IPO Banks

Pitch, Selection and Mandate

Philippe Espinasse

• Publisher: Palgrave Macmillan
• Year: 2014
• Print ISBN:
  9781349489756
  9781137412935
• eBook ISBN:
  9781137412942
• Topic: Commerce
• Subtopic: Finances d'entreprise

Former banker Philippe Espinasse, offers advice for the interview, selection and appointment of lead banks, as well as for the execution of an IPO. The book includes case studies from around the world and explains negotiation techniques through which issuers can save considerable time, effort and costs, and also limit their potential liabilities.

Part I

Assessing Candidate Banks

1

The Paradigm Shift: The Negotiating Advantage

Choosing the most qualified candidates for the job is clearly an important consideration, but understanding how much can be negotiated with them as part of their appointment is key to achieving the best possible offer terms, as well as – importantly – a smooth IPO (initial public offering) process devoid of politics, and one where the banks fully focus on the tasks at hand.

To newcomers or the uninitiated, engaging lead banks for a private sector IPO, or for a privatization, at first glance seems like a straightforward exercise: anyone should in theory be able to invite a selection of firms to present to a company and its shareholders, and to select those houses with, what looks like, the best credentials and the lowest fees. However, mandating the wrong candidates can have far reaching consequences: transactions may need to be pulled, postponed or otherwise delayed if insufficient or inadequate investor demand has been gathered, thereby affecting corporate plans for further development. Similarly, a completed but botched offering may ultimately preclude companies from later raising capital, or stakeholders from selling down part of their holdings at sufficiently attractive levels and for a considerable period of time. Getting it wrong is therefore not an option and it very much pays to be prepared when a primary equity exercise is being contemplated.

The run up to investment banks’ appointments, as well as the form their mandates take, also constitute a unique opportunity to negotiate terms that would otherwise become more difficult to introduce at a later stage. Accordingly there is much more to the process than simply choosing a syndicate. Imposing a variety of conditions for the smooth execution of an IPO in the short window between the dispatch of an RFP (request for proposal) to banking candidates and the signing of an engagement letter with a subset of these firms is therefore essential to saving time, effort, costs – and also limiting an issuer’s and its shareholders potential liabilities under the various contracts into which they will be required to enter.

Lead banks, for the purpose of an IPO, basically fall into three categories. The first category includes one or more banks essentially tasked with guiding the issuer when negotiating the contents of the listing document with the stock exchange or regulator (depending on the market where listing is being sought: in Hong Kong, the exchange acts as the front-line regulator for the negotiation of listing documentation, while in the US, the UK or in Malaysia, third party regulators are tasked with the review and approval of prospectuses). These are generally called sponsor banks (in Hong Kong or for the main market in the UK), principal advisers (in Malaysia), Nomads – nominated advisers in short (for AIM, the second board in London) or issue managers (in Singapore) and their names often appear on top of those of the other houses on the cover of a prospectus, or positioned in the top left-hand corner. For that reason, these firms are often called ‘left lead’ in the United States. A specific domestic licence is necessary to act in such a capacity in the market where the company is ultimately to be listed. By contrast, the other senior roles an investment bank may have in an IPO require different types of licences, and also involve marketing to investors, whether domestic or international (or both).

Under the second category, the role of sponsor, or equivalent, may or may not be cumulated with that of the global coordinator, whose remit is broader and consists in managing all aspects of the IPO, from documentation to valuation issues to marketing considerations. One or more firms can be appointed in that capacity.

The third and final category consists of one or more bookrunners who, again, may or may not each also simultaneously act as a global coordinator and/or sponsor, and whose role is most particularly confined to the marketing of the offer and to the allocations of shares to investors – which is where most of the fees a bank can earn on an IPO are actually generated. A difference is sometimes made between ‘active’ and ‘passive’ bookrunners, especially in the US. As the name suggests, ‘active’ bookrunners oversee and largely control the process. Conversely, ‘passive’ bookrunners, while still participating in it, essentially take more of a back seat and also normally receive lower fees for their efforts.

Any of the other, more junior, bank roles to be handed out in an IPO, such as those of lead manager, co-lead manager, co-manager, sub-underwriter or selling group member and so on, can be decided at a much later stage – basically a few weeks to a month or so prior to the formal launch of the transaction. Similarly, it is not necessary to immediately agree which bank may act as stabilizing manager should the share price fall below the offer price in the first weeks of trading. Such a decision can be delayed until much later in the IPO execution process.

Candidates for one of the lead bank roles must necessarily be assessed based on their respective capabilities, track record and competitiveness when it comes to the fees they propose to charge for executing the transaction, and for selling shares to investors. However, simply appointing banks without taking the opportunity to simultaneously agree up-front with these prospective firms a number of parameters for the transaction would not only constitute a tactical mistake but may also be conducive to a difficult working relationship between senior members of the syndicate, with banks focusing on ‘political’ issues far removed from the issuer and its shareholders’ best interests. For example, this may involve syndicate titles, underwriting amounts, how gross fees and brokerage are to be shared or the allocation of roadshow slots.

Few issuers and their shareholders actually realize the extent to which many of the terms pertaining to an IPO can actually be negotiated with investment banks, even at a very early stage – and in a number of cases prior to their formal appointment. Indeed, creating competition among several firms beyond merely assessing the best candidates for the job enables companies to dictate in a large measure the rules of engagement. Investment bankers are always under significant pressure to win primary capital markets business. Such pressure increases with their level of seniority, and especially against the background of challenging market conditions. Fees paid for these mandates directly flow to the profit and loss accounts of their employers and acting in a lead role on one or more of these transactions, in particular for large and prestigious offerings, will beef up their credentials as reflected in league table rankings and industry awards. This in turn materially impacts the remuneration of senior bankers, even if recent years have seen dramatic changes in bonus policies, with a significant proportion of discretionary awards now paid in shares or stock options – even in the case of guaranteed compensation – over a number of years, and, increasingly, with claw-back provisions threatening amounts already paid or due to executives.

Conversely, while a number of features of an IPO can be agreed or even dictated to lead banks – or potential lead banks – at the outset, some, such as the final offer price, are best left to a later stage within the execution of the mandate. Others, for example a request for a hard underwriting, except in markets where this is a regulatory requirement (such as in Indonesia), may actually prove wholly impractical to enforce. Brokers can give a reasonable indication of the likely valuation for a listing candidate, but it is unreasonable to expect this to be set in stone as new information will necessarily be unearthed through due diligence, and as market conditions evolve over the months through which the mandate reaches its marketing stage. The methodology through which valuation will be achieved is of much more interest, as is understanding and keeping track of how this will evolve month after month, so that issuers and their shareholders can have clear expectations about investors’ likely response to the banks’ marketing efforts, and avoid last minute surprises blamed on market forces as the price discovery process is about to kick off.

Similarly, underwriting an IPO at a very early stage, while in theory guaranteeing set proceeds to a company and its owners, will generally entail a sharp discount to the issuer’s fair valuation on account of the risk taken. It may also even prevent the listing from actually occurring if the response from investors remains subdued and the lead banks are left holding a significant chunk of the shares on offer, and therefore fail to achieve the required minimum number of shareholders necessary for listing.

In this respect, employing an independent adviser or consultant to guide issuers and their shareholders along the fine line between success and failure and help ‘keep the banks honest’ can yield significant benefits.

2

Using an Independent Adviser or Consultant

Only a handful of firms and individuals specialize in the niche business of independently advising or consulting on IPOs. These usually consist of former equity capital markets investment bankers or financiers who have, throughout their banking careers, focused on the execution of equity corporate finance transactions, and who therefore have considerable experience of what an IPO entails. What they do is not often well understood nor advertised, making them more akin to practitioners of a ‘dark art’, as compared to the more widely and better known investment banking disciplines of mergers and acquisitions or capital markets financing.

Firms such as Rothschild and Lazard have long acted in such roles, in particular – although not exclusively – on behalf of governments and in connection with privatizations. For example, in 2013 in the United Kingdom, Lazard was financial adviser to HM Government on the US$2.8 billion equivalent IPO of Royal Mail, the UK postal operator, and in that same year also helped UK Financial Investments (UKFI), the body that manages the country’s stakes in bailed out banks, on its US$5.3 billion sale of secondary shares in Lloyds Banking Group. Also in the UK in 2013, Rothschild advised, alongside Canaccord Genuity, on the US$640 million equivalent listing of Foxtons, the London estate agent, as well as on the US$130 million flotation in Milan of Moleskine, the Italian stationer and manufacturer of notebooks and diaries.¹ Elsewhere, Rothschild also acted as financial adviser on the US$2 billion IPO of jewellery firm, Chow Tai Fook Jewellery, in Hong Kong in 2011.

A number of other houses have, however, also emerged in recent years – in particular in the United States and the UK, but less so in the Asia-pacific region – as many senior bankers left established investment banks in the wake of the collapse of Lehman Brothers to set up their own platforms. One such example of another independent adviser is Moelis & Company, which advised on the US$1.25 billion IPO of luggage maker Samsonite in Hong Kong, also in 2011. More recently, traditional consultancy practices have also started to branch out into IPO advisory, as an increasing number of issuers choose to appoint ‘umbrella consultants’ to help manage their new listings. In late 2013, PwC hired former equity capital markets bankers from Rothschild and Goldman Sachs to set up a dedicated team in Europe, in the hope of carving out a niche for themselves in this increasingly active segment.²

Key to the credibility and effectiveness of an adviser or consultant are their independence and an ability to provide impartial and unbiased advice. This is obviously best achieved if no conditions that may give rise to potential conflicts of interest exist, such as these firms researching, selling or trading equity securities, or their working on mergers or acquisitions in a related region, country or industry sector. Rothschild is no longer involved in underwriting IPOs since its equity capital markets joint venture partner ABN Amro was acquired by The Royal Bank of Scotland in October 2007. Lazard spun off its securities underwriting business, Lazard Capital Markets, at the time of its own IPO in 2005: this is now an independent firm. Other firms, however, can be found acting in both an advisory and underwriting capacity, for example US investment bank Jefferies, which was both financial adviser and a joint bookrunner and joint lead manager of the US$1.3 billion IPO of dairy producer Huishan Dairy in Hong Kong in September 2013.³ A firm of advisers or consultants that is also involved in an IPO in an underwriting capacity may perhaps be tempted to provide more conservative advice when it comes to making valuation and pricing recommendations to a listing candidate since it also serves its institutional investor clients. In some cases, such advice may even be frankly partial. As with investment banks, it is also important to establish which individuals will actually work with the issuer and its shareholders rather than merely pitch for the advisory or consultancy business. It is also good practice to pay a significant proportion of their fees at the time of listing and closing of the transaction or even beyond, so that the ultimate objective – that is, a successful conclusion to the IPO – remains their top priority.

As with lead banks for an IPO, quality work must be rewarded and one ultimately only gets what one pays for. Skimping on fees, which realistically should total from several hundred thousand to several million US dollars, depending on the adviser and size of the IPO, in effect constitutes a false economy. Employing a quality adviser or consultant can generate significant savings for the company that may in the end represent many times over the cost associated with the provision of its own services. A practical arrangement therefore generally entails payment of a monthly retainer throughout the execution of the offering, with a much higher success fee awarded upon completion or at a later stage. It is also market practice for reasonable out-of-pocket expenses to be reimbursed, although these should really represent a fairly modest amount as compared to those incurred by investment banks, especially where the adviser or consultant is locally based.

Much of the important work provided by an adviser is in relation to the appointment of lead banks, a process that can generally last for up to two months. A mandate may therefore perhaps best be structured with an initial phase until the formal appointment of investment banks, also enabling the adviser or consultant and the issuer and its shareholders to get to know each other better, and for the latter to appreciate the value-added services provided by the former. This appointment can then be followed by a second phase, where the mandate is re-conducted by the board of directors of the company until the actual completion of the IPO.

Irrespective of how the mandate of the adviser/consultant is structured, should one be chosen to assist with the selection of the banks and subsequently the execution of the mandate, it is key for any adviser to come on board prior to formal contact being made with potential lead banks. Obviously, the company and its owners will in many cases already have met with a number of houses pitching for the IPO, or against the background of other corporate finance mandates, in an informal manner. However, formally initiating a beauty parade or sending a request for proposal prior to the appointment of an independent adviser would be a tactical error, significantly eroding the latter’s ability to negotiate with potential global coordinators and bookrunners on behalf of the issuer. The adviser does not necessarily need to be appointed months in advance, but at the very least a couple of weeks should be allocated to enable him or her to discuss and agree the names of candidate firms with the issuer and its shareholders, as well as how best to approach them and what information to request from investment banks.

3

How an Adviser/Consultant Can Best Add Value

An adviser never replaces investment banks. Indeed, one of them clearly states this on their own website, also highlighting as their strengths both impartiality and the provision of guidance and services that traditional financial institutions are unable to deliver.¹

In an IPO, the conflict of interests that exists between the investment banks’ duty of care to the issuer and selling shareholders on the one hand, and the ongoing relationships that exist with institutional and high net worth investors who trade securities with them in the secondary markets on the other, sometimes means that their recommendations, most particularly with respect to valuation, the quality of the book of the demand, and pricing, can be biased. They may perhaps refrain from seeking from investors a valuation that genuinely represents the true value of the business; or otherwise choose to conduct a club deal rather than fully market the offering to the widest possible universe of investors. Or even, as I witnessed in my investment banking days in relation to a pretty poorly executed real estate investment trust (REIT) IPO in Asia, seek orders from investors in exchange for favourable allocations in another deal. Some of these practices are illegal in many markets, while others smack of laziness, or of a lack of commitment to the transaction, often because the amount of commissions that may be earned does not, in the banks’ views, warrant much focus on the deal or the involvement of senior and experienced individuals. An adviser should be able to easily see through,...

Table of contents

• Cover
• Title
• Part I  Assessing Candidate Banks
• Part II  The RFP
• Part III  Interviewing Investment Banks
• Part IV  Formally Appointing Lead Banks
• Appendices
• Glossary
• Notes
• Index