on global hedge funds, Asian markets bounced back much more strongly than anyone expected. The first two weeks of August were exceptionally busy, with a historic high of US$7bn of equity issuance in Asia excluding Japan and Australia.

The deal flow reflected an eventual return to liquidity for hedge funds, as well as a reallocation of capital away from the US toward Asia. The factors contributed to uniquely flush conditions and have spurred on a number of large equity blocks over the past two months, including a US$3.1bn selldown for Chunghwa Telecom, a US$1.3bn TSMC ADR and a US$2.4bn Petrochina block.

"We see a lot of activity in all markets," said Matthew Koder, UBS's Hong Kong-based Head of Asian ECM. "There is pent-up demand for capital, and valuation levels – as well as liquidity levels – have been very high. Just about every market in Asia is healthy. Korean issuance, in particular, has been extremely robust since the block trade liberalisations last year. We are very optimistic."

The rest of 2005 looks in great shape. There are several landmark deals in the pipeline, including the much anticipated US$5bn IPO for China Construction Bank (the first of China’s “big four” state banks to list offshore), the US$2.7bn Link REIT IPO in Hong Kong; and the US$500m Khazanah exchangeable bond, which will be the world’s first Sharia-compliant equity-linked deal.

Elsewhere in Asia, the Greater China technology sector will continue to drive issuance as the tech cycle remains surprisingly resilient to a downturn. South Korea, one of this year’s ECM success stories, continues to figure prominently in bankers’ travel schedules. And, in 2006, China should generate two more jumbo IPOs for state banks, the A$30bn Telstra selldown will come to the market in Australia and China REITs are expected to start. Conditions have rarely been better.

US prospects improving

In the US, ECM volumes fell from US$85.5bn at this stage in 2004 to US$71.6bn this year, and that is even taking into account what has been an exceptionally busy August. Nevertheless, the pipeline is promising for the rest of the year.

Buyout firms have continued to dominate activity in the US equity capital markets. And particularly when it came to IPOs, the speed of the corporate turnarounds from buyout to public entity became a controversial issue. Ever since the US$800m IPO for chemical manufacturer Celanese in January, which marked a five-fold return for The Blackstone Group in just nine months, financial sponsors have attempted to jam the market with portfolio companies at ever more aggressive valuations.

“There is a sense that financial sponsors are approaching the market in an over-aggressive manner relative to the true clearing price, and that they are taking too much off the table too quickly,” said Jay Chandler, global head of equity syndicate at Merrill Lynch. “What’s been lacking is the good solid, growth story.”

Indeed, despite the success of Huntsman Corp’s US$1.39bn IPO in February, the largest offering so far this year, investors quickly soured on IPOs laden with debt that was often was the result of leveraged recapitalisations to the sponsors.

For example, the US$854m IPO for Lazard Ltd in May marked the turn in investor sentiment against what was perceived as financial engineering. While not technically a buyout, the manoeuvrings necessary to extricate Bruce Wasserstein from his contentious relationship with the bank’s founders left public investors bitter. The deal immediately fell through its IPO price. Similarly, a week later Warner Music Group would struggle to hold form following its US$554.2m IPO despite significant concessions at the time of pricing.

One bright spot in US ECM, in spite of the fact that volumes are down on the previous year, was the very busy summer period, with 77 companies raising US$13.8bn in August alone. That activity made it the busiest August in the US since 2000, although it was immediately followed by the devastation wreaked by Hurricane Katrina in New Orleans. Nevertheless, the deal pipeline stayed robust, although bankers wonder whether securities regulators will be able to cope with the expected rush of deals before the end of the year.

"It's worse than ever," said one ECM professional of the SEC deal review process. "They [the SEC] are understaffed, and they are digging into a lot more issues. Some of it is legitimate, but they are not turning things around as fast as we would like."