For years – almost since the introduction of bookbuilding into European ECM deals – the structure of IPOs and rights issues has remained basically unchanged. Banks were appointed on the basis of their track record in equity transactions, their relationships and often their willingness to lend. Once appointed, they would present the investment case to analysts, produce their own research, pre-market and then market the deal to investors, and finally set the pricing.
But issuers or selling shareholders that carry enough clout with the investment banking community can sometimes radically affect the way in which traditional business has been done. One example of this is the way in which France Telecom has been able to dictate terms to its banks over the last few years.
On at least three occasions in the same number of years, FT has made demands of banks that once would have seemed unthinkable.
When it embarked upon its €15bn rights issue in March 2003 – a deal that represented a complete transformation of the fortunes of what was then a struggling company – it took the unusual step of asking banks to bid overnight for underwriting positions on the deal.
The fact that banks went through the tiresome process of submitting bids and that 21 banks ended up in the final syndicate was evidence of how much the pendulum of power had swung towards issuers. In addition, even when the leads had been chosen, they found that they were dealing with a company and external advisers with clear ideas about how the transaction should be driven.
The situation was almost exactly repeated in September 2005, when FT again asked for overnight bids, this time for a €3bn rights issue. Once again, banks scrambled to comply with the company's wishes, with 13 firms forming the syndicate. On both occasions, the surprise was not the fact that the deals were underwritten – firm commitments on rights issues are hardly a novel development in Europe – but rather the way in which the underwriting bids were used as part of the process of choosing the syndicate.
FT employed a variation on the same principle for the spin-off of its yellow pages subsidiary Pages Jaunes, in a €1.25bn IPO in July 2004. The company employed adviser Dresdner KW to run a process whereby the banks pitching for the bookrunner role would be made to compete in a number of rounds of premarketing, involving repeated contacts with the buyside ahead of the deal.
Not only that, but the fees payable to the banks at the end of the deal were linked to how close the final pricing was to the indicative ranges they had submitted. At the time there had also been talk that the company might go as far as to required firm bids – making the deal a hard-underwritten IPO – but this did not emerge.
In fact, apart from a group of accelerated IPOs on London's AIM, where a group of core institutional investors are lined up ahead of a flotation that can then follow a very truncated timetable, the only significant hard-underwritten IPO in recent times has been the £611m flotation in July this year of UK food group RHM.
Back in the early days of ECM, when the business was dominated by the UK privatisation programme of the 1980s, IPOs were generally hard underwritten and sold at a fixed price. The follow-on offer of BP in 1987 was one of the last deals to be done in this way: it coincided with Black Monday, but famously the government would not back down and held the syndicate banks to their commitments despite the 20% fall in the London market.
The introduction of bookbuilding and the execution of deals on a best-efforts basis meant that such dramatic disasters could not happen again on fully marketed deals, which could simply be cancelled or priced low if market conditions turned or demand had been overestimated.
But with the downturn in market conditions at the end of the internet bubble, the attractions of overnight risk trades were obvious to sellers, although they have frequently resulted in severe losses for banks. Bankers say that it was inevitable that this should eventually have been transferred to IPOs, and although many privately criticise the concept of hard underwriting, they are reluctant to do so in public for fear of alienating any private equity sellers that may favour this route.
"What you find is that the logic of the block trade is being extended to other types of deal, such as the IPO," said one head of European ECM. "But this is not welcome at all. What will happen is that banks will simply begin to show the same kind of league table-driven aggression that they use on block trades, and ultimately that is not good for anyone in the market."
That said, the reaction at the time of the RHM flotation was generally positive, although the paradox remains that the deals where a bank would be prepared to take on the risk would probably be those where the seller need not worry about securing underwriting. RHM was seen as a stable, defensive company, and with a yield of around 6% should not have been a tough prospect to sell.
RHM remains the only hard-underwritten IPO of recent times, although the flotation by Permira of Germany pay-TV company Premiere in March 2005 came very close to being completed in the same way. Nevertheless, bankers say that selling shareholders – particularly private equity firms – are increasingly raising the subject when talking to banks about possible flotations.
But whatever the future for flotations as risk trades, the competitive pre-marketing aspect of Pages Jaunes has already generated a trend, and it is one that is likely to continue. The IPO of Inmarsat in June 2005 was the first to be carried out in a similar way, with DrKW advising sellers Apax and Permira, but over the summer the first stages of work were completed on three more deals following the same route: satellite operator Eutelsat, cable company Telenet and Switzerland's EFG Bank.
The procedure generally requires the banks to submit lists of potential investors, which are then be scrutinised by the seller and its advisers before being narrowed down to several smaller lists of key accounts. Each bank competing for the mandate is given the task of contacting the investors on one list – which could be just two or three – and then reporting back on their feedback.
This pilot-fishing feedback is just one of the RFPs prior to the mandate and launch of the deal. There are other rounds of feedback and submissions of valuation ranges. The banks on Eutelsat are Goldman Sachs, Morgan Stanley, Deutsche Bank, Lehman Brothers and Merrill Lynch. On Telenet, they are JP Morgan, Goldman Sachs, KBC, Lehman Brothers, Deutsche Bank and Merrill Lynch.
At the time of the Pages Jaunes deal, FT's argument in favour of the process was that it kept the banks honest and avoided the possibility of bait and switch. Bankers argue that, aside from the sheer inconvenience of the structure from their point of view, the problem with the competitive pre-marketing model is twofold. First, the buyside can become frustrated with what can be four or five meetings before launch; and secondly, pricing is not improved, although there have not yet been enough deals to be able to make a coherent judgement.
"One day you will see that investors get tired of this," said one European head of syndicate involved with the process. "The issuer or seller might get a lot of training and feedback but I don't see any evidence of better pricing as a result. In fact, the buyside is finding that they can game the process."
Inmarsat was 10 times covered at the top of the range, but with a yield of 5.7% and around a decade of dividends to come before capex starts again, bankers were hardly surprised with that.
The flotation of private Swiss bank EFG, which kicked off in September and is expected to price in early October, is also believed to have followed a similar structure. On that occasion, CSFB, Lehman Brothers and Merrill Lynch ended up on the deal, but were not announced as leads until pre-marketing officially began on September 8.
Inmarsat is the only deal where bankers concede that the roles were finalised after the publication of research, but those working on the other similar deals agree that their analysts' views play a crucial part in their prospects of winning the top mandate. Some are worried that this unduly compromises the industry and will be tackled by regulators before too long.
"You can forget all the feedback, everything else – this is all about research," said one syndicate banker who has been involved in one of the recent RFPs. "It's completely understandable from the issuer's point of view though. You're paying the fees, so why wouldn't you want the bank that's most likely to be making a strong case for your stock to be leading your deal?"
That kind of explicit link is impossible in the US market, where pre-deal research has been all but wiped out by the various reforms instituted in the wake of investigations into conflicts of interest between research and sales teams. In Europe, however, there is still no cast-iron prohibition in place.