New realities: Shrugging off the Asia effect

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Despite the upheaval in Asia, investment bankers expect a near-record number of privatizations and IPOs in Europe and the US this year. By Nigel Dudley

A SUPPLEMENT TO EUROMONEY/MARCH: MARKETS 1998

Investment bankers are confident that the volume of new equity issues in 1998 will at least match last year's level. In 1997 a strong market delivered record levels of privatizations and initial public offerings (IPOs) in Europe and Asia, and a robust performance in the US.

Asia will be a virtually dead market for at least the first half of 1998 - and probably for the whole year. But Europe, driven by privatizations in both the west and east, could see as much as $110 billion of primary issues. In the US more than $40 billion could be raised.

"Governments and companies need to continue to raise capital. It can be raised if pricing can be offered at an acceptable level," says Michael Lavelle, director, equity syndication manager at Salomon Smith Barney. "IPOs will generally outperform the secondary market. If there is an exciting growth story, people will look at the issue."

At Goldman Sachs, managing director Michael Evans argues that "in Europe the markets will continue to be receptive to a fairly heavy volume of new issues. We are bullish on most European markets".

According to another banker, "movement at the moment is fairly slow because people are still working on their deals. There is, though, still a positive sentiment and I see no shift from that position. I do not see many huge deals in Europe as there have been in the past two years or in the US, where volume could be down by as much as 15%. There is a feeling that things are slowing down a little".

But this generally positive mood could be undermined by a continuation of Asia's economic crisis, fears for the value of the rouble in Russia, a further decline in president Bill Clinton's credibility and tension as western Europe approaches the final straight in the lengthy preparations for the launch of the euro next January.

Competition between lead-managers is likely to become increasingly cut-throat even though mergers between major financial institutions have reduced the number of banks chasing each mandate. "The squeezing of fees has been a consistent theme in recent years," says a London-based banker. "Just because the number of competitors has gone down, it does not mean that competition has got any less intense. In some ways it is the reverse as the weaker competition has fallen by the wayside. We are now reaching a critical point where either fees have to go up or syndicates have to get significantly smaller."

To what degree will markets continue to be affected by the Asian financial instability? The crisis caused several issues - not just in Asia - to be postponed at the end of last year. Bankers are struggling to assess how much longer the currencies of Indonesia, Malaysia, the Philippines and South Korea will continue to fall and whether the crisis in confidence will hit Hong Kong and mainland China to the extent that they are forced to devalue.

Confidence in the other Asian currencies will not be restored until there is clear evidence that governments have started to implement the economic reconstruction packages which the IMF is demanding. In the longer term, the raft of privatizations the IMF is calling for will generate new business for the banks. But bankers believe that it will be at least 1999 before this will happen. According to an Asian banker: "All the affected countries in the region are saying they will implement these measures to some extent or another. But I think some will postpone or renege on these commitments. Equally it does not make sense to sell all the assets in a distress sale. This should only be done when conditions get really desperate."

The one certainty is that little or no primary-market business is being done in Asia at the moment. "It is so bad that I am completely relaxed," says a US investment banker. "It is not as if you go to bed thinking that you may be missing out on a deal. It will be virtually impossible to do a deal of a meaningful size in the coming months."

Bankers believe that most corporate restructuring in Asia will be done through mergers and acquisitions, and that any IPOs will depend solely on the strengths of the company involved. "Those deals that happen will be the ones decided on by investment banks and investors, not the sellers," says a banker.

Among the reasons for Asia's poor prospects are that many investors have taken such a big hit that they are unable to invest. American money has been withdrawn from the region. Bankers say that American funds, which a year ago had 6% of their non-US investments in Asia - including Australia but not Japan - have reduced that figure to 2%.

There is little chance of a quick return to the position of a year ago. "These institutions are long-term investors. If they withdraw from an area, they have to do so for a longer period otherwise they can hardly call themselves long-term investment institutions," says one banker.

The effect on Europe is rather harder to gauge. "The Asia factor or concern or crisis is a double-edged sword," says one analyst. "Many European investors feel insulated to the extent that they have exposure in companies that have no Asian exposure and the crisis has less effect on their stocks. The other edge is that for the slightly less introspective investor looking globally, there is a deflationary environment which is created. This causes problems that go from the external to the internal. The degree to which investors fall into one camp or the other depends on the direction of their business. The longer the crisis goes on the more likely there is a risk."

Some of the money which was invested in Asia may now find its way into European primary issues. But it will not be a significant amount. "Until recently money that had been in Asian equities was deposited in Singapore and Hong Kong, which had escaped the worst of the trouble," says one banker. "But now they are shown not to be immune, a lot is being put into cash. Some is going into European and American investments and some into treasury bills and fixed-income investments."

London bankers remain confident that the Asian problems will not prevent them from raising money for privatizations and IPOs in Europe. Indeed bankers argue that Europe has maintained the reputation, won in the past five years, of being as efficient as the US for very large offerings.

"This is because of the calibre of the issuers," says one banker. "In addition, pension funds are moving from fixed income into equities. Third, more companies are going public. The equity market capitalization to gross domestic product ratio is 40% to 50% in France compared with 150% in the US but the gap is starting to narrow."

A further factor is the continued enthusiasm of the retail investor to buy privatization stocks. Bankers say half of equity primary issues are taken up by 200 major institutional investors, with the retail market absorbing the balance. "The market has shown it can absorb a significant amount of primary equity. Last year issues succeeded because many were bought by retail buyers. Now more shares are placed domestically to both institutional and retail investors and therefore the market can absorb more paper," says Lavelle of Salomon Smith Barney.

According to a bank analyst: "In southern Europe, Benelux, France, Germany and Scandinavia, the most important factor will be the private investor. They have started to emerge in southern Europe because of privatization. If you look at Telecom Italia, $8.5 billion of that $10 billion issue went to the domestic market. If you think that only half a dozen of the world's largest 300 investors are based in Italy, a very small amount was taken up by global investors. We will see this again this year. There will be less reliance on international investors because retail investors will keep coming back".

The retail investor will be affected by the introduction of the euro. Historically there has been comparatively little cross-border stock investment because the combination of buying unfamiliar stocks and working out exchange rates risks was a deterrent. "We don't yet know what impact the single currency will have on the 350 million citizens of Europe. Will French and German investors be happy to buy across borders and invest in new companies because they don't have to make a currency calculation?" asks one banker.

The retail investor will be enthusiastically wooed as governments press ahead with privatizations, and bankers dream up ever more attractive incentives such as loyalty bonuses, utility bill discounts and partly paid structures. But some bankers are cautious about how widespread the impact of this will be. They point out that the rise of the new retail investor has been a result of heavily marketed, generously priced privatizations rather than deep cultural change. They also argue that western European governments want the financial benefits of privatization to go directly to their own voters so will not market these issues aggressively in other EU states.

Ultimately western European governments have no alternative but to drive through their privatization programmes even if market conditions are unfavourable. It is the only way to reduce their deficits to meet the convergence criteria for membership of the euro which should be introduced to all EU countries except the UK, Sweden, Denmark and Greece in January 1999. The former communist states of eastern Europe will also continue to privatize their industries to satisfy their need for revenue and to modernize their economies.

Volumes this year are expected to match 1997 with markets raising more than $110 billion in IPOs, of which more than $30 billion is expected to be in privatizations. But this will be achieved through a broader spread of smaller issues than in the past two years. The figures for 1996 and 1997 were skewed by the jumbo privatizations of France Télécom and Deutsche Telekom.

The market for both east and west Europe will be dominated by telecoms, with one banker estimating that there could be as many as 16 issues, raising up to $16 billion this year. The telecoms market in the EU will be given additional impetus with the introduction of genuine cross-border deregulation this year.

First on the list in western Europe could be Swiss Telecom, which is expected to raise $3.5 billion in two equal tranches lead-managed by JP Morgan and Warburg Dillon Read. Also likely in the first half of the year is a $1 billion issue from Austria Telekom which bankers expect to "go reasonably well".

Other candidates for share issues in 1998 include Swedish firm Telia ($3 billion in two tranches during the second half of the year), Greek firms Pannafone ($300 million), Stet Hellas ($200 million) and Stet 3 ($1 billion), Belgacom ($1 billion), Spanish company Airtel ($800 million) and PT Finland (($1 billion). Bankers believe there could also be further tranches of Deutsche Telekom, France Télécom and Portugal Telecom.

In eastern Europe, last year's successful $1 billion privatization of Hungarian telecommunications operator Matav through a combination of strategic sale and public offering was the largest ever equity deal from the region and is seen as the model for future privatizations. Potentially the most interesting IPO this year is of $200 million for Estonia Telecom. "When this happens later this year, it will open up the marketplace," says Lavelle.

It will be followed by TPSA Poland, which is expected to raise $1.6 billion in the next four to five months. Demand could equal or even exceed that for Matav, given it has a much larger customer base. Other telecommunications companies likely to issue IPOs include HPT of Croatia ($1 billion in the second half of the year) and Hungarian company Pannon GSM ($200 million, which could be delayed until early 1999). A $1 billion offering for Turk Telekom has been planned for some months but has been delayed and may not make it this year.

"I am not surprised to see so many telecom privatizations in eastern Europe. They are very much in the first phase of privatization. They want to expand their domestic shareholder base and telecoms are a popular way to do this," says a banker.

However the outlook for other sectors in eastern Europe looks less positive. The equity offerings for Russian firms Gazprom ($500 million) and UES ($750 million), which were postponed from the end of last year because of the fallout from the Asian crash, are likely to go ahead. Hungary, whose economy has performed well despite high inflation, is seen as the clearest success story in central and eastern Europe. But, there is concern about disappointing earnings growth in Poland and political instability in the Czech Republic, which has put the much-needed privatization of the country's leading banks on hold. In Russia, there are fears for the stability of the rouble and nervousness about political stability. "At least in Russia we know what the problems are, so can build that into our calculations and pricing. In Asia, no-one realized quite what the extent of the problems would be," says a Paris-based banker.

Some sectors, such as telecoms, have a momentum of their own, irrespective of geography. The airline industry is similar. Lot, the Polish state airline, is due to offer $150 million worth of shares this year. Air France is receiving pitches from the leading investment banks and is expected to come to the market in May. The French state airline will probably sell publicly only a comparatively small amount, possibly ffr25 billion, through its IPO, because the government is committed to allocating a significant amount of shares to the company's staff.

Other French issues could include $2 billion for the state-owned car manufacturer Renault. GEC Alsthom is also considering an $7 billion offering, but SGS Thomson Electronics is thought by bankers to be unlikely to go ahead with its mooted $2 billion offering.

The most active country for new issues is likely to be Germany. However, as most of these issues will be in the private sector, they are less visible than privatizations and harder to forecast since they operate on much shorter lead times. Already this year, Allianz divested Dm4 billion of shares in Deutsche Bank through an exchangeable issue that was 10 times oversubscribed and is trading at a 25% premium. "This was a great transaction and could well set a precedent for other German issues this year," says a banker.

Comments another banker: "There is a real cultural change in the attitude of German banks and corporates. Banks no longer want to hold big stakes in their clients and vice versa. So there is a growing desire to unwind all these cross-shareholdings. That together with a greater consciousness of shareholder value means that there are likely to be more Allianz-type deals this year as the corporate restructuring gathers momentum."

There are doubts, though, about a $6 billion secondary offering for Volkswagen. This issue, intended to increase the company's capital, was postponed at the end of last year but a continued poor share price means it is unlikely to take place in the immediate future.

Shares in Italian companies will be in demand as it appears a virtual certainty that Italy will continue to submit to the financial disciplines that will enable it to join the single currency in the first wave. Road-operator Autostrade is expected to be first in the queue, raising $2 billion this year. It may be followed by state electricity company Enel ($8 billion).

"Italy has performed very well and banks have been in great demand, in particular highlighted by the Banca di Roma issue, which raised $1.5 billion last year with an additional $325 million convertible loan," says Lavelle of Salomon Smith Barney. Among the Italian banks expecting to raise capital are Ambroveneto ($3.2 billion) and INA Property ($2.8 billion).

In the UK, possible IPOs include $500 million for Intercontinental Hotels and $2 billion for Formula One. Other candidates include Thomson Travel and Computer Centre. Elsewhere bankers expect a number of financial institutions to make IPOs, headed by Spanish bank Argentaria, and followed by several Scandinavian and two Turkish banks.


Reits lead the way

The American IPO market got off to a buoyant start this year with a highly successful $1 billion issue for Boston Properties, lead-managed by Goldman Sachs. Such was the demand that it was increased from 15 million to 20 million shares.

The favourable reception for Boston Properties illustrates several trends that are likely to continue through the year. There is a considerable appetite for quality stock. Investors are more cautious than in previous years and are looking for more defensive sectors such as real-estate investment trusts (Reits). These issues started to become popular last year, accounting for one in five new issues, and are expected to be in even greater demand in 1998 and could end the year comprising half all IPOs.

In contrast the market for technology stocks which boomed in 1996 with $17 billion of IPOs is likely to ebb and flow with mixed signals coming from the sector. The negative signs were already there last year when volume fell to $8.5 billion with IPO pricing becoming increasingly weak towards the end of the year. According to Securities Data Company: "In December, not a single IPO was priced above the high end of its original filing range, the weakest monthly period for several years".

Evidence of current sentiment will be the response to the planned $30 million offering for Verisign, lead-managed by Morgan Stanley. The issue for the company, which sells the technology to authenticate internet sites and data transfer, is due in the next couple of months.

What one banker describes as the "schizophrenic" approach to high-technology stocks makes it harder to predict overall volumes for the year but anything less than a 10% to 15% drop would mean the market has performed better than expectations.

Says one US banker: "Last year the window was wide open and you could do virtually any deal. This year the secondary market won't roar ahead by 25% to 30%, and you will have to have a good story to tell about a company wanting to do an IPO and they have to be able to present a quality management team. The focus of activity will be end-driven and probably consolidation-related."

Comments another: "I am cautiously optimistic that 1998 will be a good year. It won't be as robust as 1997 but then we had the wind at our back with every possible economic indicator in our favour. It cannot possibly be as robust this year."

Further tests of the breadth of market interest will be provided by the reaction to issues this month or March for Waddell, Reed Financial and cookie manufacturer Keebler.

A further complication in assessing volumes for 1998 is the growing trend towards rapid-fire equity issues through block trades. By definition these are announced and completed in a very short period. "This trend started last year and we think it will continue for the coming months," says a banker. "This saves on cost, not so much in the gross spread but in marketing prospectuses and in management time. There is a real cost to companies to have their management on the road for two weeks when there are such pressures to perform."