US investment banks embrace riskier block share trades

Fri Feb 15, 2013 10:22am EST

Feb 15 (IFR) - US investment banks are increasingly embracing so-called block trades - direct purchases of large chunks of company shares for resale - which are seen by some as a risky and even controversial move in the wake of the financial crisis.

The trades allow sellers of shares to collect their proceeds immediately while leaving banks to carry the risk, often just overnight, of selling the stock into the market.

Typically, several banks compete to buy the blocks at an agreed price before reselling the position at a "re-offer" price above what they paid.

But in addition to potentially making less profit than by underwriting a traditionally marketed sale of shares, the banks risk a loss if they mis-calculate what investors will pay for the shares later on.

Yet at a time when profits are under pressure, the chance for a big score is increasingly tempting the big investment banks to use the block trade option.

"The competition is as fierce as it has ever been in this business," said one Wall Street banker.

RISING TIDE

Hospital operator HCA this week sold $1.8 billion of shares in the 15th block trade so far in 2013.

Those trades have raised $8.65 billion - more than double the amount in block trades over the same period last year, suggesting the traditional marketing of follow-on offerings is out of fashion right now.

More than 40% of this year's follow-on offerings - secondary offers of shares from companies that are already listed - have been block trades, versus less than 5% in 2010.

"The marketed trade has gone the way of the buggy whip," the banker said.

As was the case with the HCA deal, block trades often involve private equity funds selling off large quantities of a stock in a company they have invested heavily in to take public.

This week alone, in addition to the HCA trade, Apollo sold a $1.5bn stake in Dutch company LyondellBasell Industries ; Bain Capital off-loaded a $500m stake in Sensata Technologies ; and Blackstone sold its remaining $321m stake in Team Health Holdings.

Although there appear to have been few hiccups with block trades so far this year, the deals are seen by some in the industry as controversial.

One issue is the increased level risk of in these trades so soon after the financial crisis, which many have blamed on excessive risk-taking by banks.

However, block trades seem to have caught fire. A rising stock market, falling volatility, increased fund flows to equity and eagerness by private equity firms to sell have combined to reduce the risk of these deals going wrong.

"Never confuse intelligence with a bull market," said the head of equities syndication at one US bank.

"We have seen appetite [to do block trades] go way beyond what we have ever seen before."

BENEFITS AND RISKS

Few have benefitted from the heightened appetite for risk as much as the sponsors behind HCA. Having led a $33bn buyout of the company in 2006, KKR and Bain Capital took it public at the beginning of 2011.

They have already cashed out on the investment twice in the past three months - taking $1.06bn on a block sale of HCA shares to Morgan Stanley in December, and another $1.8bn on Monday's sale to Citigroup and Barclays.

In the latest sale, the banks purchased 50 million shares at $35.87 per share and re-offered them to investors at $36 - a 1.8% discount to where the shares had closed on Monday before the block trade.

That means the banks had a notional gross underwriting fee of $6.5m - 13 cents per share - for the deal.

That is likely less than they would have made in the traditional underwriting of a marketed share.

In a similar trade, Barclays and Credit Suisse paid $30.10 per share for 30 million shares of NXP Semiconductors, and then sold them at $30.35 - a gross profit of $7.5m.

HCA and NXP shares both jumped again after the trades, so the banks would have made more on any shares they held on to.

But banks don't always get the pricing right.

On Tuesday, Morgan Stanley offered 15 million shares of Sensata Technologies shares at $33.45 - just below the closing price that day of $33.70.

Sensata closed at $33.35 on Thursday, however, and has not traded above Morgan Stanley's re-offer price since the trade.

Whether Morgan Stanley actually lost money on the trade is hard to say. The bank's purchase price for the block is yet to be disclosed, and it is unknown if it was left holding any of the shares.

But bankers argue that, in the main, recent blocks have been good for all parties in the transactions.

"The sellers have achieved very attractive discounts, the banks that have done the blocks have been able to make justifiable fees and most of the blocks - not necessarily the second it trades but a week out - have done well," said another Wall Street banker.

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