A wave of postponed transactions because of tricky market conditions points to a difficult truth for those involved in the Europe, Middle East and Africa equity capital markets: that for many companies the IPO process is not working because investors are refusing to participate in deals at what the sellers deem a fair price.
Volatility has undoubtedly played a part — investor risk appetite has been low all year — but even when market conditions have been benign or positive, the mismatch between what buyers want and sellers are willing to countenance has, more often than not, been too great.
As the IPO price discovery process faces scrutiny, there are discussions about whether issuers can find alternatives to the traditional IPO in 2020 and beyond.
Could Europe go direct?
The difficulties in the IPO market have caused many companies to postpone or cancel listings in 2019. Across the EMEA, IPO volume is down by 44% from 2018, which was also a quiet year, according to Dealogic. As of November 15, 2019, there were 110 fewer deals done across the region than in 2018.
The problems in the IPO market have prompted some to consider whether the European market might begin to see privately owned companies attempt to list on a stock exchange directly, without an IPO.
A direct listing allows a company to go public without the hassles and pressures of an IPO. Existing shares held by private company owners are sold directly on the public exchange, with the price being determined by an opening auction.
It is a model that was used in the US by Spotify in 2018 and Slack in 2019.
“I do not think direct listings are a solution for everything, but the way that the pendulum is moving is interesting and these are being given more airtime than they have been before,” says Richard Brown a corporate financial partner at Baker Botts in London. “The debate remains US focused, but most of the features being talked about apply to London as well.”
Direct listings are not an option for all companies and are only applicable in specific conditions. However, the flurry of pulled transactions in 2019 might give companies grounds to give this listing method greater consideration as an alternative.
“People are questioning the way things are done and are moving to a more engaged approach, where we are all questioning the traditional IPO process and asking whether there are better ways of doing this,” adds Brown. “This all involves addressing different issues and making the listing process more efficient.
“You need a broad shareholder base which generates liquidity on day one and if you have that, you can list without taking the risk on the day-one IPO pop and let the market find the price.”
However, veteran European ECM bankers are sceptical that there are enough European companies with the broad number of shareholders required to do such a deal.
“We have been fielding a number of questions about direct listings and I think the answer is relatively simple,” says James Manson-Bahr, head of the EMEA equity syndicate at Morgan Stanley in London. “You need a very big register to do a direct listing; one with multiple shareholders.
“If you think about the way the US and EU dynamic works, in that the start-ups here are funded by venture capital money compared to institutional money in the US, it isn’t obvious that there are many EU assets with the necessary shareholder dynamic.”
Along with a large pre-existing shareholder register, companies seeking to list without an IPO need to have a profile high enough to attract public attention and have support for the stock on day one.
The two largest examples of US direct listings, Slack and Spotify, were both well-known long before becoming publicly traded companies, with vast pools of potential retail buyers awaiting their flotations.
“You need a well-known company with a history of successful private market transactions and marketing, and a large enough pre-IPO shareholder register willing to sell stock,” says David Koch, head of southern European equity capital markets at Barclays in London. “A prospective issuer will also need to enlist the help of banks to prepare the company for the listing, and to help ensure there is a functioning aftermarket and a potential research following. [Prior to their listings Spotify and Slack] benefited from multiple rounds of private capital raising.”
Poor performance
The two US tech unicorns have not traded well since their direct listings, which might deter other potential issuers. Slack has fallen 42% since it started trading on the New York Stock Exchange in June. Meanwhile, Spotify has experienced bouts of volatility since it listed in 2018.
While tech IPOs have also have had a mixed performance, the fact direct listings have not fared much better might persuade Europeans that an IPO is still the way to go.
“People are assessing how to access capital and it might be that direct listings are the answer, they might not be,” says Daniel Burton-Morgan, head of UK equity capital markets at Bank of America in London. “However, people are happy to ask the question and do the analysis.
“One of the challenges is that the sample set of big direct listings is small versus, say, the number of tech IPOs that on the whole have made investors good money.”
Corporate simplification — where businesses spin off divisions they no longer deem core — continues to be a popular activity and is a driver of ECM activity. While in previous years this would have meant a host of IPOs, difficult conditions might persuade some issuers to de-merge through spin-offs instead.
One of the largest deals of 2018 was the €4.2bn IPO of Siemens Healthineers, a carve-off from the German conglomerates medical technology business. Volkswagen followed the same model and floated its truck division Traton through an IPO in June this year.
The largest European listing in 2019 was not an IPO, but the €95.3bn spin-off of Prosus in Amsterdam, which comprised of the global internet holdings of South African conglomerate Naspers. Prosus’s main holding is a 31% stake in China’s Tencent. Naspers needed to decouple itself from its international holdings to reduce its size on the Johannesburg stock exchange and allow it to cut the valuation gap between itself and Tencent. It also allowed the company to draw in a larger group of international investors outside of South Africa.
For companies that have a strategic reason to separate in 2020, they are likely to consider doing so through a demerger to avoid risking a volatile IPO market.
“De-mergers/spins next year will depend on the IPO market and broader sentiment,” says Manson-Bahr. “The Prosus listing was a great example of the natural next step for Naspers to take in its continued efforts to realise fair value [for their asset base].
“Similarly, we have line of sight on corporate spin-offs for the first quarter of next year. Sub-IPOs can be very successful, but if you don’t need to raise capital, as was the case with Prosus, the more sensible thing is to do a spin or a separate listing to achieve your objectives.”
Because the reasons for a spin-off tend to be strategic in nature, rather than an issuer just seeking to profit from the sale of shares in an IPO, a spin-off makes sense in order to get a deal done, as Naspers proved.
“We were a financial adviser on Naspers’ spin-off of Prosus, which was the biggest spin-off this year and the largest global listing this year, a roughly €100bn deal which we did in September,” says Koch, adding that Barclays is in conversation with a number of prospective spin-off issuers. “It is now the largest listed consumer internet companies in Europe by asset value and one of the largest technology companies in Europe.
“That process is something we would expect to see far more of, given we have a number of diversified conglomerates in Europe that could look to create value enhancement for shareholders by creating a reference price for a subsidiary, are transforming corporate strategy and have businesses which have taken on a life of their own after growing considerably.”
One prospective issuer has already decided that a spin-off might be a more attractive option than an IPO.
Continental prospects
Continental was expected to be an IPO seller in 2019, with the company keen to carve-out its powertrain division. After tricky markets and a disappointing set of financial results delayed an IPO in April, in September it announced that it was considering to spin off up to 100% of its powertrain division, as an alternative to a partial floatation. That will likely go ahead in 2020.
Spin-offs do not mean less work for investment banks, however.
“The spin-off process tends to be coupled with an intensive marketing plan. Much like an IPO, you take the company out on the road and meet with existing investors of the parent company and the new potential investors which would be interested in the company being spun-off,” says Koch. “So when you actually list, you have a market which is waiting for it.
“You often have flow back from the parent company shareholders who are not interested in the new entity and are sellers, and you aim to match that selling with new investors from the marketing process to buy it, creating a more stable aftermarket.” GC