Equity market enters new age
No one doubts that US investor demand for foreign equities is growing - or that accessing the US investor base is an important strategic objective for foreign companies.
But many people are increasingly questioning whether companies have to go to the US to achieve this. The equity revolution taking place in Europe has transformed the capital-raising landscape for European companies, big and small. And the growth in internet trading raises the question of whether geographical considerations will matter at all in the future.
So what are the reasons for companies to list in the US? And how should they best go about it? James Rutter reports.
The words bubble and crash may have been temporarily removed from America's stockmarket lexicon, but as the market indices creep ever further into record territory it seems US investors are starting to look elsewhere for value.
The New York Stock Exchange (NYSE) is expecting the volume of trading in its listed foreign equities to rise to $350bn this year, from $190bn in 1998. As Georges Ugeux, the NYSE's group executive in charge of international and research programmes, observes: "There is a huge increase in interest in foreign equities from US investors."
Of course, investors had every reason to stay close to home during 1998. With emerging market dominoes still toppling, Japan plumbing the economic depths and Europe preoccupied with its single currency, Americans rightly sought solace in their own home-grown economic miracle.
With the exhortations of Wall Street pundits such as Goldman Sachs' Abby Joseph Cohen ringing in their ears, those that clung doggedly to the back of the great bull market were handsomely rewarded.
So why the change of heart in 1999? The bull is still rampant, and Federal Reserve chairman Alan Greenspan's recent move to a neutral stance on interest rates - albeit accompanied by a 25bp rise - looks to have ensured that it will keep on charging for some while yet.
But markets elsewhere in the world are suddenly looking a lot more attractive. Emerging markets, especially in southeast Asia, are winning back their tiger's stripes; Japan is hinting that it may finally be turning the corner towards recovery; and while the euro may be struggling on the currency markets, Europe's new single market is already prompting the sort of merger mania that gets equity investors in a lather.
One only has to view the figures for activity in the American Depository Receipt (ADR) market, by which most US investors gain exposure to non-US companies, to see that foreign equities are once again on their shopping lists.
During the first six months of the year, ADR trading volume was up by 31% over the same period in 1998 to 8.8bn shares, according to Citibank. The dollar value of trading rose by 18% to $320bn, and new capital raisings were up by 66% to $7bn. Among the significant deals was the largest ever ADR capital raising, Korea Telecom's $2.5bn offering. Three other Korean companies weighed in with significant offerings: Korea Electric Power Company raising $753m, Shinhan Bank issuing $400m and Samsung Display Devices offering $200m.
There was also the first listing on Nasdaq from an Indian company, Infosys Technology. Previously Indian firms have preferred to issue Global Depository Receipts listed in Europe.
But now that Infosys has successfully completed the SEC registration process this could change, suggests Mike Hughes, vice president and global product manager of depository receipts at Bankers Trust. "I believe more companies from India will be following that route in the next six months," he says.
And for Hughes the theme during the early part of 1999 has been clear: "Capital raising in Asia has been the key element of the depository receipt market in the first six months of the year," he says. Emerging markets accounted for 71% of the equity capital raised through ADRs. In contrast, European companies remained on the sidelines.
"Nineteen ninety-eight was a tough year for companies seeking capital abroad, particularly those from emerging markets," says Chris Sturdy, managing director at Bank of New York.
"But the number of new capital raisings from emerging markets has become a dominant factor in the market. The need to go to the US for European companies is not as pressing as in the late 1980s and early 1990s."
The diminishing need for US equity capital for European companies is a natural result of the growth of Europe's own equity markets.
The single currency, the reform of pension schemes across Europe and more than a decade of state privatisations are all combining to foster the growth of an equity culture that Europe has traditionally lacked.
As one European banker comments, whereas it used to take 14 years for a German company to get to the equity market, now it takes only a matter of months. "It's not evolution, it's revolution," he says.
With the clear potential for the formation of a single European stockmarket, as indicated by the numerous alliances hurriedly being put in place by national stock exchanges, in the not-too-distant future Europe should be able to boast an equity market of a size and liquidity comparable to the US.
European companies may now be able to raise adequate equity capital without the support of dollar investors, but in many other respects the logic behind establishing an ADR programme is as persuasive as at any time in the past decade.
"There has been a shift of emphasis from pure capital markets considerations to strategic considerations," says Ugeux at the NYSE. "These aren't affected by the liquidity of the European market, which I agree is bigger. The US being a complement for the weaknesses of Europe is no longer a theme."
Just six new foreign listings on the NYSE during the first half of the year was not a promising start. There were, for example, 18 new companies listed during the first six months of 1998. "The perception of the first half of the year would be that there may be a slowdown in foreign companies seeking listings on the NYSE. But that is due purely to seasonal factors," Ugeux argues.
Because of the need to reconcile a company's accounts with US Generally Accepted Accounting Principles (GAAP), few foreign companies are ready to list before May, given that domestic annual reports will have likely been delivered in April.
Ugeux says that it generally takes three months to complete the SEC registration process once the legal and accounting preparations are completed.
In contrast, a Global Depository Receipt programme, which can provide a listing on either the London or Luxembourg Stock Exchange, takes only four weeks to set up.
According to Hughes at Bankers Trust, many emerging market issuers still favour the GDR route, as it can always be extended to cover the US. "From a capital raising point of view, central and eastern Europe has been dominated by GDR programmes," he says. Nevertheless, ADRs still accounted for 62% of all new depository receipt programmes during the first half of the year.
The first big name on the NYSE's calendar for the third quarter is HSBC, due to list on July 16, with Deutsche Bank, Fortis and Toyota among those slated to follow.
As those names suggest, emerging markets may have dominated US equity capital raisings during the first half of the year, but plenty of pent-up supply exists in Europe and other developed markets just waiting to flood out in the second half of 1999.
The mass sigh of relief that greeted the Federal Reserve's 25bp rate hike and return to neutral bias at the end of June gave the green light to foreign listings.
In the week following the July 4 holiday the NYSE welcomed both Telecom Eireann and Norwegian Cruise Lines to its ranks. CEOs of foreign firms are once again queuing up to stand by chairman Richard Grasso's side and ring the exchange's opening bell.
"While the capital raisings during the first half of the year weren't as dramatically improved, it is significant that a significant number of European issuers are pursuing ADR programmes," says Kurt Schneiber, managing director for depository receipts at Citibank.
He suggests that the UK, the Netherlands and Germany are all set to be particularly ripe sources of new ADR issuance during the second half of the year.
Others are even more bullish. "We've never had a stronger backlog of issuers than we do now," says Sturdy at Bank of New York. "The calendar is so packed that some companies can't go to the market when they'd like to. They can't afford to go up directly against one of their sector peers."
One obvious driver of this potential glut of supply is the feverish pace of merger and acquisition activity, both within Europe and transatlantic. And despite the rally in emerging markets - Bank of New York's emerging markets ADR index was up by 30% at the end of May - there are plenty of US investors seeing Europe as a much wiser bet.
"From a US institutional perspective asset allocation favours European countries," says Hank Erbe, managing director and co-head of US equity capital markets at ABN Amro Rothschild in New York.
US investors are watching keenly the consolidation and restructuring of corporate Europe. As Erbe says: "They're looking to participate in that through new issues."
The success of the one major new issue from Europe during the first half of the year is a case in point. US investors lapped up the $1bn secondary offering of shares in Dutch data communications carrier Equant.
Since its IPO in July last year, the company's ADRs had risen to around $80 at the time of the issue, having debuted at only $27. US investors see the company as a European equivalent of MCIWorldcom - although, given the less advanced state of the telecoms business in Europe, Equant is growing at almost double the pace of its US-based rival.
Like many of the companies looking to raise capital in the US in the second half of the year, Equant has already developed a firm business platform in North America through an operation headquartered in Atlanta.
Both HSBC and Deutsche Bank, which are due to be listed on the NYSE, are completing major mergers with US banks - the Republic Bank of New York for HSBC and Bankers Trust for Deutsche.
As Citibank's Schneiber points out, the creation of transatlantic alliances "by definition requires companies to think seriously about their capital structure and how it is balanced". Or, as Ugeux puts it: "No global company can really afford to have the fate of its shares in the hands of the local market."
While these companies are reacting to their geographic expansion, other firms are being more proactive in seeing the benefits of having a US listing for their shares.
The link-ups between oil companies BP, Amoco and Arco, telecom firms Vodafone and Airtouch and car-makers Daimler and Chrysler, show how depository receipts can play a vital role not only in financing a merger or takeover deal, but also in securing the backing of US investors for a transatlantic alliance.
At Bank of New York, Sturdy says that there are at least another two or three deals in the pipeline that are looking to use existing ADRs as acquisition currency.
The trend is set to get stronger. "There's increasingly strong interest in putting ADRs in place to prepare for an acquisition," he says. "Many western European companies are realising that they don't have an ADR programme of the appropriate type to allow them to offer paper in an acquisition."
The "appropriate type" of ADR is generally seen as being a level-2 programme, which gives the company a full listing on a US stock exchange and requires SEC registration and adoption of US GAAP. From there it is a relatively small step to being able to do a public capital raising through a level-3 programme.
As Hughes at Bankers Trust points out: "A level-2 programme gives companies access to the M&A market, and given it's a listed programme it can be used as acquisition currency. But it can be quickly upgraded to a level-3 programme to fund an acquisition."
The listing also gives much broader and deeper access to investors, which, as Erbe observes, is often critical when acquisitions need shareholder approval. "Spending time and resources creating a US institutional and retail investor following becomes critical when an acquisition opportunity comes up."
It is a fact that is increasingly being recognised by firms looking to raise equity in the US. "The trend is more towards those structures that allow a broader access to investors, rather than a narrower one," says Schneiber.
However, the fact remains that, to obtain a listing on the Nasdaq-Amex exchange or the NYSE, companies have to be ready, willing and able to meet accounting and reporting requirements which are almost certain to be more exacting than those they are used to.
Hence the attraction of an unlisted ADR endures. As one banker says: "It will remain a quick route to US capital markets."
The quickest of these routes is to privately place equity with US qualified institutional buyers (QIBs) under rule 144a.
The cost is minimal, there are no SEC reporting and registration requirements, and with more than 4,000 QIBs eligible to trade 144a equity through the National Association of Securities Dealers' electronic trading system Portal, there is in fact a modicum of liquidity.
Sturdy suggests that the motivations for doing a 144a ADR are nearly always negative: "Either [the company] cannot produce a SEC registration and GAAP accounting, or will not - because of the level of disclosure required - or they haven't the time when the window of opportunity is open."
Nevertheless, for emerging market companies in particular it offers the easiest access to US capital markets without any of the associated costs or reporting commitments. The same holds true of a level-I ADR, which requires only a cursory registration with the SEC and can also be traded publicly in over-the-counter markets.
For many companies it represents the first step on the road to market respectability. In April, Siberian oil company Sibneft set up a level-I programme, and three months later completed a private placement of equity to European institutional investors that was the first significant equity transaction from a Russian company since August 1998.
But the level-I ADR is by no means the limit of Sibneft's ambitions, according to president Eugene Shvidler. "For some of our new shareholders, this placement represents their first step back into the Russian market after the crash last August," he points out. "We certainly appreciate their trust. We hope they will stay with us, all the way to our goal of a level-3 IPO and beyond."
According to one banker, emerging market firms increasingly see the value of a more transparent programme, and are looking to establish a level-2 ADR so that they are in a position to raise capital should market conditions be in their favour.
"There may only be a one or two month window of enthusiasm for their local market, so the company needs to be in a position to move post haste," he says.
Hughes agrees: "Issuers are certainly looking to give investors more transparency and better information.
"Level-I is an entry point. But more issuers are looking beyond it and seeing level-2 as the starting point."
It is also fair to say that firms who assume an ADR programme will automatically improve their visibility in the US market and the liquidity of their shares are likely to be disappointed by a level-I programme.
"For European corporates serious about the US market a level-I ADR programme is not an option," argues Erbe.
"There's particular focus on large, liquid offerings with multiple listings. US institutions like to know they can trade in multiple markets."
But others see a level-I programme as a useful tool, so long as companies recognise its shortcomings. "It's almost a no-cost trial of the US market," says Sturdy. "Often it's just an investor relations tool - a soapbox on which the CEO and CFO can stand and tell their story to US investors with credibility."
A common criticism of ADRs is that, for all but a handful of companies, they add only negligible liquidity to share trading. It is true of most level-I programmes. And if one of the major motivations is to diversify a company's shareholder base, then one can argue that ADRs often appear a failure.
Robert Thys is the London-based director of marketing for EuroNM, the alliance of Europe's growth stockmarkets. He suggests that a US listing rarely impacts the volume of trading on a company's domestic market.
"I see European companies listing on Nasdaq or the NYSE and very quickly trading comes back to the home market," he says. "That doesn't mean there's no point to it. It offers the company a window to the world, a marketing tool, if not an ego trip."
This is the main draw of an ADR programme. As Sturdy says, it provides companies with a soapbox from which to preach their message to US investors.
And if one's target is the major institutional investors, then liquidity in the ADR itself is not necessarily the name of the game. Rather, it is simply to get these institutions to buy shares, wherever they may be listed.
"To draw the conclusion that a programme is a failure because of illiquidity is to miss the point," says Sturdy. "It may be an illiquid ADR, but as a consequence of the programme there may be tremendous take-up of the company's ordinary shares by US institutions."
From the bankers involved there seems to be one common message: that to successfully attract and keep a US investor base through an ADR programme requires a significant marketing effort.
Companies have to make their CEO and CFO available to US institutional investors at least once a year, if not every six months, and target potential investors by examining the shareholder structure of companies in its peer group both at home and in the US.
"If you were to look at the most successful ADR programmes," says Citibank's Schneiber, "the companies' senior managements have invested time, energy and financial resources in reaching out to investors."
As the NYSE's Ugeux points out, while reconciling domestic accounts with US GAAP is usually the most expensive aspect of a US listing, the hidden costs are potentially far more significant. "The cost is not so much a money factor, but the sheer size of the market that requires coverage," he says.
That coverage is made easier by having the extra visibility provided by a listing on either the NYSE or Nasdaq. "An SEC-registered and listed ADR opens up accessibility to US institutions exponentially," argues Erbe. "There's still a critical mass of institutions who cannot invest in non-US equities unless they are listed. So it broadens and deepens the institutional investor base and provides access to retail investors."
But might there not also be a danger in exposing oneself to a more sophisticated, demanding and capricious investor base? Many CEOs and CFOs come back from their first US roadshow having taken what Ugeux calls "a journey into a world of investors who are seeing their company with different eyes".
The reassuring familiarities of the domestic market, where the company's name and reputation are likely to have preceded it, will be absent. Instead, companies find a narrow focus on shareholder value.
According to Sturdy, as long as firms accept that such is the nature of the beast, they have nothing to fear. "The danger is not recognising the fact that some US investors are terribly sophisticated and that in terms of information expectations are higher and tougher," he says. Nevertheless, some firms do fail to recognise that fact, and as a result are given short shrift by US investors.
The rise of the internet as a trading tool, with its legions of stay-at-home day-traders, has added another dimension to the US retail market, and turned individual investors into a far more influential body.
The retail investor base is both a challenge and an opportunity for foreign firms. For those looking to develop their businesses in North America, the marketing of ADRs and of their products can go hand in hand.
Finnish telecoms company Nokia is one foreign firm that has succeeded in selling itself to customers in both markets.
"They have clearly identified their ADRs as a significant piece of their marketing programme," says one banker. "They're reaching out to investors - aggressively selling not only their stock, but their primary product."
Again, it is the idea that capital structure should reflect business expansion. Says Schneiber: "I think you'll see that those companies that place a strategic focus on extending their brand beyond national borders also see the value in expanding their capital structure to match their strategic business intent."
One of the most reliable flows of business from overseas to the US stockmarket has been in technology and growth companies seeking a Nasdaq listing.
But for European companies there are now credible alternatives, given the growth of the markets joined in the EuroNM alliance as well as its competitor Easdaq.
Most significant of all has been the phenomenal growth of Germany's Neuer Markt. Besides attracting a wave of listings from German companies, the Frankfurt-based high growth market is increasingly starting to attract listing business from companies in other European countries as well as from across the Atlantic.
In previous years, many - if not all - of these companies would have been obvious candidates for a Nasdaq listing.
As a result, the number of new listings on Nasdaq from foreign firms has been declining over the past two years, although the volume of trading in foreign shares is growing. But there are still reasons for growth companies to list on Nasdaq.
Erbe at ABN Amro Rothschild is one of many bankers who still sees a strong argument for foreign firms to list on the exchange. "For a technology issuer in particular the US is very important," he says.
"Valuations are far superior to Europe. Analyst coverage is more intense and focused, and there are more comparable companies. There are clear opportunities for European companies to get superior valuations and create constructive demand tensions between US and domestic markets by courting a dedicated US investor base."
But the valuations game is not as straightforward as it once was, suggests Thys at EuroNM, at least for growth companies. EuroNM notched up its 250th listing at the end of June, and Thys says it now offers real competition to Nasdaq. Indeed, he claims: "Valuations are no longer higher on Nasdaq."
Thys recalls a representative of a major US financial institution speaking at a recent conference and observing that valuations of companies conducting IPOs on EuroNM was around 20% higher than on Nasdaq.
"I was pleased to hear it said by someone who people would take more seriously," laughs Thys.
The growth of internet trading is another threat to ADRs. With geographic location no longer a boundary to investment, even for the amateur tapping away on his home PC, why bother to list in the US? Markets across the world are now open to everyone.
"The underlying reason for having ADRs, from their conception in the 1920s, is the different regulations and accounting standards in national markets," says Schneiber.
"To the extent that the internet becomes a vehicle for trading, I don't know that it will change the game, because behind it there still lie vast differences. A dramatic convergence of all markets around regulations and corporate governance - that, over time, will ultimately have an influence."
As Bank of New York's Sturdy puts it, gesturing to the half-yearly report: "Every year I hear people saying that ADRs are dying. And yet here, again, are impressive numbers."