IFR European ECM Roundtable 2015: Part 2

IFR: So even though things are good now people are very aware of how quickly the market can shut, and de-risking in advance is something that remains a focus whether that’s through formal cornerstones or anchor demand coming in early. Sam, as the Asia-Pacific expert where the cornerstone is an established practice, are there dos and don’ts that should be followed over here?

Kendall, UBS: If you look at why cornerstones were invented, it was to get deals through the Hong Kong Exchange with a bunch of tycoons. “Markets are not open, we want to do business, if Li Ka-shing lends his name to having invested, locked up for six months, the markets will open”, and then it did. I think with the volatility in markets, people are less inclined to be locked up for six months, but there has been this step where you have a cornerstone/anchorstone where it’s effectively doing the same early look engagement. So getting a prospectus, meeting with management a number of times, and because you are more comfortable you’re making bigger bets and bigger investments.

We just did the Legend IPO last week, and that’s a big brand name in China, but there was still a 48% cornerstone tranche done in that. Even a big brand name like that we still want to de-risk these transactions because we are worried about markets being a little bit volatile during pricing. That was one of the reasons why Legend decided to price the IPO two cents off the top, even though the book was fifty times covered through the range, and that’s rare for a Chinese issuer. So to an earlier point, people are being more sensible.

There’s discipline on the buy-side, there’s discipline on the sell-side. People get fixated on cornerstones, but it’s just about de-risking. That’s why it was invented. And it’s called different things in different markets, but we’re all trying to achieve the same thing, which is having confidence to launch a deal, having visibility over demand, and each market can try to achieve that and each bank can achieve that.

IFR: Do you have a strong opinion over how they stack up against each other? There is always a question of how do investors really interpret anchored demand that results in an end of day one covered message. Who knows what the quality is in there? Who knows how sticky those orders genuinely are if there’s no clarity?

Hargunani, Citigroup: I agree that everything actually, with an IPO, starts off with intentions of a potential cornerstone but then normally morphs in to anchor. We were involved in the cornerstone process in Glencore, which you could argue is the only true cornerstone IPO in Europe. I know we’ve had hybrids with the likes of Rocket and nearly every Nordic IPO now has cornerstones, but Glencore is probably the most comparable one to Asian transactions.

The visibility of a cornerstone de-risks the transaction, but a lot of people look at it as a lack of liquidity. But you make a fair point that actually if you’re de-risking the transaction what you’re trying to do with the anchor process is eventually get the book covered on day one, either because a certain amount has committed to it already, or you know that by the end of day one you are going to be covered. But yes it’s about the quality of it, I think you have to give confidence to your issuing client and the market that actually it is fundamental interest that has de-risked the transaction rather than momentum or fast money that perceives this deal to be strong, and that’s why they’ll come in early.

So it goes back to Sam’s point, the whole cornerstone anchor process is to de-risk. There is a fine line between de-risking and giving a positive marketing message, because that could flip it on its head and you could have an IPO that actually isn’t good quality. So you do have to be very careful with how ultimately that is messaged to the market, but on every IPO you give much more comfort to your issuing client if you feel confident on the demand and confident on that demand at a price. But for most deals and most institutions you do have the sensitivity of being locked up and hence why the cornerstone process will stay in the minority in Europe I think.

Kendall, UBS: I think that’s so right. It’s the messaging to the market, right, and every market is different. In Asia, if a deal is not covered within about thirty seconds of opening it’s a disaster, right, but this is a market where deals are sixty, seventy times covered for a US$200m or a US$2bn deal. So not having a covered message very early is very negative, whereas in Europe, or even the US, not having a covered message on day two, it could be a good thing. You can go out with a message that we’ve had so many one-on-ones, there’s a high level of engagement, we’re starting to see conversions, but I think behind the scenes having those early-look conversations gives you the confidence. I think it’s all about the messaging that the anchor process or the cornerstone process allows you.

Vaz Pinto, SG: It’s also in terms of the quantum because, correct me if I’m wrong, but in Asia you can get deals which are basically cornerstones…

Kendall, UBS: They’re the friends and family ones.

Vaz Pinto, SG: …and that’s actually been criticised a little bit. In Europe the practice has been, it’s great to have one or two, but as Suneel was saying, it’s also good to have liquidity for the IPO and therefore if it’s 20% or 30% of the transaction you give it a kick start, but then there is more of a free for all in the allocations like we saw in Spie or Aena.

Kendall, UBS: Absolutely, we as practitioners have to take best practice from everywhere around the world and then adapt it to the local market or to that deal to make sure that it can get done. I think you can’t extrapolate one thing and say it’s going to work everywhere. It just doesn’t.

IFR: A recurring topic this year is the big IPOs that have instead been taken out by sponsors or strategic buyers. We’ve always talked about dual tracks but they appear to be more prominent and, as Suneel knows only too well, can happen at any stage of an IPO now.

Hargunani, Citigroup: You’re referring to Slovak Telecom, which will never be beaten, where the allocations were done, and literally last minute…

Halperin, Barclays: What, you had a deal already and then someone came in?

Hargunani, Citigroup: It was all allocated. It was literally a last-minute trade.

Kendall, UBS: You’d been up all night, you’d been allocating. That is really bad.

Vaz Pinto, SG: Then the sponsor stepped in after that?

Hargunani, Citigroup: Well yes, though it wasn’t a sponsor.

IFR: It was [major shareholder] Deutsche Telekom buying the rest. We also had Douglas where they began pre-marketing and the next day said actually we’ve been bought. So it’s happening more regularly. Is there a reason why now particularly?

Vaz Pinto, SG: I don’t actually think it’s happening very often. I think it’s just last year we got used to the markets in such a perfect spot that the private equity guys never got their nose in. We’ve now gone back to the sort of normality, where actually we’re starting to see them but not a lot, and in fact if you go and speak to a lot of sponsors they’ll say, “We’re selling everything we can, but we just can’t find anything to buy”.

If you go and look at most of the large sponsors you will see they’ve got huge war chests but are finding it difficult to engage. So, we’re seeing it in some IPOs, true, but it’s actually a very small proportion of what they could invest and in terms of the total number of IPOs so last year they just didn’t get a look in at all, so we kind of forgot about the dual track because valuations were great, flow of funds were great, it was just perfect so there was no other option.

IFR: How does the formal dual-track process work?

Voss, Commerzbank: There is no formal dual-track process. We’ve seen a new type of concept which has been running absolutely in parallel and then to the last minute, or completely separate one by one, first follow the first track and then the second one, so there is no such typical type of concept. But of course I can only echo that it’s absolutely to be expected when the M&A market picks up, financing is cheap and equity valuations slightly come in, due to the fact that earnings improved, and therefore it becomes more attractive. As well of course PEs having been forced a little bit to invest now.

Kendall, UBS: I was talking to one of the big UK private equity guys the other day, and they had a public portfolio of US$10bn – they had ceased to be a private equity fund and they were now effectively a hedge fund.

So as they’re trying to manage their portfolio, that next IPO instead of selling 20% of it and putting another billion dollars in their public portfolio, if they can sell the whole thing then they [avoid increasing that portfolio]. They’re looking at valuations and they look pretty good on returns and they’re saying, “Well, you know, we’ll sell the whole thing”.

So I think the buyers are looking for something. Private equity has got a lot of money, there have been some big raises over the last 12 months to two years…

IFR: And they’ve exited quite a lot as well.

Kendall, UBS: …Yes they’ve exited some, but I think the private equity guys are trying to manage the tail risk on that and they’re saying, “I just don’t need more public equity, because I’m not getting paid, there’s no upside for me here, I need to return the money to my LPs”. So I think there’s a little bit of that dynamic with these guys. They’ve been really active, and it helps them manage their overall portfolio.

Halperin, Barclays: Yes and to add two comments to the process: it is a disjunctive process. It’s often separate banks and even when there is bank overlap it’s separate teams and they really run independently of each other, which is frustrating to all of us on the ECM side…

Kendall, UBS: Particularly Suneel doing the allocations.

Halperin, Barclays: …because we’re often the last to know, which leads to a lot of angst from investors, research and sales, all the people who have really put a lot of time in to the deal. It’s an unfortunate reality but it’s competing bids and they do need to be run independently, at least to a certain extent, and it’s just a reality of the dynamic.

And then in terms of the outflow of supply and the private equity bid, I think it also is valuations getting to a more reasonable point, and cheap plentiful debt expanding. So your leverage financed investment is better funded today even than I think what it was a year ago, notwithstanding this recent blip, and there is that bid for deals that don’t work, or deals that are just starting to work, coming out and going to private equity.

Ceccarelli, SIX Swiss Exchange: Even from our perspective that’s what we see, private equity funds – the big guys – often have two options to follow, especially for some of the big assets, and, either it’s a formal dual-track process or informal, it is followed to optimise the result. What I am saying might go against exchanges, but I think that we are going to see that this competition between M&A, either from strategic or other financial buyers, and IPOs will continue, with the pros and cons for each specific transaction.

IFR: Do you think that if there is a competing bid that you’re doomed to lose on the IPO side simply because it is maybe 18 months to exit? Though the IPO should be the lowest price at which PE ever sells, so if comparing valuations the IPO looks good they should be going for that.

Ceccarelli, SIX Swiss Exchange: I think time is always important when considering an IPO. Therefore the choice on the preferred route depends on the speed of execution versus valuation versus the possibility of further upside with the equity market. I believe private equity will evaluate all these variables try to find the best for them, depending on the weight they give to each of these variables.

Halperin, Barclays: Most sellers do want to test that market, at least to a certain extent and figure out what that public valuation is. So unfortunately some of them have played it really far in to the process until they determine that bid, but they seem interested in testing it, particularly while markets are buoyant.

IFR: One of the other recurring issues is secondary market liquidity. Is that likely to continue to be an issue, and should we complain considering it is seemingly helping primary issuance?

Ceccarelli, SIX Swiss Exchange: Trading liquidity also helps the primary market. I believe the liquidity issues affect SMEs rather than the blue chips. On our market we have seen this year an increase of trading volumes. We also had a specific event that triggered the increase of the volume on a specific day, when the Swiss National Bank removed the Euro/Swiss franc cap, and therefore that day we had a dramatic increase in trading volume, in general we’d seen an increase in trading volume this year, versus the same period last year.

IFR: But the issue of secondary market liquidity is actually a positive one for IPOs and ABBs isn’t it?

Hargunani, Citigroup: Yes I think it’s playing to the hands of the primary market. I mean you speak to most of the buy-side and their main concern at the moment is liquidity, and being able to get in and out of positions and this is in the backdrop of them getting inflows. So therefore it’s no surprise why many more institutions have to look at our products, including IPOs. It is no coincidence why there have been so many blocks and, particularly if you look at a lot of the first blocks post IPO, why they are coming so tight. Liquidity’s been more important than price because institutions just can’t get the size they want in certain stocks and the block market provides that liquidity.

It’s more liquidity being fragmented, going from high touch to DMA to electronic, so the old-fashioned style of broking and being able to buy US$10m, US$20m, US$30m of this and that is much harder to source. There is more visibility in the primary product because it’s clear that this is the stock and this is how much we’re selling. It’s helping us. I’m sure we’re all seeing many more institutions that didn’t like the primary product, didn’t want to look at the primary product, but are having to look at it.

IFR: Are the discounts on blocks getting tighter?

Hargunani, Citigroup: Well I think you have to distinguish block by block. The point was made that both, at the moment, banks and the buyside are very risk adverse and that’s going to impact the pricing. My comment was more related to blocks post-IPOs, the first liquidity event post-IPO, where the discount is typically uncorrelated to the amount being sold and the liquidity amount being sold, because it’s related to getting size.

Voss, Commerzbank: We’ve definitely seen quite a few follow-ons that were priced extremely close to market if not at zero discount in a few instances, simply for the reason that investors were already waiting for the follow-on for the big liquidity event, and it was expected by the market, particularly when a lock-up was expiring. The big investors waiting for that do not invest beforehand because they wait for the opportunity of a block that comes at a slight discount. For that competition it is certainly possible to price that type of blocks business rather aggressively.

Kendall, UBS: I think that if it’s a big block, even if it’s well flagged, if it’s too tight and it’s a big liquid name people are just not going to buy. But you could have the same size block, and if it’s thousands of days’ volume, people will pay a much tighter price than you would think because they are trying to chase liquidity.

So I think to Suneel’s point, on blocks, where people are coming unstuck is they’re just assuming everyone wants liquidity, but people are being disciplined around price. Sometimes they’re being disciplined on price, sometimes on size. [In an illiquid name] they’re going to weight size as more important because it will take them a year to buy that sort of size.

As funds are getting bigger – and I think this is another reason that’s driving the early look marketing because they can get more comfortable – they want bigger size. People’s position sizes are growing – what used to be a US$25m ticket is now US$50m. If you are running US$50bn or US$60bn, a US$25m order doesn’t do it for you. You want big size.

IFR: That is a complete change. The idea that you might be more likely to get burnt doing a few billion of Deutsche Telekom than something illiquid is a complete flip. Does that mean that you can change your kind of approach to the block, and be much more on the front foot? “This is your liquidity event, you tell me how much you want, and we’ll talk about the discount later”, rather than being a discount-led product.

Hargunani, Citigroup: If you’re talking from the bank’s perspective, yes I think if it’s a liquidity event then you’re probably more focused on interest because there’s less nickel and diming over a few percent here and there.

If you’re talking about being more aggressive in terms of bidding for blocks then you’ve got to look at it the other way as well, in terms of what’s easier to risk manage. So just because it’s a liquidity event and you’re confident that there is demand, doesn’t mean you are going to bid tight because if you get it wrong then you’ve got it very wrong, whereas if it’s liquid you can correctly assess what the liquidity of the stock is as you think about your risk dynamics, which you can’t do in a first liquidity event [post-IPO] because you don’t really know what the liquidity is going to be like, other than what it currently is.

IFR: We have seen more instances of anchors for blocks, whether or not they’re agency or auction based. How do you go about sourcing them and how do you ensure that those are representative views as we have had a few occasions where there have been anchors, but the bank has still been left with stock.

Hargunani, Citigroup: I think you have to use experience to strip out a lot of the noise that you get around blocks. If you’re corporate broker or a house bank to a situation you’ve got the best insight because actually you’re taking the company on a roadshow. If you’re getting the anchors from fundamental discussions having met management, I think you can feel fairly confident that there’s interest.

A lot of the block market in Europe is based around lock-up expiries or market rumour, and then a lot of anchors maybe there one day but not on the day of the deal. So you have to be careful. It varies from institution to institution and it varies from situation to situation as well.

There’s no golden rule, but in a liquidity event when someone is saying they really want X, you can be quite confident there because there’s no other way for them to get it. Whereas in a liquid stock someone who wanted US$50m, with the block coming one or two weeks later they could have got US$30m already in the market, and there is a price point where it doesn’t work for them.

So there’s no hard and fast rule, but you’re right that the shadow book isn’t always going to come to fruition.

Kendall, UBS: I think on the blocks market, we’ve all had ones that have gone wrong, and it’s where we were thinking with this [points to heart] and not with that [points to head].

Usually, if you go back and you look at it, you had a shadow book and you just assumed that it was going to move from this discount to that discount merely because it was a liquidity event, without actually understanding the fundamentals, who was actually just high velocity and trying to arb a discount, who actually wanted the stock fundamentally. We all go to our committees and there’s group think, we all just get excited about winning for winning’s sake.

I think the secret to the block market is just the banks having discipline, the investors having discipline. Some people are very astute users of the capital markets and love the 4 o’clock call to put everyone in a room and good luck to them. They’re trying to get the best price, you’ve got to understand that. But I think the banks are also more conscious of balance sheet now, too. I think that’s driving discipline.

I mean five years ago who had ever heard of RWA or capital charges? I’m sure they were there, just no one focused on them. All of a sudden you get left long something and someone wants to charge you for it, and it’s a problem, and, so that’s been a dynamic that’s changed and has driven some discipline in the market as well.

But when you get it wrong you get it wrong, and as you say, you get it wrong badly.