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US investment banks embrace riskier block trades
Feb 15 (IFR) - Stable market conditions and intensifying competition among the ECM divisions of Wall Street banks have prompted a spate of secondary offerings structured as overnight "blocks" or capital-committed trades, a sometimes controversial but increasingly important trend that exposes banks to losses if they mis-price deals.
Led by last Monday's US$1.8bn block trade in hospital operator HCA, there have been 15 block trades - hard-underwritten deals that involve banks directly buying parcels of shares before quickly re-offering them to investors - so far in 2013 in the US, raising US$8.7bn in total.
By volume, this is more than double the same period last year, suggesting that 2013 will be another big year for block trades if current trends continue.
"It is going to keep working until someone gets their face blown off," said one ECM syndicate banker. "The marketed trade has gone the way of the buggy whip."
As with the HCA deal, a significant proportion of these transactions involves private-equity funds as sellers seeking quickly to monetise their residual investments in companies they have taken public in recent years and have owned since the previous leveraged buyout boom. A number of frequent issuers, including REITs, have also undertaken block trades to fund acquisitions.
Other notable deals in recent weeks include Apollo's sale of a US$1.5bn stake in Dutch chemical company LyondellBasell Industries, Bain Capital's sale of a US$500m holding in industrial technology company Sensata Technologies, Blackstone's US$321m sale of its remaining interest in hospital staffing firm Team Health Holdings, and the KKR-led sale of a US$930m stake in NXP Semiconductors.
Although the shift towards risk is a continuation of ECM trends in 2012, block trading activity is certainly accelerating in a rising stockmarket with declining volatility and general investor bullishness towards equities. Add an influx of capital into equity - domestic equity funds have enjoyed year to-date inflows of US$10.8bn, according to Lipper - and the conditions are ripe for this type of transaction.
TAKE THE CHEQUE
The 40%-plus of US follow-on stock issuance (including foreign-domiciled companies listed in the US) conducted through block trades so far this year compares with 24.5% last year, 18% in 2011 and 4% in 2010.
Barclays and Citigroup have led the charge, with capital-committed trades accounting for 41.3% and 37.1% of their ECM volumes last year, according to Thomson Reuters.
JP Morgan (15.4% of 2012 follow-on underwriting volume) and Goldman Sachs (21.3%) have in the past been less inclined to engage in block purchases, instead advocating marketed stock sales (although Goldman did lead last week's LyondellBasell block).
"Never confuse intelligence with a bull market. You have to look at the risk relative to your balance sheet," said a Wall Street head of ECM syndication. "We have seen appetite [to do risk trades] go way beyond what we have ever seen before."
The block trade trend is certainly controversial in ECM circles. This is not just because of the increased risks for banks so soon after the financial crisis, but also because blocks tend to be done at tight margins and are seen by some as an exercise in buying league table credit.
In part, this is because the right to buy blocks is often the result of an increasingly fierce competitive bidding process, usually with at least three or four banks, but sometimes as many as six.
The sponsors behind hospital operator HCA have been some of the most visible beneficiaries. Having led a US$33bn buyout in 2006, KKR and Bain Capital took the company public at the beginning of 2011 but have already cashed out twice in the past three months, taking US$1.06bn on a block sale to Morgan Stanley in December and US$1.8bn on the latest sale to Citigroup and Barclays.
The banks purchased the 50m-share block at US$35.87 and re-offered it to investors at US$36, a 1.8% discount to last sale and a gross underwriting spread of US$6.5m or 0.4%. Happily, shares of the hospital operator traded above re-offer in the aftermarket, reflecting strong demand for hospital stocks on expectations that they will benefit from healthcare reform.
"The sellers have achieved very attractive discounts, the banks have been able to make justifiable fees and most of the blocks - not necessarily the second they trade, but a week out - have done well," another ECM head said of the recent spate of blocks.
In some cases, a successful verdict is less obvious. Morgan Stanley sought to offload risks on a 15m-share purchase of Sensata Technologies on Tuesday at US$33.45, versus a last sale price on Tuesday of US$33.70. The stock closed on Wednesday at US$33.26 and never traded above the re-offer.
Some of the selling pressure may have come from traders shorting the stock on the assumption that it would trade down and that they could cover their shorts in the placement.
That tactic doesn't always work - and such trading patterns don't necessarily indicate that the banks involved are stuck with stock. "Sometimes people attack the deal because they think you're long," said one syndicate official close to the situation. " often the deals are actually pre-sold."
A corollary of rising risk appetites is that private-equity firms have been able to negotiate shorter lock-up agreements with investment banks. HCA featured a 45-day restriction on further insider selling, shorter than the 90-day restriction on typical follow-on offerings, while Apollo has only a 30-day lock-up on its remaining LyondellBasell holdings.
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