Supply lags booming demand

  • 01 May 1998
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Despite the booming French stockmarket and the intense demand among retail and institutional investors for quality stock, primary equity market supply in France has been relatively light this year.
The government, buoyed by the successful revitalisation of its privatisation programme last year with the France Télécom sale, has resumed its earlier strategy of selling rump stakes in privatised companies through bought deals and only has a limited number of assets left to sell through publicly marketed offerings.
And the corporate sector, which is more liquid than usual and concentrating ever more heavily on return on equity, is generally more interested in the potential for stock buybacks than new issuance.
But the pace is starting to quicken. Large deals from SGS Thomson, Rhodia and Alsthom are being lined up, generating excitement among bankers and investors who believe that the powerful stockmarket bull run is not finished just yet.

Whatever the level of new supply of French equity this year, it is unlikely to exceed the runaway demand from domestic and international investors that has lifted the CAC-40 stockmarket index by 40% since the end of 1997.
Analysts suspect there will be little more primary activity in the equity market from the French government this year, which is under less pressure to raise funds than it was 12 months ago. Apart from two major flotations - Rhône-Poulenc subsidiary Rhodia and joint venture GEC Alsthom, and a large primary and secondary offering for SGS Thomson - the corporate sector is equally unlikely to tap the market to any major degree, with listed companies more captivated by an upcoming change in legislation that will allow them to repurchase shares.
That leaves equity capital market bankers with a likely diet of bought deals as the larger companies spin off peripheral assets and, to a lesser extent, the government disposes of some of its rump stakes in privatised companies.
Meanwhile, demand for French equities is soaring, with much of the impetus coming from domestic institutional investors. The upturn in the French economy in the last quarter of 1997 and this year means that most institutions are highly liquid.
And the sharp decline in interest rates in 1996 and 1997 in advance of Emu has increased the incentive for these institutions to place those funds in the equity market. The flow of funds will speed up in 1999 following an amendment to the tax status of life insurance policies which was accepted by parliament at the end of last year.
Both new and existing policies will be exempt from income tax, as they have been until now, only if at least 50% of assets are held in equity markets. "Once the industry's first reaction of inertia is over, the French equities market could see an annual influx of around Ffr250bn of new liquidity a year from 1999," according to analysts at Paribas.
However, the French equity market is heavily influenced by foreign institutions, which hold 40%-50% of the free float and have increased their allocations to France over the past six months.
"There has been a general appreciation by institutional investors th at some of the best opportunities for improved corporate performance lie in France and Europe in general," says one US investment banker.
"The US and UK are at more advanced stages of the economic cycle, so there are also compelling cashflow arguments for investing in Europe."
A syndicate manager at one European house adds: "Initially, the Asian crisis caused a degree of paralysis and panic, but it has since resulted in an alteration of asset allocation. Western Europe has benefited from that process as the US was considered very toppy and Emu generated some excitement about the region."
Another important factor in international investors' renewed interest in France is the stunning performance of last year's landmark privatisation issue - the sale of a minority stake in France Télécom via joint global co-ordinators Paribas and Banque Nationale de Paris.
In the mid-1990s, France's reputation among international investors had been tarnished by the poor performance of several privatisation transactions, particularly the sales of steel-maker Usinor-Sacilor and Pechiney, the aluminium concern.
"There is no question that the France Télécom deal has reinstated confidence in the French retail public and the global institutional audience in the French privatisation programme," says one banker.
It has also given confidence to the French government and will embolden them in future deals.
But the privatisation of France Télécom itself had a difficult genesis. The day the deal was launched president Jacques Chirac announced a snap election.
As a result, the global co-ordinators completed the pre-marketing phase and then put the deal into hibernation, expecting that they would be able to resume in the middle of June after the election.
Everyone thought the deal was off when the Lionel Jospin's Socialist party emerged victorious, having campaigned throughout the election against privatisation in general.
In the summer, however, the new government disclosed that it would be willing, after all, to sell a minority stake in the company, providing the employees were in favour. As a face-saving exercise, it henceforth referred to the deal as "opening the capital" of France Télécom, rather than privatisation. The transaction was restarted in September "and we were on again on a pretty rapid timetable," recalls one insider.
Analysts cite several reasons for the success of the deal. One was the investment case. "It was inevitable that investors would compare France Télécom to Deutsche Telekom, and the French company compared well on that basis," says one analyst.
"Investors complained that the regulatory environment for Deutsche Telekom was not clear before launch, but with France Télécom it was crystal clear."
Paradoxically, another attraction of France Télécom was how quick it had been to face up to the threat of competition by making a dramatic cut in its rates in summer 1997.
One syndicate member praises the way the offering was handled, noting that there was a clear division of responsibilities between BNP, which was in charge of the domestic retail offering, and Paribas, which took charge of the institutional side of the deal.
The transaction was nearly 20 times oversubscribed, with demand fuelled by the announcement that the entire capital of France Télécom would be represented in the CAC-40 index, even though only a minority of the shares were being sold through the offering. Another important reason for the deal's success was the enthusiastic response from retail investors - and in this respect it represented a revitalisation of the French privatisation programme.
Normally in France, retail investors are willing to commit to buy shares only when the issue price has been set. The innovation in the case of France Télécom was that there was an incentive for retail to commit early.
Once institutions realised there would be strong retail demand, they were also willing to commit in size.
Retail investors have incentives to hold on to their stock, and bankers say that the level of retail sales has been very low by the standards of previous privatisations.
Flush from the success with France Télécom, bankers are looking forward eagerly to what may be the only company to be privatised through a stockmarket float this year: Air France.
Société Générale and Lazard Frères are advising the company, while Morgan Stanley Dean Witter and Crédit Agricole Indosuez are advising the government on the deal, which is being launched not because the government has suddenly changed its heart on privatisation, but because it has no alternative in this case: Air France pilots were given shares as partial compensation during an earlier pay agreement, and the government agreed then to create a market in the shares.
The international offering will probably total around $300m, which bankers expect will be easily absorbed by the international market at a time that international investors are growing more interested in airline stocks due to the tail off of a number of telecoms privatisations. Air France's only major disadvantage is that, unlike most of its rivals, it has not signed a strategic partnership with other airlines.
The Air France deal may be eclipsed by an offering of Renault shares, in which the state still owns a 44% stake. However, bankers are uncertain whether the government will launch a large, publicly marketed offering - perhaps of 25% of the equity - or if it will instead sell around 10% through a bought deal, a quicker process that would be targeted entirely at institutions.
One banker reckons there would be extremely strong demand from French retail if a well known name like Renault was put up for sale. "Retail investors often sell shares from previous privatisations when they invest, he says. "Since the stockmarket is so strong now, they could sell any of the earlier deal to reinvest."
The French government has been an enthusiastic user of bought deals for some time, although bankers rarely share the Trésor's excitement. "The margins in bought deals in France are surprisingly narrow if you compare them to the US or to the cost of capital involved," says one US banker. "The sellers are getting excellent deals, but the question is for how long banks will be willing to bid on these terms."
Last October, for instance, the French government sold part of its residual stake in steelmaker Usinor-Sacilor through a bought deal arranged by JP Morgan and CDC Marchés. The timing was unfortunate, coming in the middle of the worst of the Asian crisis, and the shares plummeted soon after the deal came out. The two firms are believed to have nursed large losses for weeks after that.
Some bankers had similar suspicions in early April, when the French government sold its final stake in Pechiney, partly through to industrial shareholders and partly through a bought deal of 4m shares.
BNP, Goldman Sachs and Credit Suisse First Boston managed the deal. Pechiney's share price initially fell after the placement.
But these mishaps have not dimmed the enthusiasm of investment banks to bid aggressively to win bought deals - an activity which has recently become one of the most competitive areas of equity capital markets as banks have looked to flex their muscles and use their capital strength.
In mid May, Deutsche Morgan Grenfell beat off competition from a handful of other firms - including Lehman Brothers, Merrill Lynch and Société Générale - to win a bought deal for the state's 5.8% residual stake in Seita, the tobacco producer.
Over the past 12 months there have also been a host of bought deals from corporate vendors as they have unwound strategic relationships. There were a rush of such deals at the beginning of 1997 with Société Générale arranging the sale of a 5% stake in Rhône Poulenc originally owned by Crédit Lyonnais.
Paribas disposed of a $200m holding in Elf Aquitaine while Axa UAP, the insurance company, disposed of its stakes in Paribas and Scor, the reinsurance company, through bought deals.
Some bankers believe the bought deal has been overused. Some French houses, for instance, allege that foreigners are using it as way to buy their way into the French market.
Others question whether the vendors are necessarily getting the best prices for their assets through the bought deal. "An alternative would be an accelerated book-building," argues one head of equity capital markets, who believes this would allow vendors to sell stock at, or close to, the secondary market price - rather than at a discount, as in the case of bought deals.
But the combination of the economic pick-up and the proceeds of these issues has meant that French corporates are more liquid than normal.
As a result, there have been few issues of straight equity by French corporates, much to the dismay of bankers.
Last October, Rhône-Poulenc launched a Ffr7bn capital increase to buy out the minorities of its US subsidiary, Rhône-Poulenc Rorer, while construction company Lafarge Coppée tapped the markets to finance its acquisition of UK firm Redland.
"You are seeing deals where the company has a specific story to tell, says one banker in Paris. "Equity investors don't like being diluted and will not accept transactions unless there is a good motive."
One exception is the $2bn offering of primary and secondary shares for micro-electronics company SGS Thomson, which is being led by Morgan Stanley Dean Witter, Deutsche Morgan Grenfell and Lehman Brothers.
The transaction includes an offering of 3m primary shares as a capital increase, a convertible bond issue and a sell-down of the stakes held by the company's majority shareholders - state-owned companies in France and Italy - to create greater liquidity in the stock.
SGS Thomson has been a stellar performer on the stockmarket. Since its flotation in 1994 at a price of $21.25, the stock has more than quadrupled to trade at over $85.
Bankers will be hoping for similar performance for the two large corporate IPOs which are on their way to market and which are generating considerable excitement among bankers and investors.
One is being originated by Rhône-Poulenc, which is floating 30% of Rhodia, its specialty chemicals division. The other large transaction is of Alsthom, being sold by its joint parents GEC of the UK and Alcatel of France. EW

An increasingly diverse market

What are the driving forces in the French new issue market? And what new twists will emerge as investors and issuers take a more pan-European view? These were among the questions Euroweek recently put to Simon Barnasconi, director of ABN Amro Rothschild in Paris.

How important and successful was the France Télécom share issue in re-establishing institutional investors' confidence in the French privatisation programme?

It was very important. It was the major IPO in some years, as well as the first major privatisation transaction of the left-wing government.
The transaction was also particularly successful and innovative in attracting interest from retail investors. An unprecedented number of private investors pre-subscribed in the period prior to the official OPV, allowing the vendor and the syndicate to tailor the tranches better to demand and create better tension between the various investor groups.

Do you expect the supply of equity from French corporates to increase as a result of the rise in valuations so far this year?

Only if the deals are acquisition driven. The French corporate community has in general adopted shareholder value as a key strategy which will reduce the number of non-investment related equity financings.
Lafarge's rights issue was driven by its Redland takeover; CAP Gemini may not have announced any takeover targets yet, but will use the funds for a series of smaller acquisitions. Besides, the debt market is currently providing cheap funding alternatives.

How do you see the rally in the CAC-40 index affecting international institutions' desire to buy new issue of French stock?

There are two important issues. The first is the coming of the euro in early 1999, which will drive international and French investors more towards Europe-wide portfolios.
Second is the abundance of liquidity in the domestic market, which is illustrated by the huge volumes of retail money which are being institutionalised every month through SICAVs and other forms of investment funds.

There have recently been a number of block trades in France, some of them resulting from French companies selling off peripheral assets. How successful have these transactions been?

Block trades have been increasing - not only as a result of corporates selling off non-core holdings, but also due to state or semi-state entities (such as CDR) selling off residual stakes in privatised companies.
Some of these have certainly been successful for the vendors, but not all of them have been favourable for the investment banks that have carried out the transactions. It is clear that the spreads compared to the risks incurred are at least questionable. We believe that most non-core assets have already been sold, but that some interesting blocks still remain.

Another feature of recent months has been a number of convertible and exchangeable issues. What value do these structures offer investors?

These innovative structures - such as the index-linked bond as well - will continue to be used since there is ample investor appetite for this type of security that offers medium risk and greater protection.
The issues that have been done have extremely successful, partly because of the relative lack of supply. More corporates may be tempted to tap this part of the market, also because it is not directly dilutive to their earnings.
The classical convertible market will remain closely dependent on acquisition financing. As for exchangeables, they have not generally been used to dispose of cross-shareholdings and we do not expect any significant issues in the near future.

Retail investors have played a growing role in privatisations throughout Europe. Are they becoming more important in France?

Retail is the key success factor, as illustrated by privatisations all over the world. Retail participation may vary from 50% to 85% of a transaction, but it is the driving force in the success of a major privatisation (possibly of major equity offerings in general).
It is important to allow in France for secondary offerings to include a retail offering at a so-called open price, allowing banks to market an equity story to clients on the basis of an existing share price rather than an artificial fixed price.
Retail is sufficiently informed and sufficiently sophisticated to base a decision on these factors. And there are signs that the authorities in France may change the current regulation. EW

  • 01 May 1998

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
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1 Citi 29,333.03 101 7.94%
2 JPMorgan 27,208.83 91 7.37%
3 Barclays 23,714.00 55 6.42%
4 Bank of America Merrill Lynch 20,332.10 65 5.50%
5 Goldman Sachs 20,005.21 49 5.42%

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Rank Lead Manager Amount $m No of issues Share %
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4 JPMorgan 37,278.65 134 4.85%
5 SG Corporate & Investment Banking 36,258.27 187 4.72%

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Rank Lead Manager Amount $m No of issues Share %
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3 UBS 970.80 3 14.04%
4 BNP Paribas 522.35 4 7.55%
5 SG Corporate & Investment Banking 444.17 3 6.42%