Alibaba has recently floated on the New York Stock Exchange resulting in a market capitalisation of some US$ 225 billion, further proof that IPOs (Initial Public Offerings) are back in vogue. The US IPO pipeline has been consistently strong since its 2012 blip and the UK market is performing admirably, with over 90 companies having come to market in 2014. Across Continental Europe we are seeing a similar phenomenon, with public flotations nearing 2007 levels. So have institutional investors rediscovered a voracious appetite for IPOs? Not entirely. In this edition of Overture we explore why some IPOs fail and, importantly, what leads to success. We argue in particular that upfront investment in key roles ahead of the IPO is a strong determinant of how the IPO performs.
There are a number of reasons why companies come to market. Broadly speaking, IPOs can be categorised as below:
- Companies in Private Equity ownership and whose owners are seeking to exit via a sale to institutional investors. 2014 examples include Lenta and Just Eat
- Subsidiaries or divisions of larger corporates which are spun off or partially divested to the market, for example Direct Line, formerly part of RBS, and Osram, formerly part of Siemens
- Privatisations, most recently the Royal Mail in the UK
- Privately held, often family-owned businesses, looking to the market for funding or to diversify the ownership structure, an example being AO World
Whatever the route to market, it is clear why IPOs matter. A flow of high quality companies ready to assume the mantle of the publicly quoted corporation and to access the capital markets to fund future growth is a good economic indicator.
A vigorous pipeline of IPOs is a sure sign of a healthy and expanding economy, and successful flotations create a positive feedback loop that stimulates entrepreneurship, jobs and invention.”
– Luke Johnson, ‘Tragic tale of the vanishing IPO market’, Financial Times, 30th November 2010.
While the number of companies coming to market has been robust, there are clouds on the horizon. There have been several well publicised instances of IPOs being pulled at the last minute. In August 2014 Rob Leach, the Head of EMEA Capital Markets at BlackRock, the largest global institutional investor with US$ 4.3 trillion of assets under management, was cited in the FT expressing concerns about the quality of IPOs being brought to market. BlackRock noted that over a third of companies listed in Europe in 2014 are trading below their issue price, typically falling short of their financial targets. This calls into question the integrity of their internal controlling and communication with shareholders.
Why are we seeing this under-performance? Certainly there have been significant cuts in the Equity Capital Market teams of several investment banks, so it is possible that companies are not being as thoroughly prepared for going public as they were previously. Arguably this is symptomatic of a deeper issue.
As an Executive Search consultancy we advise and work on a number of IPOs. This gives us insight into the level of preparedness for the offering. A key indicator of IPO-readiness is public company/capital market experience at a senior level within the company. We argue that this can have a major impact on the success of the IPO.
This also has a clear link to meeting financial targets. We are convinced that a company’s ability to meet financial targets is much more than an operational or technical function. Effective expectation management is not financial PR. Rather, it is the consequence of a senior team within the corporate who have a good grasp on internal forecasting, as well as an excellent understanding of how investors think about their investments – in particular what investors need in terms of both performance and communication to remain happy with their investment.
Of course it goes without saying that there needs to be a strong business proposition. Without this the company should not be coming to market, and arguably should not exist at all. Beyond the operational skills that a company requires to deliver this proposition, there are key roles that significantly influence the success of the IPO. From our experience these are:
The Chairman: A Chairman who has a good grasp of institutional investor thinking and expectations will be better able to position the company to meet those expectations. What is more, his or her understanding of the markets will influence appointments to key roles. The Chairman will also have clear ideas about what information the Board needs on a regular basis regarding the markets and shareholder perceptions. Finally, they will be a champion of clear reporting and guidance to the market, while keeping a firm overview of the company’s ability to meet these expectations.
One construct that works well, particularly for a PE-owned company, is introducing an independent Chairman with quoted experience well ahead of the IPO. Such a Chairman is ideally situated to oversee the preparation of the company in terms of key appointments, as well as the development of culture and processes.
In the context of a privately/family-owned business we have been impressed to see a Chairman, who had little public company experience, commission a benchmarking survey of best practice IR and also look very closely into the implications of the IPO for the company’s finance, communications and strategy teams.
The Board and Independent Directors: Institutional investors care about Board composition for obvious reasons. Each listing authority has specific requirements regarding Independent Directors. This is one reason why Alibaba chose to list in New York rather than Hong Kong: the NYSE accommodates a Board appointments process which allows a small number of individuals to appoint the majority of the Board without owning a controlling stake.
Board composition in IPOs has traditionally been driven by the bankers and advisors. The focus is often on industry experts who know the sector well and give comfort to investors about the achievability of targets. An Independent Director who also understands how investors value the stock and what they require to continue holding the stock can be an invaluable addition to the Board.
The Chief Executive Officer: The CEO is clearly the main cheerleader for the IPO and it is essential that the CEO brings deep sector expertise to the role. A CEO who also has insight and understanding into how investors will value the stock and how they will respond to news-flow is better placed to ensure that achievable targets are in circulation. This substantially reduces the likelihood of negative surprises. A CEO who does not have experience of how the markets work should therefore ensure that such experience is brought in-house.
Critically, a strong CEO will have a clear direction for the business – a sense of true North. The CEO will be able to hold his or her ground on issues of strategy and disclosure and, if necessary, debate vigorously with owners, advisors and stakeholders.
A worrying feature [of IPO performance in 2014] is the failure of companies to achieve stated financial and business targets even after one or two quarters [indicating] a lack of conservatism of projections, or ability to diligence these targets…
– Rob Leach, Head of EMEA capital markets, BlackRock, quoted in ‘BlackRock sounds alarm over IPO quality’, Financial Times, 5th August 2014.
The Chief Financial Officer: It is the CFO who has primary responsibility for preparing the internal forecasts and translating them into formal communications to the market. A CFO with a good understanding of the capital markets is, therefore, enormously important in an IPO.
How the CFO comes by that capital market experience is a separate question: There is no one route into the CFO role, and research conducted by Fidelio shows that the majority of FTSE 100 CFOs had moved through varied and increasingly senior finance roles within quoted companies. Some had come from banking backgrounds. A very small percentage of FTSE 100 CFOs had come through the IR function.
The Investor Relations Director: The IR role is a key differentiator between privately and publicly held companies. The raison d’etre of the IR Director is to provide an effective interface between institutional shareholders and the company. Recent research by Fidelio has indicated a broad spectrum of how pre-IPO companies think about the IR role.
Attracting an IR officer into the role can be difficult because many IPOs are dual track and in volatile markets IPOs can be pulled. Nonetheless, forward thinking pre-IPO asset owners have realised that appointing a capable IR officer sends an important signal of commitment to the market. It flags that the company wants to be professional in its dealings with the markets.
Chairman, Independent Director, CEO, CFO and IR Director: Each of these roles clearly contributes to the success of the IPO. IPOs that have performed well on a sustained basis have typically attracted talented Executives and Non-Executives with a good understanding of the markets into some, if not all, of these positions.
We therefore argue that asset owners, advisors and institutional investors, who are keen for an IPO to succeed would do well to look at the calibre of public company and capital market experience in key roles. Of course investment returns are driven by strong operating performance. A company’s ability to communicate this to the market, to set realistic targets and then to deliver on those targets is what determines the success of the IPO. These competencies need to be built ahead of the IPO; they represent investment in the company and are a good lead indicator for those with an interest in the long-term success of the IPO.
Fidelio High Notes- September 2014
- Fidelio supports clients in context of IPOs
- Fidelio working with consultancies and other capital market entrants
- Fidelio supports clients through Change Management Programmes, including the Internal Communications role
- Fidelio delivers Development Programmes for Boards and Senior Executives internationally
Please contact us with comments or for more information at info@fideliopartners.com