THE BLACKBERRIES MUST have been buzzing non-stop on the beach this summer. The moment the annual August holiday season ended in Europe, investment bankers were ready to sell stock worth e10.75 billion ($13.5 billion) on the primary market in less than two weeks.
First off the block were Morgan Stanley, BNP Paribas, JPMorgan, and SG, with a e5.1 billion sale of 249.5 million shares in France Telecom for Agence France Trésor on September 3. The deal, the third-biggest accelerated bookbuild ever, was accompanied by a e1.15 billion convertible from France Telecom, led by BNP Paribas, SG, and Goldman Sachs.
Six days later, Morgan Stanley and UBS sold e2.6 billion-worth of Sanofi-Aventis shares for Kuwait Petroleum Corp.
The next day, Santander Central Hispano sold shares worth £1.3 billion ($1.6 billion) in Royal Bank of Scotland in a deal led by Merrill Lynch that sold out in just four hours.
The success of these large deals was helped by the return of US equity investors to the European market. It's a flow of funds that has gathered pace in the past few months and which capital markets teams will be watching closely.
This welcome burst of primary market activity couldn't have come at a better time. The third quarter is usually the quietest for capital raising, but these September deals were pretty much the only bright spots in what had been a particularly disappointing quarter for equity capital market issuance in 2004.
The total of withdrawn or postponed IPOs reached its highest quarterly level in nearly four years, and many of those issues that did forge ahead had to be cut in size and repriced lower. Even with these deals included, the quarter is the weakest for ECM deals globally since the first quarter of 2003, with $95 billion having been raised, according to Dealogic. In Europe third-quarter volume was $32.2 billion.
Global equity capital markets volume and revenue have now fallen each quarter since the fourth quarter of 2003, when it first seemed the primary market had recovered from the slump that followed the secondary market collapse in 2000 and persisted from the start of 2001 through the first nine months of 2003.
The final quarter of 2003 might have been a false dawn. Nevertheless, bankers – encouraged by the success of these big deals in September and the prospect of privatization sales – are now optimistic that the fourth quarter could still bring more than e30 billion of issuance in Europe alone.
Investment bank senior executives and investors in the sector are hoping that equity capital markets (ECM) issuance will be strong enough to offset declines in fixed-income underwriting. So far this year it has not been. Although industry-wide ECM revenues for the first nine months of the year are up 33% on the same period last year, this has not been enough to offset the fall in debt capital market revenues. Total underwriting revenues – including debt and equity – for the first nine months at Goldman Sachs, for example, are 10% lower than in the same period last year.
Traditionally, the second quarter is the best for capital raising and the third quarter the quietest. Banks have it all to play for in the fourth. What can they expect this time?
Fourth-quarter precedents
The optimists make the case that secondary markets worldwide, with the notable exception of Japan, tend to rally in the fourth quarter. According to Lehman Brothers, equity market returns in the fourth quarter have, over the past 10 years, been better than those in the rest of the year by more than 4% in the US and UK and by more than 6% in Germany and France.
There is no clear explanation for this seasonal variation but the cyclical nature of earnings results and consequent forecast adjustments is one possible contributory factor.
US data show that the biggest downgrades on average occur in the third quarter, so the pace of downgrades thereafter decreases. This might also explain why Japan, with its different corporate reporting cycle, bucks the trend.
Lehman's global equity strategists see no reason for this year to be any different. Equities, they argue, are still undervalued compared with bonds and stand to benefit from a 20% boost to dividends over the next year, given current very high levels of free cashflow dividend cover.
The passing of the US presidential elections should also provide a boost by removing uncertainty. Lehman research going back to 1900 shows that returns in the US equity market tend to be weaker in the first half of an election year than in non-election years but that the second half tends to produce returns that are higher than those in non-election years.
Secondary markets are nudging up tentatively. The FTSE 100 has risen 2.4% this September and the S&P500 is up 0.5%.
Another factor that should help ECM deals in Europe next quarter is the return of US investors that first became evident in the primary market at the start of last month.
"The France Telecom deal was the first so far this year where we really saw US investors participate in a big way," says Michael Schaftel, European head of equity syndicate at Morgan Stanley. "US and UK accounts together took about 60% of the France Telecom offering and in Sanofi-Aventis the number was about 80%," he says.
Whether an account should be considered to be based in the US or UK is often far from clear. Most of the big US fund managers have large European operations in London, as do many of the hedge funds. There are reasons, though, to think that much of the recent demand from these managers is for their US investors.
Fund flow data from State Street show that net inflows to Europe started to turn tentatively positive in May and that the trend is picking up pace. There has not been a week of negative net inflows since the end of June.
"The big shift this year has been towards Europe," says Peter Sullivan, head of equity market research at State Street Global Markets. "This has not been the case for the last two-and-a-half years but the trend has been building over the last six months."