In March we wrote a piece (here) on considerations for listed companies seeking to raise capital in the face of the COVID-19 crisis. As we expected, the subsequent seven months has seen a raft of companies coming to market, with more money raised in equity by UK listed companies in 2020 YTD than in any comparable period for a decade. This piece, a companion to our earlier piece, looks back at the key trends over the last seven months and considers the outlook for UK equity markets.
Themes of the COVID-era
Unprecedented Government action
As noted in our March piece, the COVID crisis precipitated many large fiscal and monetary stimulus packages from Governments world-wide. In the UK, measures including furlough, the CCCF, and government backed loans for SMEs rescued many companies that would not otherwise have survived, and gave others breathing space to ride out the immediate crisis.
Without these measures the volume of equity recapitalisations relative to those we have seen could have been much higher. However, with recessionary conditions expected to persist for some time and significant economic challenges ahead, we expect a significant volume of recapitalisations and full balance sheet repair operations (including debt for equity swap transactions) still to come, with investors still being prepared to back companies with a strong investment story.
Innovation, innovation everywhere
The vast majority of clients and advisers have been working from home and complex deals have been executed over a period of months without any physical meetings. And yet, while COVID may have dragged some aspects of deal-making into the 21st century, the real innovation has been elsewhere:
- Regulators and industry bodies responded rapidly, with the FCA publishing guidance that allowed companies to raise capital notwithstanding the uncertainties created by COVID by publishing the COVID assumptions on which their working capital statements are based. In parallel, the UK government introduced legislation temporarily overriding companies’ constitutional documents, to allow companies to hold closed meetings. The FCA went further still in permitting listed companies to dispense with company meetings on class 1 and related party transactions, if they could evidence sufficient support for their plans. The Pre-emption Group relaxed their guidelines (initially until 30 September, subsequently extended to 30 November) to encourage investors to consider larger non-pre-emptive raisings, effectively clearing the path for many companies to raise an amount equal to up to 20% of their existing equity by way of a placing and dovetailing with the exemption to produce a prospectus under the Prospectus Regulation where companies are issuing less than 20% of their issued share capital. The market adapted rapidly to the new normal, with companies including WH Smith, SSP, Autotrader, ASOS, Hiscox and Unite being amongst those to take advantage of the additional flexibility and issuers and their advisers respecting the soft pre-emption and enhanced disclosure guidelines set by PEG. This relaxation has been very successful and has certainly influenced issuers, with the number of traditional rights issues being less than anticipated – and it is likely that there will be pressure to maintain these relaxations going forward. However the Pre-emption Group appear to be set to withdraw the concession on 30 November as this article goes to press and did indeed make an announcement to this effect on 20 November. If this comes to pass, we would anticipate a natural pivot towards rights issues and placing and open offer structures for the larger capital raises.
- Retail participation increased, as more structures were deployed to allow retail shareholders to participate even in non pre-emptive raises. PrimaryBid caught the attention of the broadsheet media and then of boards, as they offered companies the ability to build a retail tranche seamlessly into existing bookbuild processes, albeit capped at €8 million, and so these were more symbolic nods to retail participation on larger deals. Broker options were also deployed, alongside clawback to allow a wider range of investors to participate alongside institutional places, whilst Shaftesbury adopted a bolt-on (non-underwritten) offer for subscription as a feature of their recent placing and open offer.
- As we anticipated in our March piece, there has been an increase in structured solutions, often with private capital coming in alongside public equity to recapitalise listed companies. Aston Martin, Costain and SIG were three early examples of this, with Saga being a more recent example and all the more heartwarming for the private investment coming from the founding family of the business. Structuring private investment into public equity can be challenging in practice, given the constraints on what issuers can offer private equity investors in exchange for their strategic investment and the need to balance the need for investment with existing investors’ concerns about dilution. Deal-making bankers have had to work hard in challenging markets to strike deals which can be supported by boards and shareholders alike. Whilst these recent PIPE-like transactions have all featured conventional equity, we see a possibility that more structured solutions, such as warrants and convertibles, could make an appearance in the more distressed scenarios.
- In March we wrote: “For most companies, and particularly those most directly impacted by Covid-19, an equity raise alone will not suffice and a more comprehensive recapitalisation plan may be required. This may necessitate some form of accommodation with lenders and noteholders, be it amending and extending existing facilities, waiving or removing covenants, payment holidays, rolling notes over or debt-for-equity swaps, alongside a large equity raise. Alternatively or in addition, companies may combine refinancing with asset disposals.” Many companies have indeed sought holistic solutions, pairing equity raises with debt refinancings and/or renegotiation and/or asset sales. Often these elements have been interconditional, as was the case for Hammerson, whose £552 million rights issue was inter-conditional with its disposal of its 50% interest in its VIA joint venture. In other cases, including Rolls Royce’s rights issue lending syndicates’ relaxation of covenants, extension to repayment dates or provision of new facilities have been conditional on equity being raised and/or the proceeds being used to repay debt. Deal-makers have had to balance the disparate and occasionally competing interests of a range of stakeholders and align multiple negotiation timetables to deliver transactions, a considerable challenge against an uncertain market and political background.
The line between not enough and too much
Investors facing a rush of companies seeking capital on an expedited basis became increasingly sceptical and challenging of the rationale for some raises. Boards and their advisers were criticised in some quarters for seeking cash on an opportunistic basis when there were arguments that it was not really required, and in others for seeking only a partial solution when investors wanted to see a more comprehensive solution, even if it took longer to put together. While it seems most listed companies that sought to raise capital were successful, the process was not always smooth and some companies were challenged by investors over the necessity or adequacy of their cash raising plans. Investor attitudes to larger non pre-emptive raises were not uniform, either, and although most were broadly supportive and backed such raises with cash, those facing significant calls on capital were vocal in criticising companies forcing them to make the choice between investment and dilution. This dilemma is expected to become more acute in H1 2021, with companies having to plan for a more protracted economic hit than was perhaps originally anticipated in the early stages of the pandemic, notwithstanding the recent positive news on vaccines.
Board and management teams occasionally found themselves in the spotlight, with salary cuts and bonus deferrals on the agenda of investors being tapped for cash and widely discussed in the media. Perhaps less obviously, there was some media scrutiny of the ethics of management teams participating in placings, with concerns being raised about management having preferential access to discounted shares at a low point in the cycle. This has quietened now, and the orthodox view that it is positive for management to support a raise alongside investors has reasserted itself.
Capital seeking deployment: PIPEs and SPACs
“Private equity is sitting on a lot of dry powder” has been a common refrain for years now and is still often said. Preqin estimates that globally PE firms have $1.5 trillion ready to be put to work. With M&A markets having, until recently, been subdued, PE firms have looked at other means of deploying that capital. PIPEs (private investment in public equity) have risen up the agenda, although have struggled to gain a foothold in a UK market which is more conditioned towards straight equity transactions. Nonetheless, the Clayton Dubilier & Rice’s investment in the SIG recapitalisation was heralded as being an example of a PIPE, albeit simply structured, and banks have been looking at PIPEs with renewed interest.
There has similarly been increased interest in SPACs (special purpose acquisition companies), cash shells set up with the goal of acquiring and driving returns from control positions in companies. A considerable number of SPACs have IPO’d in the US and there is renewed interest in the UK and Asia, with some deals known to be in the pipeline. SPACs are attractive in the current market because they give public market investors the opportunity to hold a liquid security while supporting the M&A strategies of experienced management teams and founders. For targets and sellers SPACs provide an attractive exit opportunity and a potentially compelling alternative to a conventional IPO track.
The UK has long been considered an attractive listing destination for founders and management teams of SPACs because, unlike in the US, it does not require shareholder approval of a de-SPAC transaction or give investors redemption rights. However, with the overwhelming investor demand for SPACs being based in the US there has been pressure for UK SPACs voluntarily to adopt some of the US investor protections, which in turn may negate the advantage of the UK as a listing venue, There is also concern in the market about the impact of the UK requirement for SPACs’ listings to be suspended when they announce a de-SPAC transaction until such time as there is sufficient information about the target in the market. As a result of this perception there are now substantial discussions on how to improve the UK SPAC offering (which we are actively engaged in).
The fruits of disruption
In hindsight, our piece in March was perhaps overly focused on recapitalisations and insufficiently open to the possibility of other capital markets activity. That suited the prevailing mood but perhaps failed to anticipate the speed with which investors would seize the opportunity to invest in businesses positioned to capitalise from opportunities in the COVID era. The COVID crisis has provided an opportunity for disruptors as well as breathing life into the SPAC market as investors seek opportunities to allocate capital. As conventional retail has faced unprecedented turbulence and a host of household names including Debenhams, Maplin and ToysRUs have entered insolvency processes, online retailers such as Amazon have experienced significant sales growth. E-commerce company The Hut Group has announced plans to launch a £4.5 billion IPO and other e-commerce companies are known to be in the IPO pipeline. Online food service companies are expected to follow, at the same time as many restaurant chains struggle. Notwithstanding the challenges in the real economy, global stock markets have recovered most of their losses from earlier in the year, and in the case of the NASDAQ have hit new highs. Hong Kong deal makers report a heavy IPO pipeline, notwithstanding Ant Financial withdrawing what would have been the World’s largest ever IPO last month. European new issuances are also fairly robust, especially in those sectors which are resilient in the current environment, such as technology, healthcare and biotech.
Away from IPOs, whilst government measures to support the economy have postponed distress in some sectors it is still widely expected that distressed M&A will be more of a feature in 2021 than in 2020 to date. At least some of that distressed M&A will be equity funded or involve equity market solutions alongside business combinations. We may also see more equity-funded conventional M&A too; for example see the recent announcement of a proposed break-up bid of RSA plc, in connection with which Tryg, the Danish insurer has entered into a standby underwriting facility to fund its share of the purchase price.
The future is, as ever, impossible to predict. Much will depend on the course that COVID takes and the speed with which global economies recover. Deal windows can close and optimism can fade. But as it stands, Q4 2020 and the first half of 2021 look to be busy and varied in UK equity capital markets, with all forms of ECM activity being present.
The regulators’ quandary
Earlier we discussed the key role regulatory innovation played in facilitating deals. Many of the key reforms were introduced on a temporary basis and will be reconsidered in due course. Some, such as the change to allow companies to hold virtual company meetings, are unlikely to be adopted permanently although parliament would do well to allow ministers the power to reintroduce that flexibility (including for meetings already called) without primary legislation in the event of a further lockdown.
We noted above the FCA’s welcome relaxation of working capital disclosure rules to permit companies to state the COVID-related assumptions underpinning their reasonable worst case scenario. In practice, however, it is often challenging to identify what is, and what is not, a COVID-assumption and there is a considerable grey area between those assumptions which are clearly COVID-related (eg assumptions about the duration of lockdown) and those assumptions which relate to behavioural and wider market changes that might flow as a consequence of COVID. The FCA has a difficult task in ensuring that issuers are not precluded from sharing valuable context with investors whilst at the same time not undermining the import of the working capital statement itself. Similarly there is sometimes tension between the desire of issuers to share information with investors about the pro forma impact of recapitalisation on, for example, leverage metrics, and the FCA’s strict application of pro forma disclosure rules. In both these areas there is a good case for flexibility and facilitating more high quality disclosure, rather than less.
The Pre-Emption Group has also confirmed that it is not extending the flexibility to allow larger non pre-emptive raises now the impact of the crisis has abated somewhat and companies have had significant time to take up the relaxation. However, there is a sense now that companies have had ample opportunity to take advantage of the flexibility, but others will argue that in times of uncertainty the flexibility remains welcome. In the medium term, the PEG will also need to consider whether the genie can ever truly be put back in the bottle; there is a strong intellectual argument that if companies ought to be able to raise 20% non pre-emptively during one crisis, subject to certain consultation and soft pre-emption protocols and with adequate disclosure, they ought to be allowed to do the same in another crisis, even if that crisis is more sector or even company-specific. More widespread adoption of PrimaryBid or other retail options would further weaken the argument for strict limits on placings, particularly if structured to prioritise existing holders. In the future there will be a need to resolve the disconnect between the guidance as to the pre-emption authority which should be sought by listed companies at their AGMs (which is limited to authority to issue up to 5% of the company’s shares, or 10% to fund an acquisition or specified capital investment) and the reality of what investors are prepared to support. At present the cashbox structure bridges the gap, but a more substantive solution would be welcome.
Looking further into the future - the effective cap of €8 million on any retail tranche (to avoid the need for a prospectus under the EU Prospectus Regulation) has meant the benefits of retail participation on some larger raises were more optical than substantial, but one wonders whether politicians keen to show a Brexit dividend might alight on the idea of increasing that threshold to encourage another era of direct share ownership. Tell Sid! A review of retail participation in UK equity markets would be welcome and may help to address the reluctance on the part of banks and other intermediaries to engage in retail offers on most transactions.
More generally, we are of the view that law makers should continue to explore ways for listed companies to be able to access capital markets quickly and efficiently, and there has been a growing consensus in the market that a further review of the UK listing regime may be necessary to ensure that the UK is well positioned to attract highly mobile international capital in the future. This culminated in the announcement on 19 November 2020 that the Treasury (as opposed to the FCA) has initiated a broad review of the UK listing regime, with Lord Hill appointed as chair (see here). This review seeks to balance the thorny question of how to balance making the UK an attractive market for international companies to list, while retaining appropriate standards of corporate governance, with a focus on free float requirements, dual class share structures, track record requirements, prospectuses and dual and secondary listings. This will be a potentially significant review, coinciding with the degree of regulatory freedom that Brexit presents. Responses to the call for evidence are due on 5 January 2021 and we expect that this will be a significant area of focus for market participants during 2021.
Increased focus on ESG
ESG (Environment, Social and Governance) has been the acronym on everyone’s lips over the last 12 months and it is impossible to ignore the broader social and environmental context in which the COVID crisis has emerged. A considerable body of guidance has been published on the disclosures issuers should be making in their prospectuses about ESG matters, and these are of relevance to all issuers, not just those in heavily polluting industries or substantial operations in countries with low-paid workers. As the COVID crisis evolves we can expect to see companies raising capital subject to greater scrutiny from investors and the press on a range of maters including the sustainability of their business models, their ethics and business practices, impact on the environment and broader society, their record on diversity and inclusivity and pay practices. Whilst Europe has led the way in ESG regulation and guidance to date, increasing global awareness will drive the development of new practices and standards, which will be relevant to practitioners across the market.
The contents of this publication are for reference purposes only and may not be current as at the date of accessing this publication. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2021