Initial Public Offerings: A good time to float

Three yellow rubber ducks

Following successful initial public offerings by Direct Line Group and Esure, many industry commentators believe market conditions are currently perfect for further flotations. So, is it time for others to go public?

Initial public offerings have been rare for the past 18 months, but recent successful flotations in the insurance sector – and improving market conditions – have now made them a tantalising proposition.

The latest firms to go public are Direct Line Group and Esure Group. DLG launched its IPO in October last year at a share price of £1.75, while Esure started trading at the end of March at £2.90 per share.

The performance of the newly listed companies has been welcomed by Alastair Walmsley, head of primary markets at the London Stock Exchange Group. He says: “DLG and Esure have both shown solid returns to investors since they floated their businesses. That kind of performance is incredibly encouraging, as it tells me these deals are getting priced at the right level.”

Walmsley adds: “It is not just about completing an IPO, but about setting up as a platform for future growth. Pricing has to offer strong returns for investors in the aftermath, but these deals cannot be underpriced so the initial sellers leave too much on the table. These returns show that the IPO market is functioning well at the moment.

“Add that to the fact that equity funds are seeing inflows for the first time in years and the equity market volatility is down and this is actually a pretty good environment for companies to be coming to market.”

Walmsley is confident the market will see more insurance sector IPOs in the coming months. He adds: “We actually have, from the insurance side, three or four entities from different parts of the insurance world that are looking at a flotation so we are positive about the sector.”

There are many individual companies for which an IPO is a possibility. Acromas has recently completed a refinancing deal on its debt, and there has been speculation that it has been considering listing. Talk of a public listing for Hastings Direct has cooled in recent weeks, while Hyperion Insurance Group is still considering a potential move onto the stock market. Dutch financial services company ING Group, meanwhile, is set for an IPO of its European insurance business by 2014.

Indeed, there could be an increase in the number of listed insurance companies in the near future. PWC’s IPO Watch Europe Survey, Q1 2013, states: “IPO activity rapidly materialised after the Christmas break, almost taking the markets by surprise as companies moved quickly to take advantage of the uptick in the FTSE index and low volatility.

“The financial markets have proved more resilient in Q1 2013. Economic factors that dissuaded investors in recent years do not appear to have had a negative impact in Q1. Q1 saw the first UK private equity-backed IPOs on London’s main market [including Esure] since AZ Electronic Materials in October 2010 and may pave the way for IPOs of other PE-backed companies as the year unfolds.”

Float factors
But why might more insurance firms decide to list, and what impact does it have on their operations? The considerations are different for each company. Esure signalled its intent to list when it launched more than 10 years ago, but its listing was mostly driven by circumstance. Adrian Webb, head of marketing and communications at Esure, explains: “Esure was a joint venture with Halifax back in 2000, then when HBOS was born in 2001 we became a joint venture partner with HBOS. In 2009 HBOS was taken over by Lloyd’s and we gained a new joint venture partner.

“Neither we, nor Lloyd’s, had envisaged this and a management buyout was the only option left. As a company we went from a joint venture with a very large bank to a joint venture with another very large bank that could not really continue for various reasons – partly because it already had its own car insurance offering. So we became independent, although we still wanted long-term sustainable backing for the company.”

Only time will tell how successful that move has been, though the early signs are positive. Brightside Group, meanwhile, has been listed for a longer period. With a market capitalisation of around £110m it is not in the same bracket as Direct Line (£3.1bn) and Esure (£1.2bn), but its story is of equal stature.

Brightside chief executive Martyn Holman says: “The IPO certainly gave us the ability to raise funds and develop the business, and that was the key element. It has enabled us to make some acquisitions and drive the business forward. That was what we wanted out of it, and it is what we got. It also gives you the ability, via share options, to have more of your staff buy into the business.”

Holman adds: “[Without the IPO] it would have been difficult to grow so quickly and be so successful in the past five years, as we were not, and are still not, a business that carries any debt. The only other way we could have grown would have been to laden ourselves with debt. It is unlikely we would have got to where we are today had we stayed private.”

While an IPO offers access to capital, it comes with its own set of restrictions. Holman explains: “When you look at the business you would probably make decisions, given the insurance market cycle, to potentially cut back on your profit stream to grow your policy book. But in the public environment you cannot do that, as you have to keep moving forward.

“There will always be discussions around business structures and salary scales and, generally, as a private company, you can make these decisions and move forward. But now we have remuneration committees that are made up of non-executives, and they are effectively deciding what we can and cannot pay.”

Former Aviva CEO Andrew Moss – who resigned last year after a shareholder revolt – is perhaps the most high-profile example of how these pressures can affect a company’s management.

Investor considerations
In addition to the pros and cons the company itself must weigh up when it comes to an IPO, there is also much for investors to consider. Damian Guly, an insurance partner at PWC, says: “Investors are looking for a believable equity story. Firms saying they are going to grow need to be validated in some way and investors will buy into a growth story they believe. Either firms have a genuine niche and can access customers that will create loyalty, or it could be down a brand line, and brands have value.”

Guly says investors will look deep into a company’s strategy: “What is it doing about cost efficiency? What is it doing about fraud? What is it doing to work all the angles on the value? What is it doing about its relationship with distributors and negotiating the commission rates it pays away, and how does all that work? People are looking for a genuine story that they believe will differentiate the company from others in its market.”

Webb is well versed in this process of public scrutiny. He comments: “The process you go through in publishing a prospectus and listing the very fine detail of your business gives investors a lot of information. This is the moment at which the truth serum is injected into any company that is going through an IPO.”

Investors also want security around the returns they can expect. This can be problematic for smaller firms, according to Olly Laughton-Scott, founding partner at Imas. “Very small firms find it hard to find the stable returns that investors are looking for, and this is a problem,” he says. “We have seen firms list and then delist after a time.”

Given the hurdles companies have to clear to list and attract the right level of investment, it is not surprising how few insurance companies are currently public. Laughton-Scott says: “One has the perception that a huge number of companies are quoted, but actually quoted companies are almost the exception rather than the rule.”

Figures from Imas show only six of 320 companies in the insurance distribution sector are publicly owned, while in the insurance risk sector only 13 of 228 are publicly owned. There is certainly room for more firms to go public, and many believe there will be a surge in the months ahead. Guly says: “There could be more IPOs on both the insurer and distributor side. There are a number of companies owned by private equity backers, including underwriting businesses and distribution businesses. While the conditions remain favourable and the public markets are relatively stable – they are not going through high volatility and they are moving generally upwards – the window is open.”

Ashley Prebble, partner at legal practice Norton Rose Fulbright, concludes: “The market conditions for IPOs are as positive as they have been at any time since the global financial crisis in 2008. Insurance businesses have, on the whole, traded reasonably well over that period so IPOs are, theoretically, an available option. The success of the recent insurance IPOs may well embolden others but, as always, it will depend on it being the right time for the business in question.”

Do public equity buyouts degrade performance?

Publicly listed firms that are subject to a private equity buyout see their performance fall further behind industry rivals, according to research by three academic institutions.

The study by Warwick Business School and Cardiff and Loughborough universities compared all 105 listed UK firms that went through a PE buyout between 1997 and 2006 against firms of a similar size and industry sector. It found that the performance gap – measured by turnover per employee – widened rather than improved following the shedding of jobs and assets, compared with the control group.

Variables including market-wide trends in employment and the economy were factored into the performance calculations.

Geoffrey Wood, professor of international business at Warwick Business School, said “promised productivity gains of a takeover rarely materialised”, adding: “Rather, there was evidence of PE buyouts reducing the number of workers and squeezing wages, without making the firm more efficient.”

According to the study, the average performance gap between firms bought out by PE and the control group grew from £29 000 in the year before the firms were taken over to almost £89 000 four years after the buyout.

Professor Wood said the research found PE buyouts underestimate the importance of the workers they end up making redundant: “We found strong evidence of a higher incidence of downsizing in the firms in the year following the acquisition, even when we adjust for differences in wage costs and productivity.”

He added: “In the first year after the buyout, 59% of the acquired firms reduce the size of their workforce compared with 32% in the control group. That is a jump of 18% compare with the previous year.

“While the existing literature argues that one of the reasons for PE acquisitions is to rein in excessive labour costs, there is very little evidence of workers earning wages above the market rate ahead of the takeover – yet after the acquisitions there is evidence of a drop in mean and median wages.”

Read the full story.

This article was published in the 13 June 2013 edition of Post magazine

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