American depositary receipts have posted impressive figures in the first half of this year. According to Citibank, total dollar-value trading has risen by 18%, from $272.3 billion to $320.7 billion; there has been a 31% rise in shares traded, from 6.7 billion to 8.8 billion; and total capital raised has increased from $4.2 billion to $7 billion. It sounds like an extraordinary success, especially in view of the fact that many of the companies that have set up ADR programmes come from emerging markets and are seeking to extend the pool of equity capital they can tap beyond the shallow local markets.
The details behind this rosy data are more complex and controversial. Since their introduction in 1927 as instruments to enable non-US companies to sell their equity to US institutional and retail investors, ADRs have regularly had to face up to market volatility. In the 1990s, after steady growth in the first half of the decade, the market peaked in 1996 when 189 new programmes were launched. But over the past three years the annual number of new programmes has been constantly declining and in 1999 could hit the lowest level since 1992. Just 53 new programmes were signed by the end of June and no more than 120 are expected by the end of the year.
To many insiders, one of the main causes of this has been the emerging-markets crisis. In 1997, US investors started to repatriate investments following the Asian meltdown, and traditional sources of new programmes such as corporates from Thailand, Malaysia and South Korea were in practice prevented from tapping the market. In addition, the turmoil slowed privatization of China's huge state-owned conglomerates. "We haven't seen anything out of there over the last three years," says René Vanguestaine, managing director and global head of ADRs at JP Morgan in New York.
There is more to this than cyclical trends and crises. The sector is facing a quality problem as an analysis of actual liquidity in programmes and the number of issuers that have solid reasons to stay in the market indicates. JP Morgan research shows that out of over 2,000 programmes, the 50 largest represent roughly 75% of all disclosed ADR investment and 77% of total trading volume. If the analysis is extended to the top 200, the figures are 95% and 96%. And, maybe more important, only 100 of the issues had an average of over $100 million traded.
"Over the past few years, we have seen a lot of hype about ADRs, but a lot of programmes were set up by companies that don't have either a US presence or a real US penetration strategy," says Vanguestaine. "As a result of that, US investors don't know them and these programmes remain very illiquid."
At the end of 1998, about 74% of the programmes were in two of the four ADR categories: the most basic level I and what are known as private-placement 144a depositary receipts. These two categories give foreign companies hoping to trade on the US over-the-counter market and wishing to raise capital through private placement the opportunity to establish programmes without complying with full Securities & Exchange Commission registration and with US GAAP (generally agreed accounting principles) rules. Though these are the vast majority of programmes by number, in terms of dollar value of trading they only amount to 5%.
The other two categories - level II and level III - are respectively designed for corporates aiming to trade on the New York Stock Exchange, American Stock Exchange or Nasdaq, or that wish to launch public offerings. For these companies, SEC disclosure and GAAP compliance are compulsory and their commitment to the US is well testified to by the trading figures. These two categories account for 95% of dollar value but just 26% of the number of programmes. "These are the companies that have a real presence in the US, they are listed, do roadshows and may make offerings there, and investors know them," says Patrick Colle, European head of ADRs at JP Morgan in London.
The sector is facing another threat. With the globalization of financial markets, most US institutional investors are now finding it increasingly easy to operate directly in foreign equity markets, especially where stock exchanges guarantee acceptable levels of transparency and liquidity. "ADRs are a very convenient way of investing abroad, particularly when the local equity market is illiquid, tiny or with settlement problems," explains Colle. In Europe this is generally not the case. At the end of 1998 ADRs represented only 23% of the total US investment in European equities, with the rest held in local-currency form. The only exception is Finland, where 61% of US investment is through ADRs. This is mainly because of the predominance in the small Helsinki stock market of the country's leading share, telecoms company Nokia. Nokia is the largest issuer of ADRs, with 261 million shares with a volume of $27.8 billion traded.
Increasing transatlantic merger & acquisition activity and improved economic conditions in Asia after the turmoil could become major opportunities to attract greater liquidity to the market. Although emerging-market companies provide large numbers of new programmes, the most heavily traded shares are those of mature-market blue chips that might use their ADRs as part of the deal in making takeovers of US companies.
The use of equity in US public takeover deals has grown dramatically over the past decade. It rose from 7% in 1988 to 52% last June, and the ADR sector reflects this. Over the past two years, some of the bigger deals in US corporate history have involved ADRs as the main acquisition funding vehicle. Fully 91% of the $60.3 billion purchase of Airtouch Communications by UK telephone company Vodafone was funded through an ADR stock swap. British Petroleum used its programme last August when it bought Amoco for $54.3 billion and again this January when, under a new name, BP-Amoco, it acquired Arco for a consideration of $26.8 billion. Daimler-Benz entirely funded its $40.5 billion purchase of Chrysler in May 1998 with ADRs. So too did UK utility Scottish Power when it bought Pacificorp last December for $12.6 billion.