Mergers and acquisitions are becoming more common in Europe after a long quiet period, and equity bankers are hoping for the resulting rise in equity and convertible bond issuance.
There have certainly been some deals, and takeovers like the battle for Banca Antonveneta are likely to produce more. But with debt as cheap as ever and the rise of private equity, Harry Wilson asks whether ECM bankers are believing their own propaganda.
When an equity capital markets banker tells you that M&A is going to be the next big driver of issuance, it is hard not to react as if he had run into town for the fifth time that day to say his flock of sheep had been attacked by a wolf.
When EuroWeek asked equity bankers at the start of the year what would be the main cause of equity issuance, 37% cited M&A — more than four times the number who said government privatisations.
Yet halfway through the year, mergers and acquisitions have not produced the longed-for boom.
So what explains the fixation of equity bankers with M&A, and why are they still predicting that it will kickstart equity issuance?
First of all, some M&A deals are getting done, and producing equity issues. They may not have been the main driver of issuance, but mergers and acquisitions led to some $11.1bn of the year's $79.1bn of equity and convertible issues so far, according to Dealogic.
Netherlands vs Italy
The most notable potential acquisition in the market at the moment is the battle between ABN Amro and Banca Popolare di Lodi for control of Italy's ninth largest bank, Banca Antonveneta.
In March, ABN announced its intention to launch a Eu6.3bn bid for Antonveneta, and in preparation issued 135m new shares through an accelerated bookbuild, enlarging its share capital by 8% and raising Eu2.5bn.
Lead managers ABN, JP Morgan and Lehman Brothers, gave themselves two days to sell the stock, but only needed one, as investors flocked to the deal. The investors priced the shares at Eu18.65, a relatively tight 5.43% discount to the previous closing share price.
Jason Valmadre, global head of syndicate at ABN, sees the popularity of the deal as evidence that investors are eager to buy equity deals with an acquisition angle to them.
|Top 5 Acquisition related European ECM deals of 2005 YTD|
|Rank||Pricing date||Issuer||Deal type||Deal value $m|
|1||May 31||ABN Amro Holding||FO||3,264.7|
|2||Jan 10||Standard Chartered||FO||2,025.9|
|3||Mar 7||BAE Systems||FO||693.2|
|5||Jun 1||Evraz Group||IPO||421.9|
"Investors like to see that they are not giving cash over without good reason," he says. "They want to know that there is a serious equity story behind any raising."
Banca Popolare di Lodi is also using the equity market to support its rival bid. The northern Italian co-operative bank and its allies have built up stakes thought to represent more than half of Antonveneta — a process that is being investigated by Consob, the Italian market regulator.
Lodi, which has a stock market capitalisation of only Eu2.5bn, has gained shareholder approval for a Eu1.5bn convertible bond to help boost its core tier one capital (see box).
The Italian banking sector could also be the source of two further ECM deals. Spanish financial group BBVA is making a Eu6.3bn bid for Banca Nazionale del Lavoro, and UniCredito is buying Germany's second largest bank, HVB, for over Eu15bn.
BBVA has in the past been happy to use the equity markets to fund its acquisitions. Last year it sold 195m new shares in an accelerated bookbuild, raising Eu2bn to fund its Eu3.3bn purchase of the 40.3% share that it did not already own in Bancomer, Mexico's largest banking group.
ECM bankers specialising in financial institutions agree that the current crop of deals is likely to be only the start of a boom in cross-border mergers in the European banking industry.
"We believe there is a wave of consolidation coming that will spread through the European financial sector," says Alex Caramella, a managing director in HSBC's financial institutions group in ECM. "And this, as has already been seen, could lead to an increase in issue volumes."
Equity analysts say the banking sector will probably be one of the main sources of European M&A this year — as it was in 2004, when with $47bn in deals, made the sector the busiest by volume in Europe.
"A more stable economic backdrop, potentially lacklustre top-line growth and significant excess capital generation, suggest that M&A is likely to accelerate," wrote Credit Suisse First Boston analysts in a February report on European M&A. "Management are talking about the need for scale and the beginnings of the potential globalisation of the industry, which means that larger names are also in the frame."
Even if European banking does not consolidate much, European banks are likely to make overseas acquisitions.
In January the UK's Standard Chartered Bank raised £1.1bn in four hours by selling 118m new shares, equal to more than 10% of its market capitalisation. The money funded StanChart's $3.3bn acquisition of Korea First Bank, South Korea's seventh largest bank by deposits.
The deal recalled Royal Bank of Scotland's £2.5bn sale of 156m new shares in May 2004 to help fund its $10.5bn takeover of US retail bank Charter One Financial.
Russia steels the lead
Outside the bank sector, analysts and bankers are hoping for large deals from other industries.
ECM bankers say the share buyback craze of the last 12 months may now be coming to an end, and that cash-rich companies are becoming predators.
"Following a period of balance sheet rebuilding, European companies have a lot of cash at the moment, as evidenced by the large returns of cash to shareholders over the last year," says Andreas Bernstorff, co-head of German ECM at Dresdner Kleinwort Wasserstein. "The sense now is that investors are less paranoid about focusing on cashflow, and are cautiously supportive of acquisition strategies."
One sector where this applies is utilities. Analysts say it is overdue for a major bout of cross-border consolidation.
An example of this was Portuguese power company Energias de Portugal's purchase of a Eu1.2bn majority stake in Spanish utility Hidroeléctrica del Cantábrico. The deal led to a Eu1.2bn rights issue by EDP last November, and it is likely to be only the first stage in a much wider consolidation of Iberian utilities.
Steel companies have also made large equity placements to fund their acquisitions over the last year. The world's largest steel company, France's Arcelor, last July used part of the proceeds of a Eu1.2bn rights issue to pay for a $580m stake in Brazilian steel manufacturer Companhia Siderúrgica de Tubarão.
And just this month (June), Austrian speciality steel products manufacturer Böhler-Uddeholm used a Eu220m rights issue to fund the acquisition of its German rival Edelstahlwerke Buderus.
In May, Russia's largest steel maker Evraz raised $422m from its London IPO, telling investors on its roadshow that some of the money would be used to take part in the consolidation of the Russian steel sector. Evraz is seen as one of the main players in this process.
Russian M&A has provided the European equity market with some of its largest deals this year. In February, telecoms and insurance conglomerate AFK Sistema raised $1.35bn from its London IPO, with most of the proceeds earmarked for spending on the Russian government's auction of fixed line telephone operator Svyazinvest, which Sistema is favourite to win.
|Could M&A bring the convertible market back to life?|
At the time of writing, the European equity-linked market has gone nine weeks without a single new convertible or exchangeable bond being issued. If not dead, the market is in a coma, and CB bankers are starting to ask what it will take to resuscitate it.
Equity-linked professionals say an acceleration in European M&A could stimulate convertible bond issuance.
A flavour of this was given last December when Austrian oil company OMV issued, to a rousing cheer from CB bankers and investors, a Eu550m convertible bond as part of its Eu1.2bn capital increase to fund its acquisition of a 51% stake in Romanian energy company Petrom.
During the late 1990s M&A boom, companies often used convertibles to fund acquisitions, and bankers are hoping the same logic will prevail this year.
Already, Italy's Banca Popolare di Lodi has gained shareholder approval to issue a Eu1.2bn convertible to bolster its core tier one capital in preparation for its bid for Antonveneta.
"M&A has definitely helped convertible activity pick up in the past, and is a driver of ECM generally," says Martin Fisch, head of equity structured solutions and marketing at Deutsche Bank in London. "An increase in M&A activity would put a bit of volatility back into the market. However, for convertible issuance to benefit from an increase in acquisitions it will have to be corporate activity, not LBOs, which lead to issuance in the high yield market, but not the convertible market."
The collapse of European equity-linked issuance in 2004 coincided with a steep rise in high yield bond issuance.
Apart from signalling the prevalence of LBOs, the rise of high yield is a threat to the convertible market in another way.
In the past, convertible issuers have tended to be lower rated companies, which did not have access, on what they would consider reasonable terms, to the straight bond market.
However, as demand for high yield issues rose over the course of 2003 and 2004 and credit spreads tightened, many firms that might have funded an acquisition with a CB opted instead for high yield bonds.
Perhaps optimistically, convertible analysts now say that with cracks appearing in the high yield market, convertible bonds may once again become attractive to companies.
However, convertible valuations will also have to improve if equity-linked issuance is to recover, and this is another way that M&A could indirectly help revive the CB market.
As Fisch says, more M&A would be expected to make the stockmarket more volatile. Since convertible bonds derive part of their worth from the embedded equity call option, they will be more valuable if volatility rises.
In 2004, 45% of all European equity-linked issuance — Eu5.4bn of deals — came in the second quarter, after the bombing of commuter trains in Madrid on March 11 led to a rise in stock market volatility.
But for most of 2004, and even more so this year, equity market volatility has tumbled, hitting historic lows this year, with disastrous results for the equity-linked market.
Some equity-linked bankers, though, are sceptical about the claims that M&A will save the market. While more takeovers may give the convertible market a little fillip, they argue, it is time for CB professionals to be realistic and accept that the record issuance volumes of 2003 were an aberration, and that while current issuance may be below par there is little reason to think that when the market returns, even with M&A's help, it will be at anything like 2003's levels.
"If you look at equity-linked issuance versus equity issuance, convertibles have generally made up 15%-25% of the market, which feels about right," says one senior convertible banker. "Equity issuance is the fundamental building block of the market, so it is wrong to expect convertible issuance to be much higher for prolonged periods."
Russia's largest food retailer, Pyaterochka, also used the lure of an acquisition strategy to woo international investors to its $598m London IPO in May, emphasising that it was likely to play a leading role in consolidating the disparate Russian food retail market.
The success of these three IPOs, which have raised about $2.4bn, shows, firstly, that investors are keen to play the Russian consumer growth story, but also that acquisition strategies are one of the best ways to lure more risk friendly investors.
Rights and wrongs
One of the most frequently used and reliable ways to fund an acquisition is for a company to ask its own shareholders to pay for it. Capital increases, and more particularly rights issues, are one of the most popular methods of raising large amounts of cash for mergers and acquisitions.
"We have a number of very large M&A transactions in the pipeline that will involve financing through rights issues and equity placements," says Henrik Gobel, a senior syndicate banker at Morgan Stanley in London.
However, rights issues are out of fashion — the volume of issuance in the first quarter was the lowest for over four years.
This is partly a product of 2003, when heavily discounted jumbo rescue rights issues were used by a variety of European firms, most notably France Télécom's Eu15bn issue, to rebuild battered balance sheets.
Such deals made sense for companies that were fighting for their survival in 2003, but management teams in 2005, who want to use them to fund acquisitions, are less willing to pay a deep discount.
"European share registers are now more American than they have been in the past, and US investors are not as open as Europeans with respect to using rights issues to fund acquisitions," says Paul Gismondi, a managing director at Lazard in London. "Markets have become quite volatile, and this leads banks to price rights issues at large discounts, something that boards find somewhat off-putting."
Energias de Portugal needed a 20% discount to gets its Eu1.2bn rights offering done last year, while Dutch computer services company Getronics had to offer a 34% discount to complete its Eu404m issue in April.
Their CFOs might have been irked to see Böhler-Uddeholm price its Eu220m rights issue at a discount of just 2.9%, after setting the price through a market bookbuilding process.
This meant the price was only set at the end of the subscription period, and the firm did not have to set a lower price to allow for falls in its share price.
Another option for companies, so long as they stay below the threshold deal size where they have to offer preemptive rights to their shareholders, is to raise money through an accelerated placement of new stock.
This was the route taken by British defence company BAE Systems, which in March raised £360m through an accelerated sale of new shares, equal to 5% of its share capital, to fund its $4.19bn takeover of United Defense Industries of the US.
The stock was placed in half a day and at a 4% discount to the previous close, allowing BAE to obtain the necessary equity to fund its bid quickly, and at an acceptable price — even though lead manager UBS had signed an agreement to underwrite the deal in December.
Private equity spoils the party
While many equity specialists are resolutely optimistic about the role M&A will play in driving equity issuance through the rest of this year and into next, there are many who question whether European companies see many advantages in using it to fund acquisitions.
"There are two reasons to think that, even if M&A does come back, it won't necessarily benefit ECM," says Gismondi at Lazard. "First, companies have spent the last couple of years deleveraging and now have a large capacity to hold debt, so they simply don't need to use the equity market to fund acquisitions. Second, the technology for executing cross-border deals for stock and dealing with flowback is becoming more sophisticated."
UniCredito's takeover of HVB is a case in point. While UniCredito may have to use cash to buy HVB subsidiary Bank Austria's 22.5% freefloat, which it is estimated will cost it between Eu2.65bn and Eu2.8bn, most of the Eu15bn acquisition will be paid for by exchanging every HVB share for five new UniCredito shares.
While some equity issuance is a possibility, perhaps to fund the Bank Austria freefloat purchase, ECM bankers are unlikely to get any other business from the transaction.
Conventional M&A itself is under threat from the private equity boom. Trade buyers are finding it harder to compete for acquisitions against well funded private equity funds.
"Three months ago I was much more bullish about the M&A market for corporates," says Bernstorff at DrKW. "At that time we had three ECM transactions for corporates that were cross-border acquisition-related. But only one of them came to fruition [The Eu90m capital increase for German market research firm GfK to refinance its purchase of NOP World]. This shows the problem companies have at the moment in the context of private equity sponsors, which in many cases can outbid companies, which are generally not willing to use leverage as aggressively."
While this is unlikely to upset investment banks overall, since they benefit from the debt underwriting side of the private equity acquisition boom, it presents a problem for ECM bankers looking for a catalyst to get their business going.
However, like ECM bankers generally, Bernstorff, in spite of his reservations, remains optimistic that M&A could lift the European equity issue market this year.
"We're in the early part of the M&A cycle, and we see the potential for a lot more M&A, much of it cross-border," he says. "There is little doubt that this is going to happen, hopefully with plenty of follow-on ECM business, either from corporates or the sponsors."
Whether the market in general will listen to such protestations remains to be seen. While equity bankers insist that the M&A wolf is approaching the European corporate flock, many will see this as just the latest false alarm.