“The glass is more empty than full”

Geopolitics, volatility levels and earnings vs valuation disconnects are certainly factors affecting deal outcomes in 2018. Markets trading down year to date, ditto. These nevertheless form part of the normal job of bankers, advising issuers and sellers on navigating tricky markets.

What was surprising was to hear experienced equity capital markets investment bankers having no answers for the following systemic challenges facing their industry.

The rise of passive investors

We have previously discussed this rise, and cautioned about the risk it posed to equity capital formation. The panel said this is increasingly a factor in the free float of companies, and therefore impacting the doability of transactions. “Are there enough fundamental investors in the market to be price leaders for IPOs?” was an early and troubling question, which went unanswered.

The magic bullet of “early look” meetings is not delivering

The panel said that today almost every IPO process includes a round of Early Look meetings with targeted investors. The aim of these is to help key opinion formers get an early understanding of the business and spend quality time with management, in exchange for better informed feedback that increases the likelihood of a successful IPO and share price trading.

These have been for many years a useful part of the ECM practitioner’s toolbox. Investors historically complained that the old way of doing IPOs allowed them perhaps 30-45 minutes with management teams on the roadshow, at the end of the IPO process. Hardly enough time for them to make a fundamental portfolio decision.

But with every IPO now holding these early meetings and seeing two or three times as many investors, two things have happened. Firstly, the value of the give and take relationship has broken. Both the relationship of trust with management, and the soft obligation for investors to be open with their feedback. Secondly, in relatively busy markets, investors have too many of these coming through and struggle to focus. Take all this together and the Early Look meetings are “not derisking the deal, or even giving much visibility” and “they have created an onerous process.”

Inflexibility of the IPO process

Adding to the onerous process of the Early Look meetings, the requirement for accounting comfort means the European IPO process is too inflexible. Every transaction is in the market in the same narrow windows each quarter. No surprise that investors feel overwhelmed.

“Where is the wow factor?”

The panel were vocal about the lack of quality supply of IPOs from Western Europe. This was not surprising, given the statement by the London Stock Exchange that nine out of the ten largest IPOs of 2017 on its markets were from outside the UK (a large number from the emerging markets). Indeed, that statement was what prompted our in depth article on What are the equity markets for? What is more worrying was the other statistic which our article identified, that out of the 100 IPOs in 2017 on the LSE’s markets, there were only a dozen UK PLCs with a valuation at IPO of £100m or more.

The panel pointed out that this wasn’t the case in recent memory. 2014 was an example of an equally busy year, but with higher quality companies. They then made the explicit link between the lack of quality in the pipeline, and the failed deals and poor post-IPO trading.

“You are all expecting your deals to fail”

Was the observation by the independent moderator Keith Mullin, a well respected and highly experienced journalist in the sector. Surprising and, if you are a company looking to come to market, worrying.

Rule changes – not yet understood

MiFID II’s impact on research coverage merited only a brief but pointed comment, that “it will impact primary markets, this year or next year. There will be unforeseen consequences”. As we’ve said a few times, the role of banks as intermediaries between listed companies and investors, via the research analysts, will be diluted or disintermediated as there will simply be fewer analysts being paid to write. This will be highly relevant to the primary markets, as well as to the secondary markets.

On the changes to the UK IPO rules, specifically the prohibition on issuers meeting with research analysts during an IPO pitch process, the panel only said, “we will have to see how that plays out”.

Most surprising of all…

These were highly experienced bankers with over 100 years of practice in the markets between them. I waited for the concluding discussion on the possible solutions, or innovations, to address the current failing IPO process.

There wasn’t one. Not a single panellist offered up answers, short of ripping it up and starting again. And there the panel ended.

At The ECM Team, we support management through the private preparation processes before the deal goes live in the market. We leave the marketing judgements to the practitioners who are in the market every day, and understand how investors think and want to be treated.

But even with our limited point of view, we have identified areas of opportunity that are permissible within existing execution processes, which may help to resolve or offset the negative factors currently impacting the market.

1. Early preparation of a company’s Equity Story in a public market context. We’ve written before on the importance of the Equity Story, and management’s crucial role in creating credibility and trust with investors. And as we said, “In the heat of a live execution, with multiple demands on their time, is not the best environment for management to decide carefully how they wish to present the business to investors for the next five years.”
2. Efficient preparation of the prospectus. Using online, collaborative prospectus drafting platforms has the potential to cut up to a month out of a standard execution timetable. As windows of opportunity shrink due to the inflexibility of processes, getting back a month of flexibility for the public phase of a transaction would help to restore some of the lost engagement with investors by spreading out the number of deals over a longer period.
3. Fintech to improve the delivery of research to investors, and the quality of feedback from them. The rollout of Early Look meetings was originally intended to address the increasing lack of breadth and specifics of the feedback from the investor education phase of the IPO process – which is essential for correct price range setting. Electronic distribution of research ensures it goes directly to the right individual within seconds of publication, doesn’t get lost in the post, mislaid on a desk, or inadvertently goes into a restricted territory. It can provide page-level reporting per investor, to give greater insight into what the investor considered important. And will be a cost saving for the issuer. Using an online feedback gathering process has the potential to broaden the universe of investors engaged in the deal beyond the one-to-one, personal relationships of a syndicate and sales desk working to limited timelines and call lists. And places each line of feedback in a like-for-like framework, reducing the risk of interpretation errors.
4. In the UK – encourage participation by retail brokers. The changes in the UK IPO rules from 1 July 2018, mean that an approved information memorandum will now be publicly available at the start of a Main Market IPO’s public process, instead of at the end. The UK is the deepest capital market in Europe – not just institutional, but retail as well. With very little additional effort by the investment banks, that deep pool of retail capital could be a regular participant in UK IPOs. An extra 5% (or 10%, or 20%) of demand may well help more deals get over the line and trade well.
5. In the UK – take advantage of unconnected research for feedback. The same UK IPO rule changes now require Main Market IPOs to hold an analyst presentation for unconnected research analysts. The syndicate banks are required to invite a “range of unconnected analysts” to receive identical information to the syndicate research analysts, and give these an opportunity to publish their research at the same time. The potential breadth of investor engagement with the company’s equity story has increased. There are of course questions whether the unconnected analysts will attend after all, or write IPO research, or bother going on their own roadshows. But for those that do, there is the potential for more feedback and/or more orders than will be generated by the syndicate banks alone. I anticipate capturing that feedback or orders won’t be straightforward – yet we see this as having interesting potential if approached in the right way.

As always, if you have any questions, we’re here to help.

Please note – We’ve used our judgement to select the linked external information which we believe may be of interest. We are not however responsible for the accuracy, completeness or relevance of the information and opinions contained therein.