Equity Capital Markets
12 Points about Equity Capital Markets for CFOs by Dan Oakes, Head of International ECM Origination
• Macro and Political headwinds make investors nervous. Uncertain market conditions have created a tough environment for anyone seeking to conduct an equity flotation or Rights Issue in Europe.
• Some recent high-profile cancellations of equity transactions can also be attributed to poor planning or unrealistic expectations.
• How can a CFO help keep an equity transaction on track – and more generally, keep a company’s shareholders on board?
1. As CFO, you’re the numbers person - investors will want to meet you
Institutional investors like to meet senior management. They tend to look to the CFO and CEO as the most weighty company representatives with whom they should be granted frequent access. You may have a highly capable head of Investor Relations (IR), but it will be you, as CFO, that investors want to ask those in-depth questions about capital allocation, business performance or M&A selection criteria.
It goes without saying that having the CFO ready and available makes any deal-related roadshow far easier to fill and increases the likelihood that meetings will be attended by senior investor representatives. However, sometimes less well understood is the need for CFOs to allocate a significant amount of their regular working week to maintaining relationships with shareholders throughout the IR calendar – not just getting in touch when it’s time to tap them for more capital.
Being CFO is therefore more than just being the most senior treasurer, in charge of the numbers. You are one of the key spokespeople to all stakeholders for those numbers and all the decisions behind them, so tactical communication is as important as the numbers themselves.
2. Don’t try to pick and choose investors based on preconceptions of their motivation
When assessing which investors to meet as part of a deal or non-deal roadshow, it’s easy to assume that long-only portfolio managers such as pension funds are intrinsically “good” and hedge funds that may regularly short stocks are “bad”. But the truth is never that black and white.
Long-only investors, for example, may accept a meeting because they are seeking background that can help with an investment decision on one of your competitors – or that can justify taking profits on your stock.
Equally, when meeting a hedge fund manager, you don’t know whether they are looking for negative signals to increase a short position or positive signals to unwind it. It may even be that your stock is to be used as a long position in a long-short pair trade. In fact, in many cases the rigour with which an investment exceeds that of other market participants, as can the duration of their partnership.
So try to avoid second-guessing an investor’s motivation to attend a meeting with you. By all means find out as much as possible about their stock selection process and investment model before you meet, but then let your numbers and corporate story speak for themselves.
3. Never spend time trying to reason with investors that your share price is undervalued
A common gripe for companies is that their current share price doesn’t reflect the true upside potential of their business. It seems to be a more emotive topic for corporate executives than how their CDS spread is trading on an absolute or relative basis. As tempting as it is to spend time trying to persuade investors that the current share price is wrong, it is far more important to focus on communicating the long term credibility of the business and the reliability of its performance – and then let investors make up their own minds. If you are confident in the strategy and your ability to deliver on that strategy, efficient markets will tend to reflect that quickly.
This is particularly important in an initial public offering (IPO) where there’s always tremendous focus on what the proposed price range will be, and how it compares relative to its peer group in terms of valuation multiples. But as soon as that price is struck, the actual price becomes rather arbitrary and the only thing anybody focuses on is how the shares then trade in the immediate aftermarket. This focus will be as true for your CEO as it is for your new shareholders.
Likewise, when conducting a Rights Issue, try not to get hung up on discounts to theoretical ex-rights prices or the absolute value of the subscription price compared with your idea of “fair value”. True, strong pricing can indeed signal corporate confidence; however, a Rights Issue is first and foremost an enabler of corporate development. A strong take-up message should be the immediate priority, and one year on, the only thing that matters to investors is how the new issue price compares with the prevailing share price and whether participating has been a wise investment decision. Therefore, focus your energies on supporting the share price’s future trajectory.
4. Remember that good communication is everything
Honest and timely communication should be the goal for your everyday interaction with shareholders as your equity capital providers.
In announcing a Rights Issue for an acquisition, for example, it’s important to explain the reason for the deal, how long it will take to execute, why you have arrived at the funding mix, what the synergies are likely to be, how the success of the acquisition will be measured and over what time-frame. By allowing the market to fully understand the milestones, and updating the market as often as is needed as the completion nears, there will be no surprises by the time deal actually takes place.
There are two other points to make here. The first is the importance of erring on the side of caution when communicating the potential size of any equity transaction. For example, say you need a Rights Issue to refinance a short-term bridging loan: proposing a range of values up to EUR 500 million and then confirming that you only require EUR400 million to achieve your optimal post-transaction leverage, will be met much more positively by the market than initially estimating a lower value and then revising upwards nearer the time of launch.
The second point is how to handle bad news. Any company can have a setback – be that company-related or a shift in the macro environment. If bad news hits, tell it like it is. If the circumstances are likely to have an impact on your P&L or balance sheet, be proactive and address this immediately. Delays only erode shareholder confidence; the market always punishes defensiveness, unwarranted optimism or prevarication.
If news is so bad that any recently-announced deal may have to be delayed or cancelled, then it’s down to the CFO to be the voice of reason. That can be tough when so many people in the business, including the CEO, may have become emotionally invested in its successful completion. But the CFO has to look at investor feedback and market conditions rationally and be as objective as possible about whether the proposed deal is still viable or not.
5. Never let managing an IPO side-track you from delivering operational performance
Managing an IPO is a time-consuming, labour-intensive process. But there are no prizes for a CFO if the business fails to deliver on its financial metrics as you prepare for launch. Before embarking on an IPO, a CFO needs to think carefully about support structures and which parts of the IPO process can be prudently delegated (while bearing in mind Point 1, above, about their centrality to investor relations).
Remember that when a company comes to market, the only thing that will be relevant is how the business has been performing in the run-up to the IPO, in absolute terms and relative to prior accounting periods. Some of the highest-profile IPO failures have occurred when a company appears to talk an impressive growth story to investors – and then disappoints with sluggish financial performance immediately afterwards.
6. Get actively involved in any equity allocation process
At the tail end of marketing a new equity issue, it can be tempting to switch off as soon as book-building is completed, leaving the actual allocation of shares solely to your investment banking team. You may wish to reconsider.
Being actively involved in the allocation of shares gives you a golden opportunity to shape your company’s shareholder base, focusing on those investors who seemed most engaged with your business and who share your values. Given that you will need to meet equity investors regularly and justify your strategic decisions to them, an alignment of outlook and understanding is essential.
Of course, it is important to draw on your banking team’s knowledge and experience. However, you must be sure to ask them why they’ve made certain allocation recommendations. In turn, state your preferences clearly and make sure those preferences are listened to, recognising that such allocation decisions can have a greater impact on your shareholder base than many months of run-of-the-mill IR activities.
7. Treat equity investors as your “forward-looking co-owners”
Depending on where in the capital structure they sit, different capital markets investors will look at your business in very different ways. A bond investor may be more focused on near-term cashflows and the extent to which these can meet pre-agreed payments of interest and principal. An equity investor is far more interested in the future growth trajectory and how their stake in your business might grow in value, given that the potential rewards and risks of ownership are much higher.
As well as providing performance numbers about the business, it’s therefore vital to communicate a vision of the future: how your sector or industry is developing; how you stand at the forefront of that change; and what your business will look like in three to five years’ time. If you can view equity investors as you co-owners, with a right to know what the future might hold, rather than as people who take up an awful lot of your time asking “irksome” questions, this can feel more natural to articulate. Additionally, it would be a mistake to assume that differing investor perspectives do not create a communality of purpose: your cashflow pays not only interest but also dividends, so you may find yourself hosting an investor meeting that comprises both bond and equity portfolio managers.
8. Know how new bank regulation will affect you
There are two pieces of bank regulation coming online that have major implications for any corporate engaging with equity market investors.
First is the EU Market Abuse Regulation (MAR), which came into effect in July 2016. Among other aspects, MAR makes it far harder for investment banks to conduct speculative roadshows to sound out market appetite for a potential future transaction. Instead, corporates must now be very specific as to whether or not they intend to do a deal and in what time period, wall-crossing and cleansing investors as required. Non-deal roadshows intended to canvas investor appetite prior to any near-term deal launch are therefore more problematic under the new MAR regime.
Secondly, MiFID II (the second Market in Financial Instruments Directive) is set to come into force in January 2018 and seeks to unbundle the cost of equity research from dealing commission, making it instead a clear and separate charge for fund managers. This is likely to result in some banks reducing research capacities, with those banks remaining committed to this being either global generalists or niche specialists. For many corporates, this will mean fewer analysts covering their stock. This being the case, CFOs may need to reassess their banking relationships, asking themselves whose research coverage they least wish to lose and which they see as the go-to banks for fund-raising. This, in turn, may help determine how you allocate Investor Relations activities amongst your brokers in the future. In addition, understanding your investor base in this environment is becoming all the more important, with your banking partners a critical interface for providing buy-side intelligence.
9. Match the character of your banking syndicate to your firm
Following on from the point above, it is also important when selecting transaction partners to consider your corporate profile and whether your chosen banking team is a good fit for it. A major global investment bank can offer excellent product and service capabilities. But if you are a small to mid-sized firm, how much of a priority is your transaction likely to be compared to those of its larger corporate clients?
Likewise, a top-ranked equity analyst owes his or her ranking to the votes cast by the world’s biggest investors for analysis of the most significant sector constituents. Ask yourself truthfully whether your company fits such a profile, and whether such an analyst is likely to prefer spending what limited time is available marketing your story to the relevant investor base, or the story of a larger index constituent, which will rank higher in terms of votes for rankings and dealing commissions for their sales desk.
10. Seek out a multitude of viewpoints
It can be tempting to narrow down your source of advice on a transaction to a couple of major banks with the rationale that they must know the market best. If you instead appoint a group of lead managers, it can be very helpful to hear what each of the Equity Capital Markets teams has to say on a particular issue. As part of proper planning, a diversity of views can often help identify a better solution and even uncover an aspect that could move the transaction positively in a different direction. The best way to achieve this is to arrange bilateral calls with each bank individually, rather than anonymous multi-bank calls in which differentiated advice may be crowded out.
Equally, if a lead arranger seems more intent on getting a deal closed than getting it right, alarm bells should ring. As a fee-paying client, you should always feel in control of the process, rather than managed by it. Ultimately, you are spending shareholders’ funds, so the question should always be “am I getting the best advice?”
11. The best equity transactions combine vision with sanity
Successful equity transactions tend to be those that have a great growth story or value proposition. It is imperative that you have solid, reality-based numbers to back it up. If the CEO’s role is to sell the blue-sky vision, your role as CFO is to be the sanity checker that keeps everything and everyone under control. Sometimes that will mean playing devil’s advocate, considering how to prepare for scenarios where the market opportunity might look less rosy than first predicted, and planning how investor expectations might be credibly managed in all scenarios. Equally, if you’ve just completed a significant acquisition and another opportunity quickly presents itself, ask yourself whether the market wouldn’t prefer you to deliver on promises made in respect of the first before embarking on a second.
12. Remember that equity fund-raising isn’t irrevocable
CFOs who find themselves endlessly deliberating as to whether an equity issue is the right course of action can console themselves with the fact that movement between public and private share ownership has become far more fluid.
Being CFO is very much about making a constant reappraisal of the company’s capital structure and assessing if it’s delivering optimal value to all of the stakeholders. While always taking proper time to assess a course of action, you should remain willing to change direction in the future if justified by a change in market circumstance. In investors’ minds, pragmatism trumps dogmatism every time.
Recognising that shares represent a source of permanent capital, share buybacks are nevertheless an accepted way of delivering shareholder value and shifting the balance between equity and debt, even for companies who have raised equity capital in earlier times of need. Investors will often applaud companies that decide that the most prudent use of excess corporate cash is to buy up shares they believe to be undervalued rather than invest in speculative acquisitions at higher valuation multiples.
Moreover, returning a company to private hands – perhaps for it to relist at a later date – is now an acceptable part of the corporate cycle. It may come as a surprise that in the US, long considered the most active and liquid equity market of all, the number of listed companies has almost halved in the past 20 years.