It has not been a quiet start to the year for equity capital markets (ECM) types, whose phones have been ringing off their hooks. But then they didn't get to go home early often in 2009 either, as they enjoyed a record season for rights issues. While they can expect to remain fully occupied in 2010, it is unlikely that rights issues will take up quite so much of their time.
Last year was one for the record books. Global rights issues and follow-on deals totalled $692.5bn ($470.2bn in 2008), according to Dealogic, from 4007 transactions (2103 in 2008). Both numbers were the highest ever. North America and Europe were neck and neck with $237.8bn and $235.1bn, respectively. Japan was next with $59.2bn, followed by north Asia ($56.4bn) and Australasia ($55.6bn).
Simon Ollerenshaw, managing director in Barclays Capital's ECM division
Sifting the figures by sector, it will come as no surprise that financials accounted for 40% of the total. As banks moved to rebuild their balance sheets and repay government money, the market saw some of the biggest rights issues of all time, such as the UK's Lloyds Banking Group's £13.5bn ($21.9bn) deal and HSBC's £12.5bn offer. Corporates were no less busy. Overleveraged in a downturn, often with a need to refinance or avoid breaches of banking covenants, they re-equitised with a vengeance. The busiest sector was property (8.7%) as it did emergency repairs, followed by mining (6.9%) as it reduced its debt, and construction (5.6%) as it struggled to stay afloat.
Georg Hansel, Deutsche Bank chairman of ECM EMEA
Promising start
Bankers have varying opinions on how 2010 will compare. Certainly, the year got off to a flying start. By the second week of January, there were at least three sizeable offerings coming to market, from both financial and corporate sectors. Italy's UniCredit was hoping to raise €4bn, offering three new shares for every 20 at a 29% discount to the theoretical ex-rights price. Egyptian telco Orascom was rather desperately looking for the equivalent of $800m with a 49-for-10 at a 96% discount to the previous closing price. And German auto-parts maker Continental wanted €1.09bn via a two-for-11, priced at 14% below the previous close. Its shares rallied impressively on the news.
Bank of America Merrill Lynch's president of international ECM, Rupert Hume-Kendall, sees this as an indicator of a busy year to come. "I expect a continuation of balance sheet replenishment," he says. "We are not through the cycle yet. There are companies which are still levered and would rather not be, and I don't think there will be a lot of shareholder concern if they slightly change the balance of their capital structure."
Thierry Olive, head of global ECM at BNP Paribas, makes the point that last year included some huge transactions which will not be repeated in 2010 - such as Lloyds and HSBC. "Activity will be more normal this year, shrinking by 25% to 30%," he says. "But while last year's deals were defensive, this year they will be more for growth."
Mr Olive emphasises that strengthening the balance sheet in this way creates equity value. "Shareholders fear that, in a stressed environment, overleveraged companies will be forced to sell assets at low prices," he says. "If you strengthen the balance sheet, there is less risk and any dilution is more than compensated for by the reduction of uncertainty surrounding the company's future."
He alludes to Wolseley, the troubled UK building products supplier whose shares plummeted last year when it released a trading statement without confirming rumours of an imminent rights issue. "When it finally announced the rights issue [combined with a share placement], even though it was massively dilutive, the market was strongly supportive. By eliminating uncertainty, you create value."
There are those who expect the imposition of tougher capital adequacy requirements to prompt another surge in bank recapitalisations. "In 2010, the banking sector is again set to be a major driver amid the calls for higher capital ratios," says Tom Cane, deputy editor of dealReporter Europe. "Japan's mega-banks are leading the charge - Sumitomo Mitsui announced a $9.7bn cash call in January. China's banks will also require equity injections after a lending splurge in 2009."
BNPP's Mr Olive does not buy the 'higher capital' story. "Regulators should be sensible," he says. "It strikes me as wrong to consider increasing the capital requirements of banks now when, given the state of the economy, banks need to lend," he says.
Rupert Hume-Kendal, Bank of America Merrill Lynch's president of international ECM
Shifting trends
Corporate recapitalisations may be carried out for the shareholders' benefit, but they are also done with the credit ratings agencies in mind. Moody's thinks that last year's wave of ratings-driven deals might have subsided. "While corporate activity was relatively sustained in the downturn, the need for fresh equity appears to be reduced, though we might still see some transactions by fallen angels," says Jean-Michel Carayon, regional credit officer for EMEA at Moody's. "The ratings trend is towards stabilisation and the majority of our ratings are on stable outlook, though there are still many negative outlooks in cyclical industries."
Some bankers take the same view and now expect recapitalisation issues to reduce in number. "With a recovery in the general economy expected, we will see an easing of pressures to recapitalise, though some companies on the continent still have too much leverage," says Peter Guenthardt, head of European ECM at UBS.
That said, there will still be recapitalisations in certain sectors, Mr Guenthardt believes. One of them is real estate. "In 2009, real estate recapitalisations were mainly in the UK," he says. "This year we will see more on the continent - in Germany, for example, though not yet in some other countries. Some of the real estate market is still too bombed out and investors are still too wary."
The automotive sector is more than likely to tap equity markets. Volkswagen already has shareholder approval for a large issue of new preference shares in connection with its acquisition of Porsche, and there is talk of activity around Italian, French and Scandinavian automotive names.
Mining may be quieter this year, given the recovery in commodity prices, at least on the balance sheet front. On the other hand, as stress levels subside and the economy perks up, miners may seize the opportunity for a round of consolidatory mergers and acquisitions (M&A). The same is true across most other sectors.
"I think we will see a shift to growth-driven equity raising - rights issues for M&A, for example," says Georg Hansel, Deutsche Bank chairman of ECM for the EMEA region. "The recent crisis has produced a pattern of winners and losers, and the good players will actively try to generate market share by taking out the weaker ones. That could lead to rights issues." One likely source of M&A along those lines, Mr Hansel believes, is the whole area of commodity-related industry, such as steel.
Shareholders may support a rights offering to fund a sensible acquisition, but will they go for a more opportunistic deal? Simon Ollerenshaw, a managing director in Barclays Capital's ECM division, thinks not. "Investors are likely to look more favourably at capital raisings where there is a clear use of proceeds - M&A or recapitalisation," he says. "For recapitalisation transactions, the market will want to see that the capital raising has dealt with the balance sheet concerns for the foreseeable future."
According to Mr Ollerenshaw, unlike last year, rights issues will now have to compete with initial public offerings (IPOs) for investors' attention. "The IPO pipeline is clearly building, after a very quiet year in 2009. The US market has led the way and we are starting to see activity increasing in Europe, including some of the emerging markets," he says.
Key lessons
What lessons were learned in 2009? One seems to be the importance of checking with core shareholders before doing anything irrevocable. "A rights issue shouldn't come as a surprise to major shareholders," says Mr Hansel. "So speak to your large shareholders up front," he adds. Like Mr Ollerenshaw, he recommends making it plain that the capital increase is done for the foreseeable future: "The market doesn't like a piecemeal strategy."
When HeidelbergCement raised €2.5bn from new equity last year, it first tested a smaller deal, says Mr Hansel. "The market said rather come back with a big deal and get it fixed," he says. "That was a key lesson."
BNPP's Mr Olive says that it is important to take account of what your peers are up to. "If your competitors are strengthening their balance sheets, then it is important not to become relatively weaker by not acting too," he says. "If you get the money, you'll find ways to use it to grow further and quicker than the rest. But if no one is doing it and you do it, then you're the weak one. Surf when there are waves. If there are no waves, don't surf."
Price is always the big issue and discounts have been narrowing from 40%-plus to sub-30% in some cases. Deutsche's Mr Hansel expects that trend to continue as liquidity eases.
BAML's Mr Hume-Kendall says he does not see the need for discounts to narrow. "The average board now accepts that rights issues are not dilutive, and the desire to raise capital should triumph over the desire to minimise the discount," he says. His rules of thumb are: Go early, go quickly and do not push too hard on pricing. "I haven't come across one CEO or CFO who subsequently regretted going the rights issue route," he says.
