As new investors rush to ECM, sponsors and sellers rush to sell equity post-Fed cut – ECM Pulse EMEA
Summary
- Huge issuance levels driven by investor appetite, new money
- Concerns about sustainability of a crowded market arise
- Macro headwinds remain a concern
A remarkable uplift in risk appetite among investors is driving sponsors and equity sellers to print deals after the US Federal Reserve’s decision to lower interest rates has driven even more investors into the equity capital markets. But, there are fears that sellers may misread a hot market and push out bad trades.
The first week of October was a remarkable one with issuance worth around USD 11.7bn, almost the same as the entirety of September, which was by no means a bad month for ECM deals.
On October 2, German academic publisher Springer Nature [ETR:SPG] priced its EUR 600m IPO at EUR 22.50 a share.
A mega sell-down of EUR 2.4bn in Haleon [LON:HLM] sold by Pfizer [NYSE:PFE] was leapt on by institutional long-onlies, alongside existing shareholders, looking to grow their holdings, according to reporting by this news service.
The huge overnight trade was followed by a mammoth EUR 5bn placement in DSV [CPH:DSV] to part-fund the acquisition of Shenker, the logistics unit owned by Deutsche Bahn.
“It feels like there is a much better feel to the market than we thought there would be in early September, when we all thought things were going to be super difficult,” said an ECM banker. “But the cut in US interest rates and the positive outlook for markets is making investors focus on the opportunities that are coming to market.”
Thankfully for the market, deals have, largely, worked. On the first day of trading for Springer Nature, October 4, shares jumped EUR 24.41 each just after midday, around 8% above the IPO price, they closed at EUR 24.22 each.
Blocks have also largely traded well, with deals priced from the start of September generating an average return of around 2.5% for investors from offer-to-current price.
Source: Dealogic
Beat the index
Investor interest in equity capital markets has built throughout the year, as investors begin to see it as a method to bag fast returns, allowing them to compete against high performing benchmark indices, largely driven by a small basket of stocks, particularly in the US.
This is because ECM deals are not just brought to market at a discount, the exposures available to investors are differentiated from the general index, meaning that those that do take a punt in can generate outsized, and different, returns to index funds at a time where active investors still suffer from outflows vs inflows to passive exchange-traded funds (ETFs).
A second ECM banker noted that conversations with his trading team show that active investors in European equities heavily are now focused on general equity capital markets alongside their analysis of underweight stock sectors, like luxury goods or mining, for example.
“It has been amazing seeing the huge interest in capital markets across the board,” this banker said. “We have far more demand than there is supply, you could probably do some of these huge multiple times over, and broadly everything is working.”
But equity capital markets are becoming more of a crowded trade, with several new capital markets desks appearing across the buyside, a theme that has accentuated throughout the year with the return of Europe’s IPO market and mega blocks like the DSV and Haleon trades.
This can lead to frustration, as sources note that many buysiders with newer ECM strategies, without a proven track record in capital markets are likely to get less stock in allocations.
“There are core groups of investors who dominate allocation, including three to five hedge funds who got outsized allocations, new entrants need to work out how they can get in that tier,” said the second banker. “Those funds work extraordinarily hard to maintain their relationships with banks and issuers and while every week there are more joining the ECM party, they can’t just turn up and expect issuers and advisors and corporates to just give them stock.”
However, the influx of new money might be giving a false sense of security to the sellside given that funds will inflate orders to try and ensure better allocations, meaning the quantum of demand for deals is not reflective of the real money wanting to buy it.
“I just think there is too much capital chasing these deals,” said an ECM investor from a more established player. “It gives sellers and banks a false sense of security when in fact what really matters is five or six real money investors, and proper fundamental hedge funds, chasing rather than a new ECM strategy at a fund that hasn’t played the capital markets before.”
If deals start to go badly and Europe’s core group of ECM investors decide to down tools or sit on their hands a little to let market froth subside, issuers will find pricing increasingly difficult, as was the case through much of 2022 when fundamental investors took a step back after chalking up losses in 2021.
Macro headwinds
Alongside the risk that fundamental ECM investors lose faith in a market that starts running too hot, global economics still poses a threat to equity capital markets issuance.
The US Federal Reserve has cut interest rates, in line with the European Central Bank and Bank of England, for the first time since 2020, but the general outlook for rates is uncertain.
According to CME Fedwatch, rates most rates trades foresee a target Federal Funds Rate somewhere between 325bp and 400bp, down from the current target of 475bp to 500bp.
If the US and other Western economies soften, then the rationale for accelerating rate cuts increases, but conflict in the Middle East, and its impact on global oil prices, will put pressure on central banks to hold on further cuts, given the possibility for inflation.
“The IPO market isn’t fully open yet,” said a third ECM banker. “We expect strong activity in 1H next year, though the floodgates aren’t open yet.
“Macro risks remain the biggest concern, but a soft landing is largely priced in. It’s now a matter of central banks versus the economy. Rates are expected to fall, but if they don’t, there could be a shock.”