Equity block trades market ain’t broken — don’t try to fix it
The block trade market is an exciting, risky part of the equity business. Banks can slip up — but that shows how hard they are competing for deals. If, as it seems, block trades work well for issuers and investors, regulators like the Financial Conduct Authority should not interfere.
A series of eye-catching equity block trades in recent weeks have shown once again the power of this technique to match buyers and sellers, and the competitive nature of the market. Regulators studying it — notably the UK’s Financial Conduct Authority — should think very carefully before tinkering with it.
Last week, Numis Securities sold £688m of shares in Saga, the UK insurance and holidays business for the over-50s, in a single evening. The sale of this 31.5% stake brought to an end the 10 year old investment in Saga by Charterhouse, CVC and Permira.
Then on Monday night, Credit Suisse placed £1bn of shares in SABMiller, the London-listed South African-US brewer about to be taken over by Anheuser-Busch InBev. The seller was the holding company of Jan Kulczyk, the Polish billionaire.
In each case, the seller was able to move stealthily, but effectively, with the aid of a single bank, to place a large amount of stock at only a slight discount to the market price.
Accelerated bookbuilds are an essential part of the equity capital markets business in EMEA, and can make a great difference to banks’ fortunes in the market — for good and bad.
The outcomes, however, are asymmetrical. On most successful trades, banks do not make very much money — especially now that equity capital markets advisers such as Rothschild and Lazard are often involved, running auctions to squeeze out the best possible terms for the seller from the competing banks.
Bad trades, on the other hand, can hurt a lot. If a deal has been underwritten or backstopped at a certain price, and fails to clear, the banks leading it can be stuck with a lot of stock. Hedging such a big position can be difficult.
In benign markets, it is often possible to wait till the shares rise and trade out at a profit. But that consumes a lot of capital, and meanwhile the bank is exposed to a stock it never intended to own.
Banks that have blown themselves up with one or two really painful block trades often limp away from the action for months or even years, until they have recovered from the wounds.
Can’t live without it
Many senior ECM bankers privately wish they could do without blocks, because of the high risks and meagre returns they offer. Others enjoy the cut and thrust of it and believe they can outperform rivals by being disciplined and well organised.
But, like it or loathe it, the blocks business appears to be essential to an ambitious ECM franchise.
Last year, the usual top seven banks in EMEA ECM — the US big five, plus UBS and Deutsche Bank — held the top seven spots in the overall bookrunner league table, with a gap of nearly $5bn between seventh placed Citigroup and eighth placed Credit Suisse.
In IPOs, the usual suspects also occupied the top seven places, but the chasing bank in eighth, HSBC, was only $180m behind. Equity-linked bonds have no clearly defined bulge bracket.
In blocks, however, the gap is immense. BNP Paribas, in eighth place, did $6bn less business than Citi, or only 39% as much. This means the top banks believe it is important to their franchises to compete hard for block trades.
Slugging it out
Does that mean the blocks market is an uncompetitive cabal? Far from it.
Accelerated deals that are done to raise new capital for the company — the minority — are often handled by the banks closest to the issuer, such as its corporate brokers, or those that led its IPO.
It is natural for them to be most involved in the company’s planning, but there is, or should be, nothing to stop the firm taking advice and bids from other banks.
The FCA, in its Investment and Corporate Banking Market Study, published earlier this month, said it was keen to outlaw banks asking companies to formally promise them future business as part of loan agreements.
ECM participants have told GlobalCapital they agree with that — the head of capital markets at one private equity fund said his firm would never agree to such tying.
In the absence of such contractual promises, it is hard to see how issuers’ choice is restricted, since many banks would be willing to pitch for capital raisings.
Battling for the trades
A completely separate concern expressed by the FCA is with trades in shares or bonds where banks make a loss on deals to gain league table credit. The regulator has gone as far as to say it will consider measures to ensure league tables cannot be manipulated by loss-making trades.
To the extent that this is directed at the ECM market, it must refer to the larger element of the blocks market, which is secondary trades, where a big shareholder wants to sell a position in a listed company.
In these cases, the objectives are crystal clear. The seller wants to maximise price, and may have more or less flexibility on timing. It may or may not care how the stock performs after the trade.
These are eminently competitive situations, where any bank or broker has a chance to deploy its skills.
Some deals are mandated to banks that have worked closely with the seller for years — others, such as those for governments, are clinically auctioned. But the client is free to choose, depending on its needs.
Numis’s big scoop
The Saga trade, for three private equity funds that are very experienced users of the equity markets, shows you do not have to be a megabank to compete.
Bank of America Merrill Lynch had dominated the post-IPO selldowns of Saga stock, though Numis, the company’s other broker, had participated in junior roles.
Most ECM bankers would have expected Acromas, the PE vehicle, to sell the remaining 31.5% stake in two chunks. But Numis, which had led Saga’s recent results roadshow, was confident institutions would have enough demand for the stock to take it all in one go.
Acromas could probably have got a higher price than the 195p a share it obtained — less than the 205p and 200p of its last two block trades — but only by waiting longer.
Other banks knew there was a deal to be got, but Numis’s knowledge of where the appetite lay for the stock enabled it to persuade Acromas to go for the trade in one go. It is not clear whether the trade was underwritten, but rival bankers think that is unlikely — Numis is too small to make such a bet.
As one rival put it, Numis is “an undistracted outfit — UK midcaps is their focus and they went after it”. Brains and hard work, not underwriting brawn, won it the deal.
Money for old beer
SABMiller is a very different stock: a $100bn company, where the £1bn trade last night was only a 1.5% stake. But for Jan Kulczyk, that is perhaps a quarter of his wealth — he didn’t want to make a careless mistake.
Credit Suisse would not say whether it had underwritten the deal, but it won it on a sole basis, which suggests that, like Numis, it offered the client a better combination of price and credibility than any other bank.
In this case, investors can buy as much SABMiller stock as they want any day of the week, and they know that, as long as the AB InBev takeover goes ahead, they are going to get taken out at £44 a share.
But CS was able to find enough merger arbitrage and multi-strategy hedge funds, and a few long-onlies, willing to increase their positions, for a discount of a mere 0.88% to Monday night’s closing price.
Both these trades are different from the run of the mill. A much more typical kind of transaction was the sale of shares of Elis, the French workwear group, that Deutsche Bank ran on April 14. Private equity firm Eurazeo was selling stock for the first time since an IPO, and used a competitive auction to find the best bid.
Deutsche won — but must have wished it hadn’t. Only about a fifth of the block was placed at the 4.2% discount Deutsche offered, and the bank was left holding a 12% stake in Elis, worth about €225m.
Keen prices are good for the market
All these trades show how banks compete for blocks business, and how the fundamental determinant of success is knowing how much investors want the stock, and what they will pay for it.
This is not something the seller can know without the help of an intermediary that is in the flow of the stock and can, when necessary, wall-cross selected investors to make deeper soundings.
Sometimes banks get it wrong, and may make a loss on trades. But that does not mean either the buyers or seller have suffered. Both sides go into trades with their eyes open, and agree to a price.
If the bank makes a loss, it is unlikely to have been deliberate. But even if it were, that loss is a net benefit to the non-bank sector — both seller and investors have gained from it.
Furthermore, any league table credit won in such a way has been hard won — the shares were truly sold by the seller, and in almost all cases have been bought by investors. Such trades do demonstrate that the bank is involved in and knows about the market, as much as profitable ones.
For the FCA to try to stamp out such over-eagerness in competition, or even just to frown on it — for the baffling reason that future issuers might not be able to peruse league tables judiciously enough — would be both bizarre and counter-productive.