Bigger not always better: IPO candidates urged to shrink deals to bridge valuation gap

Data Insight ECM Pulse 26 April

Bigger not always better: IPO candidates urged to shrink deals to bridge valuation gap

Easter has passed and Europe’s bankers are still debating whether to restart the IPO pipeline as investor fears over the wider economy and market volatility fuel heavy discounting. Deals can, however, get done should issuers revert to an old tactic – in tough times, reduce IPO sizes.

Markets appear to have stabilised after weeks of volatility following Russia’s invasion of Ukraine and there has been some block trade activity in the last month. However, investor sentiment is still negative and Bank of America’s most recent equity research predicts a 10% downside for the Stoxx 600, with slower growth impacting stocks across sectors.

This is playing into the IPO market, with buyers seeking hefty discounts to take on the risk of a new position in an unlisted stock.

Issuers understandably don’t want to sell their prized companies on the cheap and the valuation gap is keeping many from the market, but there is a way around the conundrum.

“I think before the end of May we are going to get a select number of “Intention to Float” (ITFs) announcements from the larger IPO candidates that people are willing to look at, but these deals may be smaller and cheaper than people expected,” said a senior ECM banker.

When the going gets tough

In early 2021, the IPO market was booming on the back of a rampant equities bull run with investors fighting to get into deals. By spring, the mood had changed after several deals floundered in trading, including the mammoth listing of Deliveroo [LON:ROO] in London.

Many investors turned away from the IPO market and issuers had to reduce valuation expectations to price transactions, pricing smaller deals in exchange.

The UK listing of Darktrace [LON: DARK], for example, was restructured to make the transaction cheaper and smaller. The deal consisted of a GBP 189m sale of just under 11% of the company, far smaller than the 20% owners Summit Partners and KKR had reportedly planned to sell.

Spanish energy company Acciona [BME: ANA] also had to take a valuation haircut on its sale of renewable unit Acciona Energia [BME: ANE], selling in the end just over 17% of the subsidiary to reduce the impact of the price cut.

There are a handful of European candidates that could kick off a listing process in the next few weeks, including Swiss skincare company Galderma, Europe’s bellwether IPO for 2022, the e-mobility unit of ABB [SWX: ABBN] and possibly Coca-Cola Beverages Africa, according to sources.

But issuance conditions are still difficult, even for the cream of Europe’s IPO crop. “It is still very tricky to get anything done and even these big IPOs coming need to discount valuation unless the asset is a unique one,” said an investor.  “To get people’s attention, you need to pull the lever on a smaller deal size on a valuation compelling enough to do the work. People need a carrot,” he added.

Darktrace was one of the best performing IPOs of 2021 and is still over 50% above the IPO price despite the wider sell-off that has hammered many other 2021 listings.

Reap the rewards

Dutch payment’s firm Adyen [AMS:ADYEN], perhaps Europe’s best IPO of recent years, was also a small float at 13.4% of the company. The stock soared almost 90% six months after its 2018 IPO and is now up almost 600% from the IPO price.

“I am a huge fan of bringing less to market at the right price,” said a second ECM banker. “If you are an owner or a management team who feel you have to undersell your asset to get a deal, I would say then sell a little and go out and prove yourself in the market which will then reward you, just look at Adyen.”

An argument against smaller deals is that they are less liquid, but the second banker and the investor both agreed that there is not much of a difference given European IPOs tend to be extremely illiquid anyway.

A third banker was equally enthusiastic about the idea of deals being smaller if they had to be cheaper. Darktrace, which priced at a time of heightened volatility and had to answer concerns over governance issues, should be used as a model for pricing IPOs at difficult times, the investor added.

But issuers need to make it clear they will be flexible on valuation early in the process.

“Coming with a lower valuation is one thing and you need to tell the market that the valuation expectations are going to be sensible up-front, nobody is going to do the work if that message is not being communicated from the beginning,” the investor said.

 It is up to sellers now to choose whether to be flexible or not.

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