With markets frothy and the geopolitical and macroeconomic backdrop uncertain, the potential for an upset is significant. Markets have been driven upwards by excess liquidity while macroeconomic data has been muted and there is significant downside risk given elevated market levels. Corporates or financial sponsors need to navigate this challenging environment with caution and ensure their underwriters are really acting in their best interests, writes Ken Brown and Myles Evanson.
Equity markets have entered 2017 with gusto. All-time highs have been reached in the US with investors cheered by the prospect of more business-friendly policies from President Trump’s new administration. As importantly, the growing possibility of inflation is encouraging investors to exit cash and invest in hard assets. Consequently, liquidity is strong and fund flows into equities have been impressive.
For companies or financial sponsors contemplating equity raisings – whether IPOs or primary or secondary placements – the current environment offers attractive prices. In the year-to-date, EMEA equity issuance has surged, with $64 billion raised compared to $34 billion in the same period of 2016 (in part driven by two large bank rights issues for Unicredit and Deutsche Bank for a combined total of ~$22bn). Given long IPO lead times, much of the early activity was accelerated bookbuilds (ABBs) but more recently there has been a pick-up in IPO activity with 27 deals priced YTD vs 13 in 2016; the deals that have made it to market have been well received.
We believe there is a significant pipeline of deals ready to go, including a growing number of emerging market companies seeking to list on a major market such as London or Frankfurt to benefit from the increased liquidity and valuations available.
What role should an advisor play?
In recent years, there has been an increasing use of Equity Advisors for IPOs. Initially, the trend started among private equity firms and for government privatisations: now, for financial sponsors, an advisor is almost a prerequisite for an IPO. However, advisors are also increasingly being used for ABBs and by corporates. In uncertain times – such as those faced by equity vendors today – independent guidance is likely to become more valuable and popular.
The growth of Equity Advisory is being driven by a number of factors. Most importantly, both financial sponsors and companies are eager to ensure that their interests alone drive the sales process throughout. To be clear, there are no suggestions that underwriting banks deliberately seek to serve their clients poorly. However, last year a Financial Conduct Authority (FCA) report acknowledged the fees paid to underwriting banks by their buy-side clients far outweigh those paid by the sell-side. Inevitably, this introduces uncertainty and creates potential conflicts of interest.
There are multiple occasions during a deal where a vendor might want to ensure that value is being optimised. For example, an IPO may reach a wider range of quality investors if the syndicate includes a complementary group of underwriters; however, as a larger syndicate would reduce the fees paid to each bank it may not be favoured by the lead banks.
Later in the process, lead banks typically introduce the issuer to potential anchor investors to scope out the multiple to be used for valuation and the tone the deal will take. The vendor will be eager for this process to judiciously weigh the evidence in order to establish the soundest basis for valuation. While the investors the company meets may well be leading global players, they may also be the underwriters’ leading buy-side clients: underwriters may be distracted by the importance of keeping their key investor clients on-side.
Similarly, when a price range is set, a vendor wants it to reflect the valuation and market sentiment. However, other issues not directly related to the vendor or the asset being sold may affect this range, such as the underwriting banks eagerness to ensure the deal gets away easily so they can bring their pipeline of other deals to market. Indeed, the FCA points out that IPOs, for example, are on average under-priced. Finally, the vendor’s goal is for allocation of shares to investors most suited to ensuring the long-term performance of the stock; but there may be a temptation for the underwriting banks to reward their key investor clients with allocations.
Getting better value for money
Given the potential problems described above, there is an increasing appetite for objective advice from experienced capital market professionals, who are unencumbered by potential conflicts of interest. A truly independent advisor that does not underwrite ECM transactions in EMEA, can provide the vendor with reassurance and the benefit of their experience: they can highlight situations or decisions where there are potential ambiguities. They can also be relied on to stand up for the issuer and ensure they get the best transaction at the lowest cost possible.
The current Equity Advisory market is concentrated among a small number of players – but not all have the same capabilities. Understanding what is going on in the equity markets is an essential part of being able to act as a counterbalance to the weight of the underwriting banks. Most advisors rely on public trading information from external providers, which can only ever provide a snapshot of trends. In contrast, Nomura owns Instinet, the third largest broker in Europe, which processes huge volumes of customer flows. It therefore has valuable visibility into sector and geography trading flows that boutique advisors do not.
ECM transactions are often driven as much by investor sentiment toward macroeconomic factors as by company specific information. Independent macroeconomic research enables an Equity Advisor to provide comprehensive and authoritative advice, not just on the deal process, but also about market conditions. Again, unlike boutique advisors, Nomura’s macro research capabilities mean it is able to offer this additional insight.
It can also be beneficial to an issuer if their Equity Advisor has additional investment banking capabilities. For example, financial sponsors may need guidance on debt structuring for businesses being sold to the public markets, on optimising a return of cash or on M&A advice in a dual-track process. Nomura can use its experience to ensure the provision of capital in an appropriate debt structure is a quid pro quo for banks’ involvement in the IPO as underwriters. Nomura can also advise on "at- IPO" margin loans, which are increasingly popular structures, and if done correctly, can release value (with a limited risk of margin calls) and enable a financial sponsor to return funds early to limited partners, improving their internal rate of return or even recycling the cash for additional investments. Furthermore, with strong sector and geography focused investment banking teams, Nomura can work with issuers on dual track processes in a highly confidential manner, maintaining optionality while protecting the economic value of a potential exit.
Similarly, boutique advisors must work with outside counsel for legal and compliance support when putting together a syndicate, which can complicate or slow down the process. As an international investment bank, Nomura has all the necessary resources in-house, enabling a quicker response at a lower cost.
Ultimately, the right Equity Advisor will save a financial sponsor, corporate or government far more than it costs – in unsettled markets they could even save the transaction. Advisors can use their experience to prevent vendors having to pay unfair fees and other costs, helping to reduce overall deal costs. As importantly, an advisor can lower the risk associated with a transaction by aligning the process solely with the needs and objectives of the issuer. Finally, an advisor can act as a useful shield for corporate or financial sponsor management or government bodies to ensure their time is spent wisely and resources are used as effectively as possible.
To discuss these opportunities further, please contact Ken Brown (+44 20 7103 1407) or Myles Evanson (+44 20 7102 1917).Read more