Following the Covid-19 economic rebound, markets have seen elevated levels of takeover and IPO activity.
Much is often made of the timing surrounding an IPO and the idea that there is an optimal time to list a business – the proverbial ‘IPO window’. But the reality is that many companies will consider going public at some stage and will have to weigh up much more fundamental questions than just timing and valuation, such as the reasons for listing in the first place.
Delegates at Investec’s recent IPO Conference heard from the CFO of Dr. Martens, who recently went through the IPO process, the CEO of Ceres Power on the benefits and challenges of life as a listed company and Gervais Williams, Head of Equities at Premier Miton on what he looks for in a company coming to market. They discussed having a strong rationale for floating, summoning the energy for the process, building relationships, and preparing for the scrutiny of plc status.
Hanging in the balance
With equity valuations hitting record highs during the latter stages of the pandemic, it is no surprise that IPOs have raised more money in the second quarter of 2021 than in any quarter over the last 20 years. However, Head of UK Equity Strategy Roger Lee said multiple layers of explanation are needed to fully understand what is driving this.
Inevitably, noted Lee, there was an element of pent-up demand from companies that delayed an intention to float or Private Equity delaying their exits due to the pandemic and until there was greater clarity about the future of UK-European Union relations after Brexit. However, Lee pointed out the unprecedented valuations achieved by recent IPOs can only be explained by the current ultra-low interest rate environment.
The current valuations of IPOs are unprecedented in the context of previous IPO cycles.
The final element, Lee said, is success breeding success. He noted that strong post-IPO performance for many recent IPOs fuelled a virtuous circle of listings at record valuations.
However, Co-Head of Corporate Broking & PLC Advisory Bruce Garrow pointed out that the number of IPOs initiated in the current cycle – now just above 260 – pales compared to more than 1,000 seen in the mid-2000s. According to Garrow, the market is now in a relative state of equilibrium.
As storm clouds gather around supply chain issues, the end of the UK furlough scheme and the possibility of rising interest rates, he said the quality of companies seeking a listing would need to be higher to gain access to capital markets. While a number of recent IPOs have been well received, he warned that not every listing is a success.
Lessons learned from listing
Companies choose to go public for various reasons, but the most common are to raise capital for future growth and/or to provide a liquidity event for shareholders. In the case of iconic British brand Dr. Martens, the business was already cash generative, but it was owned by private equity group Permira. By definition, private equity capital is short term in nature, and there was always going to be a planned exit, explained Dr. Martens’ Chief Financial Officer (CFO) Jon Mortimore.
After exploring a trade sale and a private sale, which were paused at the onset of the pandemic, Mortimore said the company began to consider an exit through public capital markets. Upon reflection, he said the business concluded permanent capital and democratic share ownership offered a much better economic value and sat much more comfortably with the business’ brand ethos.
Permanent capital and democratic share ownership offered a much better economic value and sat much more comfortably with our brand ethos.
Despite having spent more than 30 years in finance, working for an array of high growth businesses, Mortimore admitted the IPO process was the hardest and most intense work he had ever done. Appreciating the level of work that would be required, one of the best things Mortimore said he did was solicit help.
Early on in the process, Mortimore appointed a deputy CFO. With all the banks, lawyers, advisers, investor relations and public relations officers involved, he said two brains were better than one to divide and conquer. Due to the all-consuming nature of the IPO, he was spending 95% of his time on that and needed a good team below him to continue running the business.
Don’t be shy in recruiting and upskilling your team.
Indeed, if well managed, Mortimore said the IPO process could be fun: “It’s fun being challenged and questioned. It hones your thinking and stress tests the company strategy. I really did enjoy the process.”
Communications with your investor base is the most important thing you can do – provide clear and concise messaging around your ESG targets and progress
The IPO is just the beginning
Clean energy pioneer Ceres Power was listed on the AIM market in 2004 with a market capitalisation of £66 million. Now, at more than £2 billion, the company is considering moving onto the London Stock Exchange's Main Market.
Reflecting on the company’s listing, Chief Executive Officer Phil Caldwell noted that the benefit of being listed was, first and foremost, the speed of access to growth capital.
Their listing provided the platform to raise capital quickly, both allowing the business to pursue its growth trajectory and helping stabilise the business during periods of volatility. In addition, Caldwell noted that the cost of capital on public markets is lower than at the early stages of private equity investing, where backers search for a higher risk premium.
Caldwell added that public markets could also act as a retention and incentivisation tool for staff, citing the company’s stock options and save-as-you-earn plans. “Being listed enables our people to share in the upside and the success of the business, which is really important in a high-growth purpose-led business,” he said.
Being listed enables our people to share in the upside and the success of the business, which is really important in a high-growth purpose-led business.
Over the longer term, Caldwell shared another important aspect of being listed – building credibility with local and international partners. “Having a long-term view of the company’s valuation and its progress gives investors confidence,” he said.
Reflecting on the evolution of the company’s share register, Caldwell said there had been a natural transition from a smaller number of initial backers, mainly composed of private equity and hedge fund groups, to a wider group of mainstream institutional investors. “You have to keep on transitioning your share register. Most of our initial backers have exited and done very well out of it. We have managed to replace them with different types of investors with different expectations of risk and return as the company has matured,” he said.
Garrow explained that about 70%-80% of initial investors tend to be from the home market for small and mid-sized companies listing in the UK, with about 10% in the US and the balance in Europe or elsewhere. As Ceres’ profile has grown, it has expanded its shareholder base in Europe, the US and Asia – unlocking new growth areas.
Indeed, Caldwell emphasised the importance of interacting with investors. While he admitted this requires a significant commitment – implementing reporting, roadshows, analyst/investor meetings, capital markets days, site visits, broker/industry conferences – it gives investors confidence in the company.
Due to the amount of work required and the increasing importance of environmental, social and governance (ESG) disclosure, an investor relations function is essential, said Caldwell. As the company grows over time, analyst coverage tends to increase, which can alleviate some of the responsibility of communicating financial and ESG information to investors and markets.
ESG is essential
Alicia Forry, Head of UK Equity ESG Products, explained that ESG investing is becoming an integral part of public markets, driven by regulation and demand from asset owners. Indeed, more than $121 trillion in assets is held by signatories of the UN Principles for Responsible Investment, including nearly all major UK institutional investors.
ESG disclosure is also becoming the norm within the public markets, with 71% of FTSE350 companies disclosing an emissions reduction target in 2020 and 78% stating a corporate purpose beyond shareholder profits. Increasingly, it is also becoming an important topic of discussion at the IPO stage.
For companies looking to get started, Forry shared a list of practical tips. First, look at your business, the industry it sits within and determine the ESG risks and opportunities. Second, decide where the responsibility for ESG progress lies. She recommended it be a board-level position – someone who is senior and able to speak regularly with investors.
Third, choose a suitable framework for disclosure, such as the standards set out by the Global Reporting Initiative (GRI) or Task Force on Climate-Related Financial Disclosures (TCFD). Fourth, appoint someone – internally or externally – to coordinate the data gathering. Fifth, prioritise which third party score provider the company will engage with, as the applications are time-consuming, but the result will be important for investors.
Communication with your investor base is the most important thing you can do – provide clear and concise messaging around your ESG targets and progress.
Finally, decide how you will communicate progress on ESG matters – whether this will be integrated with financial reporting or involve a dedicated sustainability section on the website, for example. Forry said: “Communication with your investor base is the most important thing you can do – provide clear and concise messaging around your ESG targets and progress.”
Ultimately, Forry said investors want ESG considerations to be embedded in the overall strategy of a business. They are looking for clear targets and disclosure to hold the company to account. Preferably, targets should not be too long-term, and ideally, they should be linked to management incentives.
More than meets the eye
The word on everyone’s lips at IPO is ‘valuation’. But Garrow explained it is not about maximising valuation; it is about arriving at the right valuation.
While market context and economic events can certainly influence the valuation of a company coming to market, a lot of it comes down to the quality of the business, said Garrow. He explained that investors are looking for companies with a resilient and differentiated business model operating in a strong market with underlying growth dynamics. A strong management team with a solid track record that can build relationships with investors is also crucial, as is transparency around metrics and the willingness to be judged against key performance indicators (KPIs).
To de-risk the IPO process and gauge investor interest ahead of time, Garrow outlined the importance of running test marketing. “Because of all the work and the cost that goes into planning for IPOs, it is important that valuation is pitched correctly, at the appropriate time and is cornerstoned by investors ahead of time,” he said.
The first stage of the process is called pilot fishing and involves about 10-20 investor meetings with the company management team roughly three to nine months before the IPO. Following this initial phase, the pre-deal investor education sees analysts speaking with about 50-70 investors. Then comes the IPO roadshow, when company management engages once again with investors.
It’s not about maximising valuation; the quality of the book and the aftermarket are absolutely fundamental.
Following the roadshow emerges a valuation range and cornerstone investors, from which the bank can start building a book of demand. “We give preference to quality names that come into the book early, with a definitive order. We don’t want to build the book around investors that come in on a ‘hot deal’,” Garrow said.
In addition, Garrow stressed the importance of allocating an optimal amount of shares per investor. If an order is too large, this could discourage an investor from purchasing more once the company has been listed. To this effect, he said an IPO is an art, not a science.
Finally, reminding us that “an IPO is for life, not just for Christmas,” Garrow explained it is important for businesses to realise that although some investors will exit at the IPO, it is the beginning of a journey upon which many will look to make money in the medium term.
It is important to recognise the journey starts at IPO; it doesn’t end there. For the majority of investors, an IPO is just the beginning.
Appealing to investors
Offering the perspective of the investor, Gervais Williams, Head of Equities at Premier Miton, reflected on the importance of participating in IPOs: “As fund managers, we need to be open and alive to new opportunities. The nature of companies which are well-positioned for the future varies over time. If you stick with your winners, you will find the world will pass you by.”
If you stick with your winners, you will find the world will pass you by.
He explained that quoted companies could evolve more rapidly due to their ability to raise capital quickly, responding to changing customer behaviours and the evolving landscape, particularly climate change.
When selecting IPOs to participate in, Williams said he looks for companies with upside potential. While there can be differentials between the valuations of companies coming to market and their listed peers, he said as long as the difference is not too large and the price is fair, the process can begin, whereby the company can raise additional capital to deliver further growth.
At the top of Williams’ list are companies with good commercial prospects and the ability to generate cash. An easy way to gauge business resilience, he said, is through a company’s customer service – as this indicates how attuned the management team is to what is happening on the front line.
In addition, Williams said he looks for businesses operating with integrity, with a surefooted management team that is clear about the purpose of business and its reason for listing. For example, having a social agenda regarding climate change helps companies attract customers and retain staff. It will be an important feature for the long-term reputation of the company.
Asked about the famous “IPO window”, Williams acknowledged there are times when it is easier to raise capital – particularly when the market is buoyant – and companies should avoid seeking a listing in holiday periods. However, he said most of the time, the opportunity is there.
My view is that we will see more listed companies in the UK stock market in the next ten years than we have currently.
While private equity has been prominent in recent years, Williams argued that public markets would become more popular in the future due to increasing debt levels, slowing growth and rising margin pressure. “My view is that we will see more listed companies in the UK stock market in the next ten years than we have currently,” he said.
He believes the long-duration growth stocks that have led the US market to new heights will find it harder going forward and income stocks will become more popular. In this case, he said the UK market, which is home to companies with more surplus cash, could be in a good position to outperform.
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