Windows of opportunity

Takeaways: The IPO window isn’t closed entirely, but the bonanza is over. Investors are looking for a certain je ne sais quoi and keener pricing – open windows may also be limited in 2015. This opens up dual process or pure M&A opportunities – but HY borrowers should watch-out – it probably won’t get better than this. Although the first UK rate rise seems unlikely to come before autumn 2015, if the Bank of England is right and CPI lurks around 1% for most of the year.

When markets close the IPO door…

After such a frenzy of IPO activity in early 2014 –followed by some lacklustre outcomes – a pause was always on the cards. However, early autumn market volatility has pretty much brought about an all-stop in IPOs. Of the wave of around £7bn of IPOs expected after the summer break, only Jimmy Choo has chugged over the line. Has the IPO window shut in 2014 and what prospects are there in 2015?

We don’t think the window has closed entirely. There is still just about time for further action this year, if markets stabilise. However, investors have certainly adopted a more cautious, discerning stance that will carry into 2015.  Increasing geopolitical risks, diminishing global growth prospects and a changing capital landscape have led investors to think more carefully about the resilience of their investments. Investor reactions to profit warnings underline this shifting perspective – the median fall in share price is at its highest since 2011.

So investors will be looking for companies with elements that will set them apart from the crowd – and those lacklustre IPOs. Companies that are highly differentiated, with high growth, strong management, a good track record and realistic value expectations will still be attractive. However, the IPO bonanza is over. It’s not just that the capital landscape is different, 2015 will also have more limited windows for getting IPOs away. In particular, there is likely to be limited appetite in the run up to the General Election, particularly for companies who may be affected by regulatory changes or cuts to government spending. The recent changes to the annuity regime means investors could cast this net broadly. Appetite post-election will be result dependent; however just about every result we can think of could give investors reasons to pause.

…they can open an M&A window

What of those slated to float this quarter? Some may wait on the back-burner; however, the sale of United Biscuits at the eleventh IPO hour and of Siemens hearing-aid business has heralded the return of dual-process and the reopening of M&A avenues. Of course, a sale has always been an attractive option for investors seeking the surety of complete exit. However, IPO valuations were just too alluring until recent volatility brought increased execution risk. VSTOXX, the European volatility index (akin to the US VIX index) has fallen back from its mid-October peak of around 32, to around 20, however it is still well above its mid-summer lows of around 12. Some deals will get away, but recent pricing suggests this may be at lower valuations. Meanwhile, M&A valuations are picking up and corporate appetite for inorganic growth looks set to pick up as deflation and stagnant economies limit organic expansion.  Although, companies are not looking for deals for their own sake – prudence reigns here too.

So, it’s the end of the IPO bonanza, but M&A activity could bring a little more tension to the process. IPOs and trade sales offer different advantages and its likely both will be on offer – minus the hubris. No bad thing.

Get your HY skates on

Yildiz Holding financed its acquisition of United Biscuits with 60% equity and 40% leveraged debt. Open lending markets have certainly helped to fuel the return of the M&A market this year.  Global M&A value for the year stands at just below $3 trillion, the highest level since 2007. Global high-yield (HY) bond issuance tied to acquisitions is up 40% from the year-earlier period and the highest on record for any comparable stretch, according to Dealogic.  M&A related borrowing isn’t anywhere near as high as previous booms – no need to hit the panic button – but lenders have certainly been happy to support deals.

That said, M&A volumes haven’t been immune to the autumn wobble. This October saw the lowest deal value since 2011. Again we believe markets will pick up, but those seeking HY debt either for acquisition or refinancing shouldn’t delay. Debt markets are unlikely to rediscover the poise they had in the first half of 2014 and availability won’t get much better than this. The end of US asset purchases happened rather quietly. Markets were well prepared for the news and the Bank of Japan balance sheet expansion provided a large distraction. However, that doesn’t mean the Fed’s move has had no impact. US QE crowded out investment grade debt, lowered yields and pushed investors along the curve into HY. The Fed will hold its QE holdings for now, but the allure of HY will wane and market volatility will rise as the market normalises and the clock counts down to the first rate rise.

Investment grade appetites should remain and there will still be demand for HY in a low-yield world; but with greater discrimination – especially in higher risk credits. Phones 4U provided a reminder that high risk companies do actually default sometimes. Defaults may stay historically low in 2015, but we expect more of them as further reminders. Moody’s this week echoed our analysis that companies are overestimating profit forecasts and underestimating the challenges of the post-crisis economy. Of 108 EMEA companies Moody’s first rated in 2013, two-thirds of them underperformed their own growth and deleveraging expectations in the year of rating assignment, primarily from missed EBITDA expectations. The ratings agencies expects this gaps between expectations and reality to widen in 2014:

“EMEA high-yield companies rated in 2014 could see the gap between their actual and forecast financial performance widen, as they continue to overestimate their ability to grow and improve margins in an increasingly uneven economic growth environment in Europe.”

Deflating times II

The Bank of England’s Inflation Report came in pretty much as expected – forecasts for growth lowered a little and inflation expectations cut by much more.  In 2014 and 2015 inflation forecasts are 1.2% and 1.4% from 1.9% and 1.7% respectively. The UK still looks in much better shape than its neighbours; but, too low inflation has become a new, unfamiliar worry. An interest rate rise is highly unlikely whilst the Governor is – or is close – writing ‘Dear George’ letters for CPI below 1% in early 2015. So bets have shifted to autumn 2015 for the first rate rise. Sterling has dropped on perceived dovish result.

But, the problem of how to drive sustainable and competitive growth remains acute across Europe. Mr Lew’s ‘lost decade’ concerns may be too conservative.  But he’s right on the need to do more beyond monetary easing. The UK has resolved its dispute with its opponents – led by Germany – over patent box tax breaks. But, Europe needs to find some means of kick starting growth – and finding some way of encouraging R&D would help.