Equity capital markets bankers are fearful for the rest of the autumn IPO season after two deals in London left a sour taste in the mouth. The usual "it's deal-specific" mantra is being repeated by syndicate bankers desperate not to taint their own pipelines by association, but not everyone sounds convinced.
Peer-to-peer lender Funding Circle was the smaller of the two offers, at around £440 million before the greenshoe. Global coordinators were Bank of America Merrill Lynch, Goldman Sachs and Morgan Stanley. By the afternoon of October 5, one week after pricing and three days after unconditional trading in the stock began, the shares were some 23% below the IPO price.
Luxury carmaker Aston Martin's deal was for £1.8 billion, but was entirely secondary shares. More than two-thirds of Funding Circle's deal was raising new money. Aston shares go unconditional on October 8, but since conditional trading began on October 3 the stock has fallen 9%. Global coordinators were Deutsche Bank, Goldman Sachs and JPMorgan Cazenove, but there were a further eight banks below them.
"It's clearly not good for sentiment," said one banker close to the Funding Circle deal. "No one is chest-beating here and saying what great multiples they got for the companies, but I do think this is quite specific. It’s unusual to get one deal where there are such wildly varying valuation views, let alone two in the same week."
"No one is chest-beating here and saying what great multiples they got for the companies"
That point was echoed by bankers close to, and away from, the two deals – that it was possible to look at both stories in a similar light, in that in both deals investors felt able to make credible arguments that they were worth top multiples, alongside a name like Ferrari in the case of Aston Martin, or big internet platforms in the case of Funding Circle.
But not everyone.
"The problem was that there were also plenty that thought Aston should trade like Peugeot and that Funding Circle should be closer to Lending Club," said the banker.
There were plenty of investors willing to commit orders well within the narrowed ranges. Funding Circle compressed its original range of 420p-530p to 440p-460p, before pricing at the bottom of the revised range. For Aston Martin, the change was from £17.50-£22.50 to £18.50-£20.00, and it priced at £19.00. Both books were comfortably covered at the final pricing, according to bankers, although multiples were not released. There was sensitivity, though: Aston Martin was comfortable at £19.00, said one banker, "but it couldn't have gone above that".
The first three months of 2017 was the first quarterly profit for Aston Martin in 10 years, and bankers admitted that it was a story that required great conviction – particularly as the company has embarked on a substantial capex investment in a new range of models. "You have to utterly believe in Aston Martin to be in that deal, otherwise you will really look like an idiot," said one banker away from the IPO.
Funding Circle was even more ambitious, pricing off 2019 revenues – a five times multiple, no less. Perhaps unsurprisingly, allocation was super-concentrated. About 85% of Funding Circle's IPO was sold to just 10 accounts, according to a banker at one of the leads, making it effectively a club deal – a decision taken in the interests of providing a stable, long-term shareholder base.
That might not have worked out as intended. That banker thought none of those accounts had exited yet, but also conceded that one would expect the risk manager of even the most committed investor to request a position reduction in the face of a double-digit fall.
Was the club-like nature of the deal a factor? "I have been sceptical for some time about something that people describe as a virtue – the idea that the top 10 investors get X% of a book," said one banker away from both deals. "I think it puts a lot of risk on it. If one fund bins the lot, and another follows, perhaps 20% of your book just disappears."
The broader point may have been the limited audience for such a story in the first place. "The issue with Funding Circle is that it is a concept stock, so there's no natural underpinning," said a banker at one of the firms involved in the deal. "You've got people shorting it, it's basically a club deal, and as soon as someone sells out it goes down. People won't stick around then."
Funding Circle actually opened up on its first day of conditional dealing, on Friday September 28. "I don't think you can say it was mispriced – there is just a lack of depth in this market," said the same banker, who added that the subsequent poor trading performance had been a surprise. "Yes, there is a limited audience for it, but people believed in it. The performance was not predictable."
"I don't think you can say it was mispriced - there is just a lack of depth in this market."
In time-honoured fashion, bankers away from both deals were quick to express bafflement at how those close to the deals could have misread investor intentions so badly.
"It is difficult for me to understand how a group with a quirky concept goes around to meet investors who get sufficiently comfortable to place an order and then on the first day they sell at 10% less," said one. Bookrunners, for their part, preferred to argue that it is perfectly possible to love an IPO at the offer price and not love it when it starts to fall in the aftermarket – even though it is now cheaper.
Who will buy?
One manager at a big investment firm agreed that one problem Funding Circle was always going to have was the limited buyer base. "You've got UK funds, of course, but it's not really even a fintech," he told Euromoney. "You had to believe in the business model. Part of the reason that we didn't get involved is that we think there are others that do a similar thing and also that we don't know what will happen through the cycle."
Ultimately, both deals suffered from requiring unusual conviction – and the fact is that many names could just sit them out and wait for the dust to settle.
"I am sitting here looking at piles of research and thinking about why people do IPOs," said the same investor. "They are good reasons generally – they don't just do them on a whim. But then you think about the need for people like us to invest in them. There is a world of stocks out there that we know a lot more about."
There was little doubt that Funding Circle was additionally hurt by short-selling – and that this is a greater risk on IPOs where pre-deal investor education throws up such diverging views. The peculiarity of the IPO book-building process is that the only way for a non-believer to express their view is by not participating, but as soon as the stock becomes available, that view can be played out in real-time through borrow.
"I don't want to overplay the shorting point," said one banker close to Funding Circle, "but you saw little volume in the first couple of days of conditional trading, and then the day before settlement, when borrow became available, it went down hard."
Another banker lamented the fact that some investors were ever comfortable lending out stock immediately on completion of an IPO. "I was speaking to one investor who told me that it was their internal policy not to do so for the first three months of trading, and it's quite interesting that people are thinking that way," he added. "It only takes one, though, and it's the same story as with borrow generally: 'If I don't do it, someone else will.'"