The IPO, which was priced on October 10, 2013, was one of the most talked about floatations of the year. Not only did the deal see the privatisation of an institution that can trace its roots back to a Royal charter in 1516, the performance of the deal in the aftermarket was one of the most remarkable seen since the financial crisis.
After listing at 330p on October 10, the shares soared almost 38% on their first day of trading — the highest first day return of any European IPO since 2007, according to Dealogic — and hit a peak of 607p in December.
This staggering performance caused ripples of consternation. Suggestions that the IPO had been mispriced abounded and by November, bankers were being called to answer questions about the terms of the transaction before a parliamentary committee.
But although the deal has offered a 70% return over its first three months, bankers from across the equity capital market argue that suggestions that a deal as complex should have been priced differently are unfounded.
“Seeing how much the deal is up, you could say it was mispriced but I think any bank would have priced it in a similar way,” said one head of ECM. “The government had to make this deal a success so they approached the pricing with a bit of caution, and the buyside may have taken advantage of that. It also got caught up in the UK’s outperformance — with money flowing into the UK from the US, it’s only going to drive the performance of deals like this.”
Looking back, some market participants blame the timing of the deal for the pricing difficulties. The privatisation was launched amid substantial threats of strike action from postal workers that were due to hit over the run-up to the Christmas period — when they would have caused the most damage.
“That’s the time when the number of parcels is up by about 60% and letters go through the roof too,” said one postman. “It’s a lot busier than the rest of the year, so you can imagine the trouble it would have caused.”
Investors and bankers alike could certainly imagine the trouble, and it was this looming prospect of strikes that may have pushed the pricing for the IPO downwards.
“Fund managers were asked whether they wanted a stock for a company that, though well understood and with good sector comparables available, may see all its staff walk out in its busiest period,” said an ECM banker. “My sense is that the 330p is a discounted market price reflecting the possibility of stated strike action.
"If that hadn’t been the case, fund managers may have been pushed to 400p-450p for the IPO — a rise from 450p to where the stock is trading now represents a more reasonable return that just equates to the removal of an IPO discount.”
Other bankers have put the early price rise at the door of long-term investors looking to quickly build a stake given the past history with privatisations in the UK, and as retail investors flipped their shares.
“We were surprised that it traded up so aggressively,” said one senior banker. “I think some long-term asset managers saw a lot of available optionality, and took a view from looking at past privatisations that they could take out more costs than they previously estimated. That drove the share price up disproportionately as people jumped on the back of that.”
The stock leapt 40% in the week after its listing, but the relatively stable pricing seen since the first few weeks of trading suggests to many bankers that the initial bump was driven primarily by larger investors taking significant positions in the name. These accounts had seen their original allocations limited by the Department for Business, Innovation and Skills, which pushed for a larger retail portion, but quickly took charge of the aftermarket. The Children’s Investment Fund, for example, had been offered only £1m of shares through the IPO, but by late October had built a position of more than 5%.
“It’s clear that the initial rally was driven by one or two large investors building up significant positions, and that took the stock above the 550p mark relatively rapidly,” said one ECM banker. “Technicals drove it to that level, but since then the stock has levelled off. Those long term investors are now sitting on their shares, so trading hasn’t been particularly volatile.”
But after the IPO, did the share price rise to a level that is realistically in line with its value, or is it in line for a fall? The view of the investment community is more or less balanced — four analysts have buy recommendations, five say hold and three have sell recommendations. In mid-December, analysts at UBS — one of the banks that had advised the UK government on the sale — reiterated a sell recommendation, providing a 12 months price target of 450p (the stock closed at 593p the day the report was published).
“Our key concern is that at the current valuation, the market’s expectations are too high,” the Swiss bank’s analysts wrote.
This particular piece of research was issued only days after a potential rival to Royal Mail was revealed. LDC (the private equity arm of Lloyds Banking Group) and Dutch mail service PostNL announced on December 13 that they would establish a joint venture to allow TNT Post UK to roll out an end-to-end postal delivery service across the UK.
Having completed trials in London from April 2012 and in Manchester from October 2013, with the deployment of 1,000 posties in each location, TNT Post UK expects to hire another 20,000 postmen across the UK over the next five years. Royal Mail has appealed to the regulator, Ofcom, about the new venture.
“In other countries where there is competition, minimum loss is 1 percentage point per annum, with 12%-20% lost in total,” noted UBS in its research note. “This would equate to a cumulative total of more than £460m of lost annual revenue for Royal Mail.
“Investors are, at the current share price taking a very clear view that ...end-to-end competition will not have a material impact. We believe the only way that can be true is if the regulators intervene, as it is difficult to see how Royal Mail could offset all the impact of market share loss via price alone.”
Bankers in London noted that Royal Mail has an enviable market position in the UK given that the company has not yet been heavily challenged by other operators.
“It’s hard to unpick how any competition would affect it,” said one senior ECM banker. “But Royal Mail has an established position so they should be able to weather it well. The main concern would be for their parcels business.”
Control of the UK parcel delivery market in the UK is key to the appeal of Royal Mail for many investors. While Royal Mail delivers more than 99% of the 17.4bn UK letters posted each year, the outlook for this sector is poor. According to bottom-up segment analysis from PwC (published in July last year), total mail volumes are expected to fall by 30% over the next 10 years, with the volume of letters posted set to drop by on average 4.5% a year through to 2023. This is in line with Royal Mail’s own expectations of a 4-6% decline for letters year on year.
Conversely, parcel volumes are expected to grow from 6% of total mail volumes in 2005 to 22% in 2023, buoyed by an increased reliance on e-commerce and more business-to-business deliveries as the European economy recovers.
In the first half of the financial year 2013-2014, Royal Mail reported revenue from UK parcels had grown 9% year on year to make up 51% of its group revenue. It is already way ahead of other European mail firms in its shift to a parcel focused strategy — in 2012, BPost and PostNL reported revenues from parcels of only 7% and 15%, respectively.
That Royal Mail is far ahead of its peers in finding a revenue substitute for a declining letters business may illustrate why the UK firm stands at a premium to its peers in terms of valuation. Royal Mail in early December was trading at an EV/Ebitda ratio of 9.6 times, ahead of Bpost at 5.6 times, Austria Post at 9.0 times and PostNL at 6.0 times.
However, for some bankers, the Royal Mail’s outstanding multiples only show how overpriced it now is in the markets — and how difficult was the task of pricing the IPO.