Commerzbank reviews European IPO markets in 2015
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Dan Oakes, Managing Director & Head of International ECM Origination
In the summer of 2011 there was much discussion amongst equity market participants about whether the European IPO market was structurally flawed or broken. At the time, a wave of high-profile deal failures had provoked a public display of disaffection between ECM bankers, investors, financial sponsors and IPO advisers. A breakdown of trust was implied, and unfavourable comparisons were made between an “inflexible” European issuance model and markets in the US and Asia, which were credited with operating more dynamically.
More recently, healthy IPO volumes during H1 2015 have been supported by global market indices breaking all-time highs and notable (if temporary) inflows into the equity asset class in the search for yield. However, significant macro, geopolitical and company-specific events in the second half of the year weakened sentiment and produced a sustained period of heightened market volatility. With IPOs always the first casualty and a long list of deals queuing for execution after the summer break, would Europe’s market participants have learned any lessons from the past?
Whilst a handful of IPOs still failed to price in H2, a significant number were (re)structured in full recognition of the more challenging markets and a prevailing motivation for both sell-side and buy-side to keep this important conduit open for growth financing and exits under the right conditions. In this context, the following levers were deployed effectively in H2’s choppier markets:
Vendor restraint: to mitigate investor resistance to PE firms and other “insiders” cashing out, IPO exits were structured with a dominant primary element (e.g. Intertrust, Netherlands/€486m/Blackstone), or a minority initial free-float (e.g. Bravida, Sweden/SKr2.8bn/Bain), in these cases re-framing the IPO as the first step in a longer-term transfer of ownership from private to public hands and aligning Europe more closely with US market practise. For European IPOs raising at least €250m, average H2 initial free floats were 20% smaller (51% in H1 vs. 41% in H2), although investors were compensated with issue volumes that were 39% higher on average (€740m in H1 vs. €1.0bn in H2).
Cornerstone investor tranche: whilst sovereign wealth funds and family offices have for long been major supporters of Asian IPOs, Europe has found it harder to identify and attract investors able to commit in size ahead of launch across a given price range. The IPO of NN Group (Netherlands/€1.8bn) was a notable exception in 2014, with three funds together pre-committing €150m towards the IPO itself and over €1bn in exchangeable bonds. A number of issuers have followed suit in H2 2015 to improve the viability of their transactions: CLX Communications (Sweden/SKr850m) allocated 74% to 8 cornerstone investors in its IPO, whilst Dometic (Sweden/SKr4.6bn) was able to announce that books were covered on day 1 thanks to cornerstone commitments of around one-third of its IPO. Attendo (Sweden/SKr4.3bn) successfully completed its IPO with 5 cornerstone investors announced upfront as having committed to 81% of the shares initially on offer. The initial offering size was increased by 20%, the transaction was substantially oversubscribed and the shares traded strongly in the aftermarket.
Down-pricing: although frequently seen in the US (e.g. Square Inc., $243m), there has long been a cultural aversion in Europe to pricing below the initial price range, even in the case where market multiples have worsened. Although container group Hapag-Lloyd (Germany/€265m) priced its October IPO 13% below the bottom of the original price range, a profits warning post-launch from close peer Maersk had impacted valuation and sentiment parameters. By listening to the views of the company’s new co-owners and compromising on price paid per share, pre-deal shareholders made a deal possible that may otherwise have struggled to cross the line and procured sufficient equity capital from external sources to fund stated growth targets.
Down-sizing: Fast-growing insurance provider Hastings (UK/£210m) launched its October IPO to support future underwriting business in advance of the new Solvency II capital requirements. To safeguard the transaction in the face of worsening market conditions, the selling sponsor (Goldman Sachs) reduced the size of their intended exit by 75%, whilst two existing shareholders with 4% each committed to subscribe nearly 10% of the shares on offer, significantly reducing what the market would have had to absorb. A 5% price reduction responsibly compensated investors for the reduced free-float and likely aftermarket liquidity, and the deal was completed quickly on a fixed-price basis. With exogenous factors similarly overshadowing Bayer’s carve-out IPO of its polymer business Covestro (Germany/€1.5bn), the target deal size was reduced by 40% and the offer price range reset. With the parent company making up the equity shortfall with a direct capital contribution to ensure post-IPO leverage would be unaffected, the order book filled rapidly and final pricing came at the top of the revised range.
“Reverse Greenshoe”: on the same Covestro transaction, the traditional stabilisation mechanism was reconfigured by way of a put option; to support the share price in the immediate aftermarket, the stabilisation agent may purchase shares at a price at or below the issue price, and deliver them back to the issuer. This allows stabilisation to occur once an allocable book has built at 100% of the base deal size. The knowledge that the lead managers will be stabilising the aftermarket price for up to the first 30 days is an important source of comfort to IPO investors, without which they may be reluctant to commit to the transaction. However, stabilisation is conventionally achieved by over-allocating the base deal by approximately 15%, the underwriters then covering their natural short position by way of aftermarket purchases or the exercise of a call option. The traditional mechanism therefore requires demand to be generated during bookbuilding for 1.15x the base deal size; reversing the traditional structure made stabilisation possible at lower levels of demand, a significant advantage for executing viable deals in challenging markets.
Initial Public Offering without public offering: an IPO is more exposed to market risk than other deal types - a 2-week management roadshow with concurrent bookbuilding only starts once the prospectus has been published and the price range has been announced. IPOs also frequently incorporate a domestic public offering to take advantage of local retail demand, so that a minimum offer period is required after publication of the prospectus. By removing the public offer (at the cost of a full technical listing of the shares in a second EU country), auto-components firm Schaeffler (Germany/€938m) was able to shorten the offer period for its IPO, delay publication of its prospectus and delay price-range setting. An accelerated bookbuilding process was then launched on a narrower price range than would normally have been the case and the deal could be right-sized to reflect the then prevailing market conditions. The company achieved its primary fundraising target and although the deal-size was smaller than first anticipated, the Schaeffler family had created a liquidity platform for future sell-downs during the most unstable period for the auto sector since the bankruptcy of General Motors in 2009.
The combination of the above enabled deals to cross the line amidst market volatility that had both peaked and averaged higher during H2 2015 than in H1 2011, when accusations of the structural market flaws were first aired (see graph below). With a few weeks still remaining in 2015, European IPO issuance has in fact been the highest of any year in the past 5 years, with €54bn raised according to Dealogic (+12% year-on-year). Furthermore, the “failure rate” in the sample (Western European IPOs raising €250m or greater) is the lowest recorded in the 5 year observation period (see table below).
Whilst IPO discounts have undoubtedly widened at times during H2, and preferred treatment for the larger deals sometimes at the expense of the smaller ones, there has been limited evidence of the all-out buyers’ strikes which have occurred in previous years. Furthermore, with average 1-month and 3-month aftermarket performances of +6.2% and +6.0% respectively for H2 2015 IPOs well below average returns in less volatile markets, bookbuilding processes seem to have delivered balanced results that do not overly favour those investors still willing to commit risk capital to debutants. The willingness of the buy-side therefore to remain engaged whilst their own invested portfolios and IPO aftermarkets generally may have been experiencing temporary weakness has been both a critical factor in the smooth-running of this capital market and an indicator of an overall rebuilding of trust.
Successfully executing an IPO is of course not the end in itself but the start of a new chapter in any corporate journey. However, an increasingly pragmatic and constructive approach from both buy-side and sell-side on pricing and the selective incorporation of structural innovation have enhanced the resilience of this vintage of transactions to the negative market forces that led to that unseemly standoff not so many years earlier. This has arguably improved the efficiency of this form of capital allocation in the shorter-term, and should encourage other candidates to discount any concerns about the sunk costs and emotional fatigue inherent in a failed IPO process. If both sides in the game are actively listening to each other and adapting their behaviour accordingly, have European IPO markets reached a new level of maturity?