GC VIEW Equities: not flight from risk, but flight to quality

 A smattering of large deals in the last few weeks shows that a weak pound and volatile markets bring opportunities as well as risks. High quality companies that can offer yield or a strong record of growth can still shine.

 When the UK voted to leave the European Union on June 23, it was the nightmare scenario for risk assets in Europe that no investment banker had wanted to face. Such a profound shock to the economic and political order was bound to lead to months of disruption and risk aversion.

The equity market’s reaction so far has been a mixture of the predictable and the quixotic — leading to some bargains for investors, such as on UK insurance stocks.

But even the most ardent Brexiteer must be a little surprised at how well the equity new issue market has recovered from the blow. Against all the odds, deals are being done

For one thing, Brexit is just another ingredient in the cocktail of risks the market has been forced to swallow in 2016 — joining the slowdown in emerging markets, the coming US election, political instability in the Middle East and the prospect of another banking crisis in Italy.

So far this year, global IPO issuance has halved from the same period last year, to $52bn. Europe’s market has contracted 57%, but the US market has shrunk even more.

Of course, the Brexit vote has caused companies to think twice before embarking on capital raisings. Several IPOs have been put on the backburner as a result of the vote. Hollywood Bowl, the UK’s largest 10 pin bowling lane operator, has postponed its all-secondary IPO, meant to go ahead this month, citing volatility caused by Brexit. And SSH, the Slovenian government agency, has postponed marketing the privatisation IPO of Nova Ljubljanska banka, the country’s largest bank, until the situation calms down.

Yet Brexit is not, so far, the desperate tragedy for equities that some in the City of London thought it would be. Despite the economic chaos that may follow in the weeks and months ahead, a possible interest rate cut from the Bank of England and the question marks that now hang over London’s status as Europe’s top financial centre, there are still some very deep pockets out there for equity deals.

Investors still need structural growth. They want large, liquid stocks, for preference. And above all, when government bonds carry negative interest rates, they want yield.

The first sign that equity investors still had confidence in Europe came on June 30, inside a week after the referendum result. Obrascon Huarte Lain, the Spanish construction group, pulled off an €815m block trade in Abertis, the toll roads group.

UBS, Bank of America Merrill Lynch and JP Morgan sold the 13.9% stake above the bottom of the price range and at an 8.8% discount.

Two thirds of the deal went to US investors, highlighting the deep international demand for the right European stocks at good prices — such as those offered by block trades and IPOs, which almost always embody some discount.

Brexit also did not stop private banking and long-only investors piling into the oversubscribed Sfr148m IPO of Investis, the Swiss residential property company. Investis has no revenues outside Switzerland and offered a yield of 4.4%, making it a safe earner for investors spooked by Brexit.

Both these deals could have been written off as outliers. But then on July 6, Melrose Industries, the UK industrial buyout firm, announced a £1.7bn rights issue to enable it to buy Nortek, a US packaging company almost twice its size.

This, too, hit the spot for investors. Melrose has an impressive record, having returned £2.4bn of cash to shareholders in January after selling its last big purchase. And Nortek is a nice, clean US company, a long way from the woes of Europe. Melrose’s stock soared when the deal was announced.

But probably the clearest sign that investors have not written off Europe, but are being discriminating and hunting for jewels in the rough, is the strange Italian theme that has permeated the market in the past month.

Of all markets that have suffered worst since Brexit, the pain of Italian stocks has been the worst. Italian banks, in particular, have been clobbered, as investors have priced in a higher risk of European Union fragmentation, which would leave Italy’s weak banking system vulnerable.

Yet in the past fortnight, a string of Italian and Italy-related equity deals has got done.

UniCredit placed a block of shares in Hera, the multi-utility company, on July 7 at a tight discount of 4.3%. Admittedly the deal was only €39m, but it was run as a competitive auction. The sale was multiple times covered.

Four days later, UniCredit was in the market as a seller itself — first selling 10% of its Italian subsidiary FinecoBank for €328m, and then the next night, 10% of Poland’s Bank Pekao for €749m.

The discounts were a percentage point or two deeper than they would have been before the Brexit vote, but nothing punitive. That Italian and Polish bank paper for an Italian seller under pressure could go so well was remarkable — and was down to the strong anchor demand unearthed in wall-crossing, especially from US long-only funds.

Fineco and Pekao are both strong banks in their markets. Weaker ones would not have flown. But the point is, investors were willing to look at the story and invest. It was not just a few brave wall-crossed accounts — when the books were opened, over 100 names poured into the books on each deal.

There is just one IPO of any size live in western Europe at the moment, but it confirms the pattern. The Italian government is selling up to 46% of Enav, the country’s air traffic control network, in a multiple times covered listing that is set to be priced near the top of its range.

In bullish times, such a low growth and frankly unexciting business might not thrill investors. But the deal team’s decision to launch before the referendum has been amply vindicated.

Enav offers investors a 5% to 6% dividend yield, coming from regulated, stable income, and the security of a company backed by the Italian state. The deal was covered on day one of the bookbuild, and by Wednesday was multiple times covered throughout.

For a few days, this summer looked like being a very gloomy one for ECM specialists. Now, they can safely take some time off, knowing that the market is open and in decent shape, ready to tackle at least the better half of the autumn roster of deals.