Europe’s equity markets expect a year of rebuilding

For those involved in the equity capital markets, 2021 could be a year to savour. After a year that most will want to forget, the encouraging vaccine news has spurred hopes of a return to normalcy for businesses in the year ahead and that has prompted strong flows into equities in the last two months of the year. 

It could be a particularly fruitful year for those in Europe. While US stock markets are dominated by tech names, which rose as remote working took off during the pandemic, Europe has more exposure to cyclical stocks — the sorts of business that were hit badly as the virus took its toll. But as economies re-open these stocks are expected to benefit.

“We have a pretty upbeat outlook for next year, particularly at a macroeconomic level,” says Martin Thorneycroft, head of EMEA cash ECM at Morgan Stanley in London. “Our strategists published their outlook indicating a continuation of the V-shaped recovery fuelled by the prospect of a vaccine, the re-opening of the economy and by the continued epic monetary and fiscal stimulus that will persist through 2021. 

“Interestingly they see Europe as a key beneficiary of that recovery, primarily because European equity markets have a heavier weighting towards more cyclical sectors.” 

At only around 13% of total EMEA ECM volume, IPOs have disappointed in 2020 as the Covid-19 pandemic prevented a number of companies from having the confidence to move ahead with their listings. 

The total volume of €22.9bn is flat year-to-date to last year but the share of the market is 7% lower — a gap that is only going to grow because of the record $29.4bn Saudi Aramco IPO that was priced in December 2019. Compared to 2018, volume is down around 57%.

However, there is confidence that 2021 will turn out to be one of the busiest years for IPOs for some time, a boon for Europe, which has long sought new listings to boost its indices to drive more investor flows to the continent, away from the US and Asia.

“The European IPO pipeline is very robust, at the time of speaking, we’ve got numerous IPO mandates for early next year, and plenty of candidates for primary issuance in the new year,” says Alex Watkins co-head of equity capital markets, EMEA, at JP Morgan in London.

“It is weighted towards what investors want exposure to: more growth-orientated defensive businesses and some technology-focused names. IPOs will represent a much bigger portion of overall ECM activity and be a bigger driver of the market.

“New companies coming to market will help replenish the number of listed European companies; the good news for entrepreneurial, growing companies is that markets are very receptive and the valuation premium for those characteristics is high. I think there is now a well-balanced discussion about being public compared with, say, two years ago when a lot of conversations were around staying private for longer.”

Morgan Stanley’s Thorneycroft is also optimistic about IPO volumes, adding that the pipeline is being filled by “businesses that might have gone public in 2020 being deferred into 2021 as well as some deals being pulled forward from businesses that might have been thinking about going public in 2022.

“Some of these have benefited from Covid-19 or have just seen multiples in their sector expand dramatically and are accelerating their IPO plans, so I think you will get a sharp uptick in IPOs, equity markets allowing.”

Banks are already generating substantial investor interest for the most exciting deals of 2021.

“For the most interesting prospective IPOs, we are already receiving inbounds from people saying that they might want to anchor or cornerstone a deal,” adds Thorneycroft’s colleague, James Manson-Bahr, Morgan Stanley’s head of the EMEA equity syndicate.

While a number of companies tapped equity capital markets in 2020 to fight the Covid-19 pandemic, others were able to offset any dilutive share raises by taking cheap debt from the government, particularly in continental Europe.

However, at some point, companies will have to repay those funds, which in many cases will lead to the dilutive equity raises that companies were trying to avoid.

“Governments in continental Europe, UK and the US have been so forthcoming in terms of their help during the pandemic, more so in continental Europe, that I think some necessary financing decisions have been postponed,” says Luis Vaz Pinto, deputy global head of corporate finance and global head of equity capital markets at Société Générale in Paris. “French corporate debt is now equivalent to 140% of GDP, Spain has corporate debt worth 81% of GDP and Italy, is around 70%. 

“However, this is not debt that has been taken on for investment purposes, which would have generated further earnings down the line, some of it has been to raise cash as a buffer, but it is actually mostly unproductive debt that has been taken to compensate for losses in company business, and therefore unproductive.” 

He adds: “For the time being, the favourable conditions that we have had of low interest rates, and 80% state guarantees, with these state loans having been given at preferential rates, has meant that we have kicked the can down the road and some businesses have postponed decisions for the necessary equity to provide the right capital structure.” 

However, there is hope that equity investors will step up to help companies to repay that state debt, particularly in sectors where there is a strong re-opening angle and therefore equity profits to be made.

In November Lufthansa, the German flag carrier, exploited a rally in equity markets driven by the positive vaccine news to issue a €600m convertible bond, which attracted orders from over 200 investors. While Lufthansa still has a large amount left to repay from its €6bn government bailout, the deal is a sign that equity investors will support recapitalisations, through either a convertible bond or a straight equity raise.

“The convertible bond we did for Lufthansa in November is an interesting example of investor attitudes because a €600m deal in the overall scheme of what Lufthansa needs to raise is a drop in the ocean,” says Andreas Bernstoff, head of equity capital markets at BNP Paribas in London.

“However, the market could not get enough of it and it came at a time when the market was healthy and investors wanted that sort of exposure.

“There is no fundamental investor issue around refinancing government bailouts and a lot of them will expire early next year.”

M&A is also expected to lead to more equity fundraising in 2021, as the devastation caused by the Covid-19 pandemic has created a need across Europe for sector consolidation. 

Some transactions are already being lined up. In November, UK insurer RSA said that it had agreed a deal to sell itself to a consortium consisting of Danish insurer Tryg and Canada’s Intact Financial for £7.2bn.

Intact will take its Canadian and UK businesses, while Tryg will pay £4.2bn for its Scandinavian operations and fund it through a rights issue next year.

“The fact is, M&A has been noticeably quieter this year but what we are seeing now as you dig beneath the surface is that our M&A bankers are as busy as they’ve ever been, so we feel very confident around M&A next year,” says Suneel Hargunani, co-head of EMEA for equity capital markets at Citi. “That is going to filter down into equity fundraisings, for sure.”

Equity capital raising was a large part of the market in 2020, but a lot of this activity was to fund emergency balance sheet repair in the teeth of the Covid-19 pandemic, rather than to fund M&A or corporate growth. 

However, with the worst of the pandemic hopefully over most expect next year’s raises to be strategic and less focused on immediate survival.

“Clearly the macro impact of Covid is hard to predict, but in terms of primary issuance, I don’t think we will have the same frenetic nature that we had in some cases this year as the impact of the pandemic took hold,” says Edward Sankey, global head of ECM at HSBC in London. “A lot will depend on the capital structure of the companies and how well they are able to weather the macro impact.

“The UK obviously has had the luxury of the 20% non-pre-emptive raise, which Europe hasn’t had. I imagine therefore that there will be a number of European companies, which will continue to come through to raise equity via the rights issue route or combo offerings. There is a healthy pipeline of acquisition-driven equity issues.”   GC