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EuroWeek View: The RBS/Lloyds giveaway: ECM at its best

Traditionalists among the ECM set won’t be impressed, but plans for a £33bn distribution of Lloyds Banking Group and Royal Bank of Scotland shares to the general public are moving closer to fruition. Those whose eyes glaze at the mention of the “idea that just won’t die” would do well to look again: it is ECM structuring at its best.

An influential think tank — that numbers many Downing Street alumni among its backers — this week swung behind a plan to sell down the government’s RBS and Lloyds stakes in conjunction with a novel, and radical, distribution of shares to the UK public.

The plan was hatched in 2011 by advisory boutique Portman Capital Partners, ex-bankers with equity-linked backgrounds, as they tried to model a putative exchangeable bond issue — but kept running up against derisory option values as a result of the structural overhang of shares (The £66bn Lloyds/RBS conundrum, solved!, from EuroWeek, 20 May 2011).

The crux of the scheme is that free shares are distributed to taxpayers (perhaps defined as those with a National Insurance number and on the electoral register) and held in a nominee account. Those shareholders would only have to cough up for the shares — paying a base price or floor price — when they decided to sell. 

Since then, the scheme has gained political traction, culminating in the publication of a Policy Exchange pamphlet, authored by former Deutsche Bank equity research head James Barty and Emily Redding, a research fellow at the think tank.

Its backers say it is also gaining traction in the markets. That makes sense. Some critics think block trades, perhaps combined with an exchangeable, could work — even in such a politically-charged atmosphere. Why waste time with such a radical departure from ECM tradition, they ask.

Other critics (even in surprising places) think of it as a gimmick designed to provide political cover for a sale, perhaps below the in-price paid by the government.

Both are wrong. The scheme addresses the real problems that would come from a staged series of block sales.

The traditional method runs into two problems, one market-related, one politics-related. The first is that a stock overhang can easily cap a share price as investors position for a discounted deal. The second is that any government selling an asset can take political heat if it sells at a price perceived to be cheap (ex-post, too, so share price gains are seen as a giveaway).

Sometimes the problems can be intertwined. A block sale removes the overhang and the shares bound upwards — and therefore so does criticism of the seller.

The Portman proposals flip the problem on its head. Instead of having no buyers above the likely sale price (the in-price), now there are no sellers below the floor price. Meanwhile, individual taxpayers reap the benefits of higher prices in the future.

But the benefits of the structure don’t stop at flipping around the overhang issue. The structure also helps the transaction create its own demand.

A concurrent institutional and retail placement — which would also set the floor price for anyone offloading the free distribution — could give the government up-front cash for some of its stake, with demand heavily bolstered by index tracker and benchmarked money that needs to adjust to the new, much higher index weights that the bank shares will have.

The point isn’t just that funds will need to correct an existing underweight. It is that even if funds want to maintain an underweight position, they will still need to buy in appreciable size. Right now, a fund benchmarked to the FTSE 100 might be able to get away without holding any RBS stock. But if RBS’s weighting goes up seven times, it is unlikely to take the risk of missing out on the only liquidity event that will allow it to buy in at the floor price.

The £112bn all-share merger of Mannesmann with Vodafone in 2000 is a good example of a deal that created just that sort of institutional demand, say some observers.

The distributed element and the placement element would combine to give the Treasury full control of the deal. It could vary the size of the distribution to induce additional demand for the placement. It could even use some of that additional demand to allow the banks to raise capital at the same time. The Policy Exchange authors model a distribution of around 60% of the government's holding in RBS and a sale of the remainder; Lloyds would have 75% of the government holding distributed.

Some investment banks have gone as far as expressing interest in underwriting the institutional portion of the deals, such is the confidence in the demand that will be generated by the distributed portion, say its backers.

When the UK started privatising state assets in the 1980s, it didn’t just set a trend for reversing the post-war orthodoxy of nationalisation, it also devised the techniques to do so. Most important was the strategy of creating price tension by targeting discrete investor groups — regional, retail and institutional — and using captive demand to drive up the price and aftermarket performance.

The Portman plan for the bank stakes is just as innovative. It deserves to be judged on its merits, not dismissed as a game of politics, or as unworkable pie-in-the sky.

Disclaimer: The writer possesses a UK national insurance number, is on the electoral register and has learnt never to pass up a free option.

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