That makes them a good story; and in bull markets, at least, good stories mean rising stock prices and good returns. If ever a market demonstrated these simple truths, it was the domestic US market in 1995. As American investors rediscovered the delights of investing at home, there was more than enough money available for those new issues that caught their attention. Neil Stewart looks at the various elements of an IPO, including pricing, valuation and the all- important roadshow; and profiles the strategies and inner dynamics of four of last year’s IPOs: Gucci, Boston Beer, Borders Group and Tele-Communications International.
The recent flood of American IPOs is being called everything from madness to mania. And, to be sure, there seems to be no stopping the new issuance flow as it rides the bucking bull market.
With companies eager to take advantage of strong PE ratios, and investors scouring the horizon for the next Netscape, Americans have turned their trading screens homeward in search of fair value.
‘We did a good job of cleaning up the calendar,’ says Ernesto Cruz, managing director and head of equity capital markets for the Americas at CS First Boston, a leading IPO underwriter. ‘The pace is starting to build again, and we expect a pattern similar to last year, with a heavy inflow from most economic sectors, including privatisations, which will be a big driver in the second half. In the end, the story is clear. Investors are always on the look-out for a new and exciting story, and that’s exactly what IPOs are.’
The numbers are staggering. Some 565 IPOs raised almost $29 bn in 1995, according to Securities Data Co. About $12.4 bn was raised in the fourth quarter alone, outstripping the record set by fourth quarter 1993, which boasted $10.1 bn.
Institutional investors seem to have an enormous amount of cash available for stories they like: witness the fact that Lipper Analytical Services now tracks 638 growth-oriented funds likely to buy new issues with $287 bn in assets. That compares with just 167 funds in 1980, with $16 bn in assets.
Of course, there are losers as well as winners in the IPO sweepstakes, with the latter camp epitomised by those who bought into Netscape early in its listed life. Investors glow whenever Netscape is mentioned, remembering the first day of trading when the stock shot up 108 per cent. The IPO gave Netscape’s outstanding stock an immediate valuation of $1.1 bn, a figure that has soared to $5 bn since then; and its stock is currently trading at over 400 times projected earnings for 1996.
Silicon Valley alone had 68 offerings in 1995, a rate of 1.3 a week, beating its 1993 record of 57 IPOs. Nationwide, a record 215 technology companies raised $8.6 bn.
International issuers took their share of the spoils, too. Italy spawned the largest cash offering ever with the $3.95 bn privatisation of energy company Ente Nazionale Idrocarburi (Eni). Meeting 800 institutional investors on a frenzied roadshow, Eni’s pricing was steered home in November to a warm reception.
Back in North America, investors are less happy with Canadian National Railways. With its offering price twice boosted before the IPO, and lauded as Ottawa’s best ever spin-off, CNR dropped like a stone to close the year some 25 per cent down.
Nor are fund managers pleased with the Asia Pulp & Paper issue, one of the first Asian ADRs of the year at $310 mn, which tumbled over 29 per cent during 1995.
Pricing Imprecision
When it comes to pricing, bankers are second-guessed all the time. Valuation is one thing, but investor demand during the bookbuilding period is quite another. The pundits are agreed that the heart of an IPO is the roadshow, and the prospect is one that inspires both dread and excitement among management. Investment bankers scoop them up, turn books inside out, dictate value and target investors. This less than delicate process often yields to unexpected pressure.
In the second-half boom of 1995, many deals were brought in way above the filing range, and still soared in the aftermarket. Some would argue that Netscape was a clear loser from the pricing process. The company, which expanded its offering from 3.5 mn to 5 mn shares, and twice raised its price from the $12-14 range to its opening price of $28, saw its stock shoot as high as $71 on opening day.
Did company founders, newly-minted multi-millionaires as they are, kick themselves for following the bankers’ advice about price? Can those bankers really claim to have displayed good market knowledge and judgement in their pricing of Netscape?
In practice, appropriate pricing is always a thorny issue and at its most tricky with high-growth, high-tech companies. If they are priced too high, the company may never get its start. Some would even argue that Netscape’s success was attributable – at least in part – to the wide investor interest on its first day of trading. Others would claim that its peers were underpriced. But all would agree that a rising stock price is good news for shareholders and companies, whatever the issue price. Investors see great returns, while a company’s balance sheet brightens with access to capital.
As opening day approaches, the art of pricing takes on added importance. Ernesto Cruz acts as an intermediary between the bankers and sales force in the pricing of issues, managing demand that develops during book-building. Orders come in to CSFB’s computerised book, and when there is enough demand to price a deal, Cruz balances prices with orders.
When judging allocation, Cruz looks for ‘good accounts’ that will buy more in the secondary market, as opposed to ‘bad ones’ that flip stock as soon as there is an uptick. ‘We comb through the book and present the best possible alternative to issuers,’ says Cruz. ‘On that basis we recommend a price that will clear the IPO and allow for a secondary market trade-up.’
The process is a balance of fundamental valuation and investor demand. ‘Not all stocks are born equal,’ notes Cruz. ‘Small cap, modest growth stocks are valued at a discount as they are perceived as illiquid and riskier. Fewer investors are interested and we need to develop demand.’
When pricing is concluded the lead manager and syndicate stand by the valuation. Under SEC rules, they can support price by buying stock in the aftermarket to protect the stock price against zealous sellers.
Another important aspect in the IPO process is the prospectus. ‘The art of prospectus writing has evolved along with the boom,’ says Gerald Lodge, a managing director of investment banking at CS First Boston and a veteran of capital raising and M&A deals. ‘The first pages are important, summarising strategy and merits in a way a fund manager can understand. It’s a balance between positioning and making sure investors have data – whether information is positive or negative. For some companies, the prospectus is helpful in finding and defining strategy. It does not have to be boring.’
In an increasingly institutional market, the heart of the marketing of a new listing is still very much the roadshow. ‘The sheer power of institutional assets means investors have to meet with the management before they can put numbers in front of orders,’ says Lodge. ‘The rubber really hits the road in one-on-one meetings.’
The typical IPO roadshow lasts two to three weeks and is an arduous trip through 10-15 cities, sometimes taking in three stopovers in a day. Group meetings feature formal presentations, slide shows and Q&A sessions. These are bracketed by 30-40 private sessions with institutions, with anywhere from one to 15 fund managers in attendance. To deal with the load on international issues, sometimes two teams take to the road to cover different continents, helping keep management fresh.
‘We are believers in practice,’ Lodge says. ‘Management teams may resist, but we get them to sit with us in mock interviews to prepare for investor grilling. Some are experienced in meeting with investors, though IPO teams have a wide variety of skills and comfort levels. Our aim is to make sure they give clear responses to any question – and there are hard questions out there.’
But, notwithstanding the gruelling roadshow schedule, endless rubber-chicken lunches, bleary-eyed breakfast presentations, and intense one-on-one meetings, Lodge believes there are few situations more enjoyable for management than seeing investor interest in an IPO growing as they do the rounds. ‘In a successful IPO,’ notes Lodge, ‘management and owners get a fair price for their stock and investors get good stock performance in the secondary market. It is a rare moment when everyone is happy.’
Though roadshow communications are handled by bankers under strict disclosure requirements, Lodge says IR staff are integral. In many of the IPOs handled by CSFB, an IRO travels with management, attending meetings and preparing presentations. Lodge adds that while glitzy presentations have become the norm for IPOs, traditional slide shows with succinct charts and graphs are what institutions really want to see.
As bankers are out pounding the pavement with management during the roadshow, securities sales people are burning up phone lines looking for the right investors. Which investors are selected depends on the investment profile, knowledge of the company and an understanding of the institutional investor appetite.
‘There are value, yield, growth, cashflow and momentum investors to be sifted through, all of which have varying tastes in management style,’ says Lodge. ‘It’s a delicate interplay between bankers, the syndicate and the sales force.’
And at the end of the day, when the bankers have gone home, there is still no rest for management. As one veteran puts it, companies need to remember that the IPO is just the beginning. ‘There is life after listing,’ he says.
Another veteran of the business echoes this sentiment. ‘The honeymoon following an IPO doesn’t last forever,’ says Carl Thompson of Carl Thompson Associates, an investor relations firm specialising in the small cap IPO market. ‘In fact, that’s when the next battle starts. A public company must begin cultivating new relationships with analysts and institutions right away to pick up the slack as momentum investors move out of the stock.’
International Cable Play
The shuffling of communications and media businesses was unrelenting in 1995 as investors grappled with deregulation, convergence and globalisation.
The management team at Tele-Communications Inc, John Malone’s mammoth cable operator, has been working overtime on a reorganisation aimed at giving investors access to unique assets without the baggage of other operations.
‘We needed separate securities for each business and greater managerial focus, flexibility, and investor orientation for each market segment,’ explains Steve Smith, director of IR at TCI. The reorganisation plan, announced in 1994, splits TCI into three units – cable and new technology, programming, and foreign operations. Each now has its own class of stock tied to performance.
The first step was the spin-off of Tele-Communications International to handle foreign operations in July. Some 18 per cent of the new unit was sold in a $320 mn IPO. After a couple of months languishing around the issue price, the IR message clicked and analysts started covering the stock. Tele-Communications International took off to close the year up 42.2 per cent.
Graham Hollis, CFO of the new unit, says the valuation took months of dialogue with Wall Street. ‘We exchanged models, looking at the group of assets, revenues and earnings potential,’ says Hollis. ‘There was a degree of subjectivity because the business is so forward-looking. In the end, we gained a good understanding, and were left with the challenge of getting the message out. We were a discounted cashflow story going into a momentum market – not what IPO investors were looking for. The roadshow was crucial as we had to tell the story behind the deal.’
With lead manager Merrill Lynch, Hollis visited more than 20 US and European cities in a fortnight, meeting some 50 institutions in one-on-one meetings. Overseas investors finally took around 15 per cent of the offering. ‘It was a bonding experience,’ Hollis says. ‘Management never tires of telling a good story. Still, we were surprised how much education investors needed about the new look of international cable.’
The management team decided to use its presentations to set itself apart, using a high-powered computer with CD-Rom. Slides, video and audio were presented seamlessly, underlining the company’s communications strength to investors.
But along the way, Hollis and his team realised that the company’s financials were only telling half the story, so they bunkered down with the Merrill Lynch crew in mid-roadshow and designed benchmarks to measure the business in key markets. They then promised to report on these to investors every quarter. Hollis points out that these unique benchmarks are improving communications with shareholders, and raising the company’s credibility.
Hollis may have fond memories of the roadshow but he doesn’t deny it was tough. ‘Investors were exhausted by the activity in the media business last year,’ he says. ‘They had to pay extra close attention to us. Our play is more subtle than Disney.’
Boosting Boston Beer
A taste for beer is an uncommon component in the list of investment criteria. It’s even more uncommon to market an IPO with six-packs and a toll-free number. But that was the approach taken by Boston Beer Company Inc for its IPO. The company sold 990,000 shares to its beer-drinking customers for $15 each in 33 share allotments, $5 less than its regular IPO of $20 for 3.5 mn shares. Lead-managed by Goldman Sachs, with co-underwriters Alex Brown & Sons, Hambrecht & Quist and Advest, Boston Beer listed on the NYSE under the symbol SAM, a reference to its flagship Samuel Adams brand.
Some $75 mn was raised by the microbrewer. ‘Customers who liked our beer jumped on the opportunity to become shareholders,’ says Ed Block, an independent consultant handling IR for Boston Beer. ‘People liked the idea of framing their share certificates and putting them up next to the liquor cabinet.’
The response by Boston Beer drinkers was overwhelming, with 145,000 applications for the 30,000 subscriptions available. The regular tranche was bought mostly by institutions, and Block is currently working with Chemical Mellon to identify its new shareholder base. Meanwhile, a staff member has been hired to solidify the company’s relationship with its new customer/shareholders.
During the two-week US roadshow, CEO Jim Koch had to persuade investors to buy into a beer company at a time when beer drinking in America is on the decline. Yet microbrewers, which have 2 per cent of the business in the US, are growing rapidly; and Boston Beer is the largest of these, with a sixth of the market. Koch plans to boost his share of the total beer market from 1/400 to 1/300: ‘We want to go from invisible to infinitesimal,’ he says.
Koch, a former management consultant and fifth generation brew-master, drove Boston Beer’s rise to the top of the heap writing off-beat radio spots himself. ‘At lunch meetings on the roadshow,’ recalls Block, ‘Koch would finish off his speech and hoist a Sam Adams. He is devoted to the product, which proves American beer can be as good as imported brands.’
Though an early prospectus priced the stock between $10 and $15, bankers settled on $20 for opening day. Trading opened at $26, shot up to $32, and is currently in the $23 range. ‘The folks who bought in at $15 are sitting on a nice little profit,’ notes Block. ‘Our aim now is to get them to increase their stake.’
Another challenge for Boston Beer is persuading investors that the company can grow while keeping its microbrewer status. ‘It’s a quality-quantity issue,’ says Block. ‘Quality is our first priority, and our goal is to grow while keeping production facilities small. We pride ourselves in taking customers back to pre-prohibition days when beer was hand-crafted.’
Crossing Borders
Books? With the rage of Wall Street centred on vaporous, venture capital-backed Inter-net plays and movie house mergers, the basic bookstore may seem a dying breed. Surprise: the business is booming.
Book superstore Borders Group, unchained from ailing discount retailer Kmart in a May 1995 IPO, recorded 1995 sales of over $1.8 bn, earnings growth of 28 per cent. Capitalised at $800 mn, Borders is making it clear to investors that books are a growth play.Kmart originally planned to retain 48 per cent of Borders but ended up selling all but 13 per cent for $521 mn. Later in the year Borders bought up the remaining stake from Kmart. Priced by lead manager Goldman Sachs at $14.50, Borders attracted coverage from nine analysts and edged the stock over $18 by year-end. The group consists of three chains: Borders Superstores, Planet Music and Waldenbooks, America’s number one mall-based bookstore chain.
Patrick Moore, manager of group planning and resource management at Borders, joined the company a month before the IPO, together with Rick Vanzura, vice president of the unit, to get its investor relations off the ground.
‘Borders built its IR from the ground up,’ Moore says. ‘First on the agenda was attending to the underwriters’ analysts. It was important they had all the information needed to initiate proper coverage. At the same time we set up the mechanics for retail investors to get materials.’
Vanzura and Moore’s mandate was to play the first year close to the vest. In 1996, they plan to spend more time shopping the Borders story. Apart from the roadshow, the Michigan-based company has done no travelling to brokerage conferences or analyst meetings. ‘We specifically did not hype the stock,’ Moore says. ‘We wanted to have several quarters of meeting and beating Wall Street estimates. We are letting the company’s performance speak for itself. As a medium cap, the stock will only move well if we perform. Basically, we let sell-side and buy-side analysts do their work while manning the phones to give any information they need.’
While gearing up for an IR push this year, Vanzura and Moore keep busy tracking news and analyst coverage. They tap into First Call analysts’ notes every day and get news and stock quotes off the Internet. ‘News is of a premium in the securities marketplace,’ says Moore. ‘As soon as our stock budges, we get calls from brokers, institutions and individual investors. We constantly track analysts’ comments and models to ensure there are no errors or ommissions. We stay tuned all the time.’
One of the first lessons for the new Borders IR team was that its stock moves drastically in response to changes at its main competitor, Barnes & Noble. ‘It was a challenge to explain that we have a different company, format and strategy,’ says Moore.
Italian Fashion Hits NY
One of the star IPO performers of 1995 burst out from an unlikely quarter. In amongst October’s spate of Silicon Valley issues was Gucci, the stately and more than a little tarnished Italian fashion house. Disregarding a history of scandal and murder, investors bought into the offering wholeheartedly, sending the stock soaring nearly 80 per cent by year-end.
‘It was great timing,’ says Lynn Morgen of Morgen-Walke Associates in New York, the IR firm engaged by Gucci shortly after the IPO. ‘Investors saw the opportunity to buy Gucci just as the business was turning around, but before it had fully benefited. Moreover, luxury companies were outperforming discount retailers in the market.’Founded in Florence in 1923, Gucci exemplifies the globalisation of markets. The IPO was a dual listing on the New York and Amsterdam stock exch-anges, with lead manager Morgan Stanley working out of London to raise $620 mn for Investcorp, the Bahrain-based investment group which took control of Gucci back in 1993. After a ‘green-shoe’ over-allotment option, the offering amounted to 28.18 mn shares or some 48 per cent of the equity.
Gucci’s international pedigree was enhanced by a management team that led the two-week roadshow to key European and US cities. CEO Dominico Desolay and CFO Robert Singer are astute individuals, clued in to US investors.
‘The challenge was the lack of a US peer-group,’ says Morgen. ‘All the major luxury goods companies are in Europe and US investors couldn’t compare Gucci with a known category. They were asking questions as though Gucci was Nieman Marcus but that comparison does not hold. Also, while the brand is known, the connotation is one of family feuding. Investors had to be made aware that there are no Guccis in Gucci anymore.’
While European investors posed questions pertinent to the sector, US investors sought to compare Gucci to The Gap, the popular mid-market clothing store, asking how many new stores would open this year – hardly an issue for Gucci.
Basically, the roadshow message was the restoration of the quality of the brand and the opportunity for growth. Morgen points out that at the time of the roadshow, Gucci was number one in brand recognition in the luxury goods sector, but number five in terms of its sales.
When the final tally was in, the offering was bought half in Europe and half in the US. ‘Europe really understands this category while the US does not,’ says Morgen. ‘Our IR programme is sensitive to that, though both groups of investors are kept informed in a balanced way.’ Morgen-Walke is handling the account out of New York as well as Paris, where the firm recently opened an office. Meanwhile, Gucci has hired an IR manager to take charge of in-house operations.
Reporting methods have helped Gucci. Although listed on the NYSE, it has opted to do semi-annual earnings announcements but has promised investors that it will release sales figures every quarter. And Morgen notes that the stock really took off after a conference call with US and European investors in early December to announce sales for the quarter ending in October.
