The relative ease with which the UK government’s £3.2bn sale of Lloyds Banking Group shares was completed shows just how buoyant the equity capital markets are in Europe now. But the success of the third largest accelerated bookbuild ever in the UK obscures a more worrying truth: banks are struggling to capitalise on the booming ECM market.
The banks on the Lloyds deal worked for free, and while they can write it off as a special case as capital markets work for governments is often poorly paid, that fact highlights the difficulties of making money in ECM. (See “Retail in focus for UK privatisations”.)
Indeed, compared with many deals this year, a zero-fee trade might look like a blessing – at least the banks involved did not lose any money.
Contrast that with a series of deals in 2013 when banks were forced to gamble with their profits for the year-to-date when competing to appear on the biggest deals.
In fact, even as Bank of America Merrill Lynch, JP Morgan and UBS were selling the Lloyds deal on Monday night, Goldman Sachs was sole bookrunner on a €955.5m overnight placing in Continental on behalf of Schaeffler. In an increasingly familiar pattern, the bank closed the deal with the stock only partly sold.
Speculation from competitors was that Goldman was left holding 25%–50% of the shares offered to market. The bank was bailed out by a stock that traded remarkably firmly and held above the level where the shares were offered, and by implication where the bank had backstopped the shares.
Rising markets have been helpful following a number of failed blocks this year, with Gagfah the most spectacular example. Goldman and Deutsche Bank each had stakes of about €120m after failing to sell even a quarter of the share placing in mid-July, but positive results a month later caused the stock to jump by 8.6% in a day, propelling the banks well into profit.
Quick and dirty profits
Accelerated bookbuilds account for 68% of volume in the current quarter and 60% of the US$140.4bn issuance in Europe so far in 2013. Many of these trades are run on an agency (or best efforts) basis that earns small and risk-free margins, but a large proportion – particularly the largest deals – are risk transactions with the mandate awarded to the highest bidder. Profits are not certain and losses distinctly possible.
Together, Lloyds and Continental show the difficulty for regional ECM heads in boosting profits in the most receptive equity market for five years. In the first half of 2013, EMEA ECM volume was up 79.9% year-on-year, but because of quick deals fees were up just 33.3%, according to Thomson Reuters data, not taking into account the costs of holding residual positions or selling below where a stock was purchased.
Many ECM bankers dislike the way the business has developed, but there is at least an argument that such on-risk deals are positive for the market as a whole.
The natural cycle of markets is such that rights issues come as companies rebuild; these are followed by selldowns as major shareholders exit their positions when stock prices rise; and the cycle culminates in IPOs once investors are sufficiently reassured that the economy is sound and they are ready to speculate on new issuers.
“These liquidity events – and how they perform in the aftermarket – are very important for ECM,” said Darrell Uden, head of European ECM at RBC Capital Markets. “Current liquidity is being fuelled by hedge funds becoming more active in sizeable deals, and continued US funds flowing back into European equities. If these transactions are executed correctly, there can be a significant collateral benefit for other ECM product.”
A flood of demand for UK estate agent Foxtons’ IPO led to top of the range pricing on Friday and an immediate 20% return for investors lucky enough to be allocated stock. (See “Dream start for Foxtons”.)
It has taken five years to play out, but the IPO market in Europe is back, although fees are not what they were.
“Block fees are tighter and IPO fees are now more skewed towards incentives than they once were. We are also working to introduce companies to investors six to 12 months before a listing to give key accounts time to make bigger and more focused investments, which does require some additional resource on our part,” said Jim Renwick, chairman of corporate broking at Barclays.
“However, after five difficult years for ECM in Europe, it is getting easier. Volumes are up and investors are happier to negotiate on valuation having made money themselves, which is crucial to support IPOs.”
