Hedging against Britain's volatile IPO outlook

Kenny Wastell
19 October 2016

Tweet
Facebook
LinkedIn
Google plus
Send to

The UK IPO market has experienced highly unpredictable activity throughout September and October, with investors losing confidence in public exits and one advisory firm suggesting GPs hedge against the risk of a public market crash. Kenny Wastell reports

Following a period of low IPO activity leading up to – and immediately following – the UK's vote to leave the European Union, private-equity-backed flotations started appearing once again in the country's exit landscape throughout September and early October.

In mid-September, Electra Partners-backed tenpin bowling operator Hollywood Bowl priced its IPO with a market cap of £240m. Having initially scheduled to float in July, the company postponed its plans in light of the Brexit vote, only to proceed two months later as the UK's public markets enjoyed an apparent uptick in investor appetite. Further encouraging signs appeared a fortnight later as Vista Equity Partners-backed banking software provider Misys announced its intention to float, in a process it hoped would raise £500m.

However, signals have since started to emerge that public market investors are losing confidence. Less than two weeks after Misys announced its plans, the firm was forced to cut its IPO valuation by around £1bn and request permission to reduce its free-float from 25% to 20%, according to a source close to the matter. The development followed quickly on the heels of an announcement that CCMP Capital Advisers- and Hermes GPE-backed UK gym operator Pure Gym had cancelled its plans to float owing to "challenging market conditions".

The evident toughening of the public market landscape has coincided with the UK Conservative Party Conference, which took place at the beginning of October. During the event, a number of speeches by senior cabinet ministers implied that – in addition to leaving the EU – Britain could well be on its way out of the European single market.

Speaking to unquote" prior to the Conservative conference, Investec corporate finance director Garry Levin said: "With the vote creating economic, political and constitutional uncertainty, you would have thought that triumvirate of concerns could have been a killer [for IPOs]. But the political uncertainty was resolved very quickly, without the need for a Tory leadership election, so that settled nerves on the political side. Then Theresa May kicked for the long grass because, though her view was 'Brexit means Brexit', she felt there was no need to rush headlong into negotiations."

Belt and braces
Since then, the political landscape has changed considerably, with May indicating the UK would commence the formal two-year process for leaving the EU by March 2017. While the post-referendum devaluation of sterling initially increased the attraction to public UK assets with non-sterling revenues, it is now increasingly clear investors are becoming nervous about the prospects for the country's economy.

Moritz Sterzinger, a consultant at advisory firm JCRA, says a large part of the risk associated with flotations is the lock-up period – often as long as 180 days – during which time private equity firms are unable to fully divest their stake in a business. While firms are both legally and ethically unable to hedge against an asset in which they hold an interest, he proposes vendors might hedge against a specific index in order to mitigate the risks of a bear market.

The most straightforward manner of doing this, says Sterzinger, is for private equity houses to purchase put options against the broader public market when listing a portfolio company. This would thus guarantee they would be able to receive a pre-agreed payout, should the chosen market drop below a certain level. Such a strategy would generate greater security for prospective vendors, albeit in return for sacrificing a proportion of any potential profit. "The challenging part," Sterzinger says, "is to pick the stock index that provides the best proxy hedge for the stock you are holding and to determine the optimal tenure and quantum."

The indications that are emerging surrounding the public markets are concerning. Indeed, should private equity houses begin listing portfolio companies while hedging against the broader market, the implication is that a crash might be on the horizon. However, as has been the case since the Brexit referendum, it is hard to predict the direction UK politicians might take next. Should it become apparent they are determined to pursue a so-called "hard Brexit", the public markets might prove an unlikely exit route for GPs in the months ahead.