Review of the Year 2018 and Outlook 2019

There is little sign that the recent rise in volatility in equity capital markets will subside in 2019. As such, EMEA’s top IPO houses face a challenge next year in how to avoid pulling deals due to “negative market conditions”, the oft-repeated and inadequate phrase sellers used to explain their decision to delay a listing this year.

As of November 16, 48 IPOs announced in 2018 had been withdrawn, according to Dealogic data, curtailing billions of euros of potential issuance volume.

This number is almost double the 25 deals pulled during the same period last year. According to Dealogic, 248 IPOs were priced across EMEA for a total of €38.4bn in 2017 until November 16.

IPO issuance volume is 15.6% lower than the same period last year where 311 deals were priced for €45.5bn.

October was a particularly bad month for equities as 13 deals were postponed in the midst of an market sell-off that devastated fund positions.

This included Amsterdam-headquartered auto-leasing firm Leaseplan as well as Spanish oil and gas company Cepsa, which had been set to be one of the largest listings of the year.

The market’s troubles continued into November as four deals were pulled, notably Eurotorg, the Belarusian supermarket chain, which had been set to be the first big international listing from the country.

The scale of the volatility of the last quarter of 2018 surprised market participants, prompting them to consider how periods of bearishness, however brief, will affect new listings in 2019.

“We are undoubtedly seeing an increase in the frequency of periods of volatility and much of that simply has to do with where we are in the cycle, including stretched valuations and the threat of both slowing earnings growth and tighter monetary conditions,” says Martin Thorneycroft, head of EMEA cash ECM at Morgan Stanley in London. “When the market is volatile, it makes for a more challenging IPO market, directly impacting investor confidence.”

But it wasn’t just volatility that led to IPOs being postponed in 2018. There were plenty of deals that struggled, even when secondary equity trading was positive, for reasons including mispricing and unfancied businesses and sectors.

And many deals that did manage to get priced struggled after pricing. Aston Martin’s IPO, which was priced on early October, never recovered from early pressure on the stock and by the end of the week of November 16, was trading at £14 a share, down 26% from its IPO price. “One of the biggest themes of 2018 has been a fairly binary IPO market, with several of our 2018 deals trading up strongly, including the likes of Adyen, Netcompany or Knorr-Bremse,” says James Manson-Bahr head of the EMEA ECM syndicate at Morgan Stanley. “These were big movers that created alpha.

“However, clearly some others did not do so well. What we’re now seeing when we look at our pipeline [for 2019] is far more self-selection. All banks have a big pipeline of mandates and there has been an awful lot of pitching activity but the market as a whole is being self-selective.”

Size matters

Other prominent IPO bankers also expect greater investor selectivity next year given the mixed performance of deals in 2018, as well as the higher percentage of pulled transactions.

Companies without an established track record in a developed country or region might struggle, with funds unwilling to take a risk on an unknown business.

“In the second and third quarter, we have seen an unprecedented percentage of IPOs pulled post intention-to-float, which is the result of increased selectivity by investors,” says Gareth McCartney, head of EMEA cash ECM at UBS in London. “Given the market backdrop, this is likely to continue into 2019 — with an initial focus on larger deals in developed markets.

“Mid-sized and more marginal equity stories will remain challenging to execute. Volume will continue to be skewed towards high quality larger assets, where the debate is more on final pricing versus do-ability of the transaction.”

Although large-cap IPOs are likely to be in vogue in 2019, deal sizes might have to be smaller. Indeed, another defining characteristic of the 2018 market was that order size decreased, even on IPOs of highly regarded companies.

Syndicate banks throughout the year have reported that orders from investors who have long been considered “deal players”(ECM’s most regular buyers) have shrunk.

This has meant that sellers have had to rely far more on long-only funds to execute deals. But if traditional ECM buyers are reducing orders substantially this will make deal execution more difficult.

Investors will continue to be engaged with new deals but if they put in smaller orders, as has been the case through much of 2018, deals will fall in size.  

“Size is going to be one of the key factors next year,” says Sam Losada, head of EMEA ECM at Bank of America Merrill Lynch in London. “That has been a real learning curve since the summer of 2018 and size really does matter. Investors are very much engaged but their order size has reduced significantly.

“To determine the right size of IPOs we are now increasingly going through a detailed bottom-up analysis of where we think the orders will come from.”

He adds that bookrunners will have to spend more time looking at the specifics of each deal, who the accounts are that have been interested in early look meetings, what feedback they have provided, how likely they are to participate and for what ticket size.

Reducing deal size might be beneficial in helping syndicate teams succeed in selling deals at times of market stress.

However, deal sizes can only go down so far — investors tend to value liquidity after the IPO in order to be confident of the deal trading well in the aftermarket. The smaller the deal the lower the liquidity.

“The most successful IPOs of 2018 have been large IPOs, deals like Knorr-Bremse, Siemens Healthineers and Adyen, which points to the importance of liquidity, a very topical point throughout 2018,” says Manson-Bahr. “Looking at which European IPOs are likely to do well in 2019, it feels like the smaller deals, by which we mean anything under $400m-$500m, are going to have to be truly differentiated to get traction with investors.”

Accelerated bookbuilds

One of the peculiarities of Europe’s IPO market when compared with the US, for example, is the length of time IPOs are marketed — traditionally between three to four weeks.

This has not been much of problem over the last 10, mostly benign, years. However, since the return of heightened volatility, often for whole months at a time, the risk of an IPO being postponed, as was the case in October, has increased.

As a result, sellers may try to speed up the process.

“I think some of the higher quality offerings which have been pulled simply because they were the wrong deals at the wrong time, will come back and maybe they will come back on a more accelerated basis,” says Thorneycroft.

“The increased volatility in the market means that if you can bring something back, but only be public for four or five days, that would have to be a pretty attractive approach when compared with the four or five week process which is normal for IPOs.”

The accelerated offering approach will only work on deals that the market is familiar with — i.e. recently pulled. For offerings such as Cepsa, postponed in October, an accelerated January listing could be a possibility.

“For those IPOs that withdrew in the last three months of 2018, they could come back to market on an accelerated basis in the first half of 2019, with a shorter bookbuilding process,” says Losada.

The structure of these accelerated listings will mean that deals which return will likely skip the pre-deal investor education and research period. Bankers will likely approach investors who were interested in the transaction before the postponement and build a shadow book before a short management roadshow.

This would mean coming to market without research. “If you are publishing pre-deal research in conjunction with an IPO there are fairly strict stipulations around the period of time you need to leave between publishing research and putting management on the road,” says Thorneycroft.

“That is hard to compress into a short period of time which is why we tend to do three week processes as an absolute minimum, but if you don’t need to publish research and have an asset which is well understood, say you have done education before, then it becomes easier to do an accelerated IPO.”

But given how volatile markets have been this year, banks are likely to spend more time building shadow registers before any deal is launched to lower the risk of failure, like they do for block trades, with a wall-crossing exercise before launch.