Dan Oakes, managing director and head of international ECM origination at Commerzbank.
Macro and political headwinds make investors nervous. Uncertain market conditions have created a tough environment for anyone seeking to conduct an equity flotation or rights issue in Europe. Some recent high profile cancellations of equity transactions can also be attributed to poor planning or unrealistic expectations. So here are my thoughts on how a CFO can help keep an equity transaction on track — and more generally, keep a company’s shareholders on board.
1. As CFO, you’re the numbers person — investors will want to meet you
Institutional investors like to meet senior management. They tend to look to the CFO and CEO as the most weighty company representatives with whom they should be granted frequent access. You may have a highly capable head of investor relations (IR), but it will be you, as CFO, that investors want to ask those in-depth questions about capital allocation, business performance or M&A selection criteria.
It goes without saying that having the CFO ready and available makes any deal-related roadshow far easier to fill and increases the likelihood that meetings will be attended by senior investor representatives. However, sometimes less well understood is the need for CFOs to allocate a significant amount of their regular working week to maintaining relationships with shareholders throughout the IR calendar — not just getting in touch when it’s time to tap them for more capital.
2. Don’t try to pick and choose investors based on preconceptions of their motivation
When assessing which investors to meet as part of a deal or non-deal roadshow, it’s easy to assume that long-only portfolio managers such as pension funds are intrinsically “good” and hedge funds that may regularly short stocks are “bad”. But the truth is never that black and white.
Equally, when meeting a hedge fund manager, you don’t know whether they are looking for negative signals to increase a short position or positive signals to unwind it. It may even be that your stock is to be used as a long position in a long-short pair trade. In fact in many cases the rigour with which hedge funds approach an investment exceeds that of other market participants, as can the duration of their partnership. In many instances given the diversity of asset classes they invest in, hedge funds can be a one stop shop sounding board for many differing funding options.
So try to avoid second-guessing an investor’s motivation to attend a meeting with you. By all means find out as much as possible about their stock selection process and investment model before you meet, but then let your numbers and corporate story speak for themselves.
3. Never spend time trying to reason with investors that your share price is undervalued
A common gripe for companies is that their current share price doesn’t reflect the true upside potential of their business. It seems to be a more emotive topic for corporate executives than how their CDS spread is trading on an absolute or relative basis. As tempting as it is to spend time trying to persuade investors that the current share price is wrong, it is far more important to focus on communicating the long term credibility of the business and the reliability of its performance — and then let investors make up their own minds. If you are confident in the strategy and your ability to deliver on that strategy, efficient markets will tend to reflect that quickly.
This is particularly important in an initial public offering (IPO) where there’s always tremendous focus on what the proposed price range will be, and how it compares relative to its peer group in terms of valuation multiples. But as soon as that price is struck, the actual price becomes rather arbitrary and the only thing anybody focuses on is how the shares then trade in the immediate aftermarket. This focus will be as true for your CEO as it is for your new shareholders.
Likewise, when conducting a rights issue, try not to get hung up on discounts to theoretical ex-rights prices or the absolute value of the subscription price compared with your idea of “fair value”. True, strong pricing can indeed signal corporate confidence; however, a rights issue is first and foremost an enabler of corporate development. A strong take-up message should be the immediate priority, and one year on, the only thing that matters to investors is how the new issue price compares with the prevailing share price and whether participating has been a wise investment decision. Therefore focus your energies on supporting the share price’s future trajectory.
4. Remember that good communication is everything
Honest and timely communication should be the goal for your everyday interaction with shareholders as your equity capital providers.
There are two other points to make here. The first is the importance of erring on the side of caution when communicating the potential size of any equity transaction. For example, say you need a rights issue to refinance a short-term bridging loan: proposing a range of values up to €500m and then confirming that you only require €400m to achieve your optimal post-transaction leverage will be met much more positively by the market than initially estimating a lower value and then revising upwards nearer the time of launch.
The second point is how to handle bad news. Any company can have a setback — be that company-related or a shift in the macro environment. If bad news hits, tell it like it is. If the circumstances are likely to have an impact on your P&L or balance sheet, be proactive and address this immediately. Delays only erode shareholder confidence; the market always punishes defensiveness, unwarranted optimism or prevarication.
5. Never let managing an IPO side-track you from delivering operational performance
Managing an IPO is a time-consuming, labour-intensive process. But there are no prizes for a CFO if the business fails to deliver on its financial metrics as you prepare for launch. Before embarking on an IPO, a CFO needs to think carefully about support structures and which parts of the IPO process can be prudently delegated (while bearing in mind Point 1, above, about their centrality to investor relations).
6. Get actively involved in any equity allocation process
At the tail end of marketing a new equity issue, it can be tempting to switch off as soon as book-building is completed, leaving the actual allocation of shares solely to your investment banking team. You may wish to reconsider.
7. Treat equity investors as your “forward-looking co-owners”
Depending on where in the capital structure they sit, different capital markets investors will look at your business in very different ways. A bond investor may be more focused on near-term cashflows and the extent to which these can meet pre-agreed payments of interest and principal. An equity investor is far more interested in the future growth trajectory and how their stake in your business might grow in value, given that the potential rewards and risks of ownership are much higher.
8. Know how new bank regulation will affect you
There are two pieces of bank regulation coming online that have major implications for any corporate engaging with equity market investors.First is the EU Market Abuse Regulation (MAR), which came into effect in July 2016. Among other aspects, MAR makes it far harder for investment banks to conduct speculative roadshows to sound out market appetite for a potential future transaction. Instead, corporates must now be very specific as to whether or not they intend to do a deal and in what time period, wall-crossing and cleansing investors as required. Non-deal roadshows intended to canvas investor appetite before any near-term deal launch are therefore more problematic under the new MAR regime.
9. Match the character of your banking syndicate to your firm
Following on from the point above, it is also important when selecting transaction partners to consider your corporate profile and whether your chosen banking team is a good fit for it. A major global investment bank can offer excellent product and service capabilities. But if you are a small to mid-sized firm, how much of a priority is your transaction likely to be compared to those of its larger corporate clients?
Likewise, a top-ranked equity analyst owes his or her ranking to the votes cast by the world’s biggest investors for analysis of the most significant sector constituents. Ask yourself truthfully whether your company fits such a profile, and whether such an analyst is likely to prefer spending what limited time is available marketing your story to the relevant investor base, or the story of a larger index constituent which will rank higher in terms of votes for rankings and dealing commissions for their sales desk.
10. Seek out a multitude of viewpoints
It can be tempting to narrow down your source of advice on a transaction to a couple of major banks with the rationale that they must know the market best. If you instead appoint a group of lead managers it can be very helpful to hear what each of the equity capital markets teams has to say on a particular issue. As part of proper planning, a diversity of views can often help identify a better solution and even uncover an aspect that could move the transaction positively in a different direction. The best way to achieve this is to arrange bilateral calls with each bank individually, rather than anonymous multi-bank calls in which differentiated advice may be crowded out.
Equally, if a lead arranger seems more intent on getting a deal closed than getting it right, alarm bells should ring. As a fee-paying client, you should always feel in control of the process, rather than managed by it. Ultimately, you are spending shareholders’ funds, so the question should always be “am I getting the best advice?”
11. The best equity transactions combine vision with sanity
Successful equity transactions tend to be those that have a great growth story or value proposition. It is imperative that you have solid, reality-based numbers to back it up. If the CEO’s role is to sell the blue-sky vision, your role as CFO is to be the sanity checker that keeps everything and everyone under control. Sometimes that will mean playing devil’s advocate, considering how to prepare for scenarios where the market opportunity might look less rosy than first predicted, and planning how investor expectations might be credibly managed in all scenarios. Equally, if you’ve just completed a significant acquisition and another opportunity quickly presents itself, ask yourself whether the market wouldn’t prefer you to deliver on promises made in respect of the first before embarking on a second.
12. Remember that equity fundraising isn’t irrevocable
CFOs who find themselves endlessly deliberating as to whether an equity issue is the right course of action can console themselves with the fact that movement between public and private share ownership has become far more fluid.
Being CFO is very much about making a constant reappraisal of the company’s capital structure and assessing if it’s delivering optimal value to all of the stakeholders. While always taking proper time to assess a course of action, you should remain willing to change direction in the future if justified by a change in market circumstance. In investors’ minds, pragmatism trumps dogmatism every time.
Recognising that shares represent a source of permanent capital, share buybacks are nevertheless an accepted way of delivering shareholder value and shifting the balance between equity and debt, even for companies who have raised equity capital in earlier times of need. Investors will often applaud companies that decide that the most prudent use of excess corporate cash is to buy up shares they believe to be undervalued rather than invest in speculative acquisitions at higher valuation multiples.
Moreover, returning a company to private hands — perhaps for it to relist at a later date — is now an acceptable part of the corporate cycle. It may come as a surprise that in the US, long considered the most active and liquid equity market of all, the number of listed companies has almost halved in the past 20 years.
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This communication is issued by Commerzbank AG and approved in the UK by Commerzbank AG London Branch, authorised by the German Federal Financial Supervisory Authority and the European Central Bank. Commerzbank AG London Branch is authorised and subject to limited regulation by the Financial Conduct Authority and Prudential Regulation Authority.
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