Equity capital markets enjoyed roaring success in 2014, with a glut of initial public offerings in Europe. For the year ahead, bankers expect corporate spin-offs to emerge as a key trend, although political events could produce unwanted volatility. 

Flush from the success of an extremely active 2014, equity capital markets (ECM) have been in a positive mood since the start of the new year. Participants are expecting much of the issuance in 2015 to revolve around large corporates spinning off subsidiaries or business lines as separate entities in an attempt to extract maximum value from receptive investors.

Companies deemed most likely to indulge in this activity are those in the capital goods and commodity production, pharmaceutical and retail sectors, many of which have ungainly internal structures.

“Some corporates have subsidiaries which, as standalone businesses, would have market capitalisations in the tens of billions of dollars,” says Ed Sankey, European co-head of ECM at Deutsche Bank in London.

A continuing theme

Mr Sankey believes a significant number of spin-offs will populate the ECM space in the near future, thanks to low volatility and an absorbent equity market. “The spinning out of these to existing shareholders of the parent, or indeed listing them on a stock exchange via an initial public offering [IPO], will be a continuing theme for the next few years.”

This spin-off trend emerged at the end of 2014, with two standout deals. In November, Italian energy company Enel sold a large stake in its Spanish power utility business, Endesa, on the open market, raising more than €4bn in the process. And in late December, UK consumer goods manufacturer Reckitt Benckiser listed its pharmaceutical arm, Indivior, as a separate company on the London Stock Exchange.

Meanwhile, pharmaceutical giant GlaxoSmithKline has expressed its intention to jettison ViiV, an HIV-centred healthcare business. Mining giant BHP Billiton is also considering plans to spin off assets focusing on aluminium, coal, manganese, nickel and silver extraction. Fiat Chrysler may jettison its Ferrari business line in the near future, too.

While many ECM participants back the corporate spin-off trend, others urge caution. "A carve out of existing businesses takes time. They tend to be announced well beforehand and can take months to complete,” says Klaus Hessberger co-head of ECM for Europe, the Middle East and Africa (EMEA) at JPMorgan in London. “Some firms have these plans already in the pipeline, but the closing of these is likely to happen only in the second half of the year or later, given the workload related to this. We may see more spin-offs by the summer.”

Global IPO volumes by region

IPO bonanza

There is no dispute that the Endesa and Indivior transactions came at the end of an extraordinary year for ECM. The markets saw $933.3bn of new issuance, up 12% on the previous year, and the highest volume of activity since 2007, according to data from Dealogic.

Much of this growth was fuelled by IPO issuance. September saw the largest IPO ever, a $25bn deal from Chinese online marketplace Alibaba Group. Initially expected to top out at about $20bn, massive investor demand pushed the deal’s bookrunners to issue further shares and break the $22.1bn record set by Agricultural Bank of China on the Hong Kong Stock Exchange in 2010. Globally, IPO volume grew by 52% to $263.3bn last year.

Tom Johnson, head of UK ECM for Barclays in London, says: “The years between 2009 and 2013 were not particularly kind on the IPO market. Markets were volatile and growth was weak in many key economies. Most companies were just trying to survive the financial crisis and the ensuing recessions. That left a lot of pent-up IPO supply.”

Conditions were more fertile in 2014, with confidence in the eurozone finally rising, and the US on a good run of economic growth. Companies that had held off from floating on the market were now champing at the bit.

“A lot of companies had been waiting for the IPO market to open. After a handful of deals got strong support in the final quarter of 2013, that was a signal for companies to dust off their IPO plans in preparation to launch as early as possible in 2014. This is why there were so many IPOs coming to market in a short period of time,” says Mr Johnson.

European growth

Europe was the main beneficiary of this burst of activity, with IPO volume on the continent rising to $69.6bn, 94% higher than in 2013. European ECM volume as a whole grew 22% to $275.3bn, while activity in the US fell by 6% to $296.8bn.

“There was a big inflow of US money into Europe last year. Due to its poor economic performance, US equity funds had underweighted Europe in their investment portfolios for a number of years,” says Mr Hessberger. “That suddenly changed and many funds were neutral or even overweighted on Europe. That meant a greater number of receptive investors for IPOs and other ECM transactions.”

Away from the IPO scene, European financial groups also chipped in with a number of equity capital issuances ahead of the European Central Bank’s (ECB) asset quality review (AQR) announcement in September. Much of the preparatory issuance had been completed in 2013, and many analysts expected any 2014 capital increases to take the form of Tier 1 or Tier 2 debt, which is cheaper to issue than traditional equity capital.

However, June saw Deutsche Bank sell €8.5bn-worth of new shares, raising its Tier 1 capital ratio from 9.5% to 12%. In April, Italian lender Monte dei Paschi hit the market with a €5bn equity sale, following on from similar efforts by Greek banks in March.

Unfortunately for the equity capital markets, the hot pace set in the early part of 2014 did not last. Bankers and investors came back from their summer holidays expecting the issuance frenzy to continue, but the Alibaba deal in September perhaps represented a high-water mark for the year. In October, worries over growth in China and government budgets in Europe produced a spike in equity market volatility. On October 3, the volatility index for the S&P 500 stood at 14.55. Less than two weeks later, on October 16, it had shot up to 29.26, the biggest move of the year to that date.

As a result, many deals that had been scheduled to go out in this period were put on ice. Those that went ahead anyway in October suffered a failure rate of more than 50%, according to Adrian Lewis, head of ECM for EMEA at HSBC in London. “Compare that to the 92% success rate for deals in the first quarter of the year. By October, investors were focused on protecting their existing portfolios in very unpredictable markets.”  

Global IPO volumes

Bank capital

January and February are usually quieter months for ECM activity. Companies often need fourth-quarter or year-end results in place before launching an IPO or raising further equity, delaying issuance until March. However, ECM’s hiatus in late 2014 nudged more deals than usual into this period. A sprinkling of activity occurred in December and, in the early weeks of January, the UK online train ticket retailer trainline.com was the first to stick its head above the parapet with a £500m ($755.2m) float. Later in the month, German cable operator Tele Columbus followed with a deal expected to be worth about €450m.

Both of these deals were dwarfed by a surprise bout of equity capital issuance from Spanish lender Santander, which hit the market with a €7.5bn share sale on January 8. Although the bank passed September’s AQR, many analysts still viewed its capital structure as weak. January’s issuance boosted its Tier 1 ratio from 8.3% to 9.7%, sending a confident message to the markets at the start of the year.

Santander has also put pressure on other large eurozone lenders to bolster their own ratios, as the ECB introduces specific capital targets for each bank. Only 25 banks out of the 130 in September’s AQR failed and the biggest banks largely passed with flying colours. However, estimates of the overall capital shortfall remaining in the eurozone banking market range as high as $230bn, opening the door to financial institution issuance matching or exceeding its 2014 figure of $155.2bn this year.

Market normalisation

Although US ECM volumes lagged behind Europe’s last year, that is not expected to be the case for 2015. 

“Global ECM issuance may reach the same levels this year as last, but we’re unlikely to see European volumes surging so far ahead this time,” says Mr Hessberger at JPMorgan. “In that respect, markets will likely normalise, with similar ECM growth rates on both sides of the Atlantic.”

Mr Hessberger is optimistic about ECM performance this year. “The global macro situation is largely favourable. US economic growth remains strong and the ECB will maintain a supportive stance towards eurozone stability. The low interest rate environment is unlikely to change, and the slump in oil prices should lower costs for many firms and boost equity values,” he says.

There are, however, issues to watch out for. Across Europe, growth is stalling and prices are falling. The eurozone’s dip into deflation has so far been brief and fairly mild, but there are fears any further steps down this path could lead to a long period of weak demand.

Greece’s long-term participation in the single currency also remains in doubt. As The Banker went to press, the Greeks stood on the eve of fresh elections, which could put into power radical parties that reject EU-imposed austerity. Though the impact of a Greek exit from the euro has been played down by some European legislators and policy-makers in recent weeks, markets remain jittery. There is significant pressure on the ECB to swiftly introduce a quantitative easing programme involving the purchase of eurozone sovereign debt to help soothe the situation.

Elsewhere, the general election in May could induce a slump in UK ECM activity. “The UK is always a significant source of ECM issuance, so we may see the London market try to pack in as much into February and March before volatility picks up nearer to the vote,” says Mr Johnson at Barclays. Volatility is almost certain to surround the date of the election, as polls do not indicate a clear win for any party. A prolonged and messy bout of coalition building may be necessary in its aftermath.

Staying alive

Over the past few years, operating margins for banks have thinned and regulatory costs increased. Return on equity for bank shareholders has been shrinking and malpractice investigations have drained many a bank’s kitty.

As these changes have played out, ECM bankers have been able to sleep relatively easy in their beds, safe in the knowledge that their side of the business does not consume anything like the technology and capital resources of derivatives trading or other investment banking activities.

However, they are not immune to cost pressures. “Profit margins for banks on ECM activity, particularly IPOs, have been squeezed in recent years, thanks to market fragmentation,” says one senior ECM banker. “The pressure is particularly acute in Europe, where there are dozens of competitor banks, many of which occupy very secure niches.” More competition equals a greater incentive to cut fees and aggressively chase business, reducing margins further. “In the US, banks will charge 400 to 500 basis points [bps] for an IPO. In Europe, the typical charge is 250bps,” says the senior banker.

The breakdown in ECM revenue makes this disparity clear. Last year, ECM activity in the Americas was 32% of the global volume, but attracted 47% of the revenue. In EMEA, activity was 30% of the global total, but this only won 24% of the revenue.

This pinch is not just being felt in Europe. In early January, Standard Chartered chose to close its ECM operation in Singapore “with immediate effect”. The senior banker says: “Standard Chartered’s ECM business was only something like 24th largest in the global rankings. Unless you are top 10 or top five, or unless you operate in a well-worn niche where no one can compete with you, it’s very hard to stay alive in the ECM business.”

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