- 1 What is Equity Capital Markets (ECM)?
- 2 Equity Capital Markets Salaries and Exit Opportunities
- 3 Primary Markets versus Secondary Markets
- 4 The Initial Public Offering
- 5 Bought Deals – Secondary Equity Offerings in Canada
- 6 Shareholder Analysis for Equity Capital Markets
- 7 Equity Capital Markets Update
- 8 Related Reading for Equity Capital Markets
What is Equity Capital Markets (ECM)?
Equity Capital Markets (or ECM) is a financing group in the investment bank that deals with equity capital raising, from origination to structuring to distribution. ECM is most well known for helping corporates with the issuance of equity/stock – whether through primary offerings (Initial Public Offerings or IPOs for companies looking to list) or secondary market issues. Services that fall into the domain of ECM include:
- Initial Public Offerings
- Seasoned Public Offerings/Follow-On Offerings
- Secondary Offerings (a major shareholder wants to divest a large block of shares in-part or in-whole)
- Subscription Receipts
- Instalment Receipts
- Rights Issues
- Private Placements
- Private Investment in Public Equity (PIPE)
- Preferred Shares
- Convertible Bonds
- Mandatory Convertibles
- Mandatory Convertible Preferred
- Hybrid Capital (also DCM)
Within the bank, ECM is split into origination and syndication/distribution.
Equity Capital Markets Origination
Origination (originating deals) is more closely aligned with classic investment banking and is responsible for pitching for equity issuance. This team will speak to why it makes sense to issue equity based on market multiples for valuation, investor appetite and general strategy.
Origination will also provide advice on what the best structure or product is best – for instance, a straight equity issue or a convertible bond – and offer indicative numbers for pricing, timing and how the market may react. Similar to the investment banking coverage teams, equity capital markets origination will also be split into industry verticals such as oil & gas or healthcare.
When not involved with execution, ECM origination offers support via shareholder analysis and advice on repurchases and other ideas related to equity via an ECM update.
Equity Capital Markets Syndication
Once equity is issued, it ideally is spread out in a liquid market at the right price. The syndication team is in constant correspondence with syndication desks at other investment banks and maintains relationships with the institutional and retail investors who eventually purchase the shares. This desk is also responsible for making sure that the issue goes smoothly and that the price is stable – an exercise that evaluates daily trading volume, market reception and investor demand.
Investors want a piece of hot new issues (such as Facebook or Alibaba), so the syndication desk must figure out an appropriate amount to allocate based on subscriptions to institutional investors as well as to retail brokerage channels (Dean Witter, Smith Barney) for investment advisors (IAs) to further distribute within their client portfolios.
Equity Capital Markets Salaries and Exit Opportunities
Compensation will entail standard investment banking base ($70,000 – $90,000 starting as an analyst) but a smaller bonus of 75%-100% of salary.
Exit opportunities are abundant for equity capital markets professionals. As with DCM bankers, ECM bankers can lateral to investment banking. Equity sales and equity research are more options for ECM bankers if they prefer to stay on the sell-side. There are also numerous options on the buy-side, with many funds requiring equity analysts.
Primary Markets versus Secondary Markets
Equity offerings marketed by an investment bank can be via primary market or secondary market. A primary market offering is when the company is the seller of shares – cash proceeds from the offering will go into company coffers. Assuming that there are existing shareholders, as the stock is issued from treasury and therefore increasing the numbers of shares outstanding, this is dilutive to current owners of the stock.
A secondary market offering is when a shareholder of a company offloads some or all of their shares that are already exchanging hands in the broader market. As the company itself is not involved in the transaction and no new shares are issued (existing shares are exchanged), existing shareholders are not diluted.
Both primary and secondary offerings will lead to greater shareholder diversity as it will be a large holder or group of large holders divesting their shares to the public market.
The Initial Public Offering
The relationship banker in investment banking coverage will handle the prospectus writing and sizing – ECM will comment on the feasibility and assist in marketing and execution.
Decisions that need to be made include what stock exchange the company should list on. Each exchange’s rules and the securities law of each country differ. For marquee floats (recent examples include the IPOs of Alibaba and Saudi Aramco), exchanges will pitch companies on why they should list in a specific jurisdiction. The banker will advise on the following questions:
Should the company list in the US or Canada (NYSE or NASDAQ? TSX? Should the company dual list and trade on both?) – and what are the ramifications of each? The US allows for a deeper investor pool, but it depends on appetite at the moment. What kind of dual class share structures are allowed? What kind of reporting requirements are there?
The actual IPO needs to be syndicated – the advising investment bank can help decide on the following:
- What banks should be in the equity syndicate?
- What kind of execution allows for the best pricing?
- Where will the stock go after it floats?
Usually, equity issuances are underpriced, which allows for the stock to pop afterwards, boosting investor sentiment (and encouraging investors to participate in IPOs to begin with). By “leaving some money on the table”, companies can make sure the offer size is filled and covered many times over (banks will pro-rata allocate to investors if this is the case) – usually if there is an exit, they have already made a lot of money already and are crystallising value at an attractive multiple (private markets are where the smart money is).
There may also be a greenshoe or over-allotment option of ~15% should the issue be oversubscribed, and more stock can be issued (also applicable for seasoned offerings – sometimes mentioned as the issue has “room to grow”).
Interestingly enough, an equity issue may not have proceeds going to the corporate itself, but rather it is an exiting shareholder divesting their stake. If that is the case, the company will not be able to use the funds for corporate purposes – it doesn’t affect the company (other than the incremental cost of filing and reporting publicly). A good example of this was the Government of Ontario floating Hydro One.
The lead bank for an IPO tends to be where an investment banker has a relationship early and pushes corporate banking to provide credit support until (and after issuance). Another prerequisite in being a lead bank is to have the bank’s equity research division cover the stock, as that provides exposure and marketing for the firm.
The titles that banks compete over for ECM are the same as for DCM – Sole Bookrunner, Joint Bookrunner, etc.
Bought Deals – Secondary Equity Offerings in Canada
In the US, equity underwriting tends to be on an agency or best efforts basis – banks will take a fee for issuance but should the deal not be successfully syndicated, the company may not issue or may not issue fully. In Canada, banks tend to purchase the entire issue at a steeper discount and sell it off.
Of course, with the greater risk, Canadian banks earn a greater return. Sometimes, global banks will balk at the opportunity because they are unfamiliar with the security and do not want to hold risk on their books. Generally, this is a huge moneymaker for the banks – however, the risk is very real with quite a few hung deals (share price falls below the bought deal price and banks eat the loss as they cannot clear out the inventory). This tends to happen with resource companies when an overly ambitious lead offers pricing that is unrealistic.
From a corporate finance perspective, this can be perceived as leaving money on the table as it hurts the economics of issuing equity, so more sophisticated Canadian corporates have tapped US banks for execution when forced to issue equity (example: recent EnCana issuance led by JP Morgan).
ECM will disseminate shareholder analysis to corporates to shed light on who the primary investors are and what strategies they follow. If certain shareholders are missing, let’s say a dividend index, ECM can speak to the rules that must be followed to broaden shareholder acceptance (raise your dividend once a year).
They can also compare the holdings vs peers (for instance, these US fund managers hold Suncor but not Canadian Natural Resources – could they be served by doing a tour with Blackrock, PIMCO and T.Rowe?) and find out how to better communicate the company’s story and alleviate investor fears.
Looking at whether funds are underweight or overweight a stock compared to the index or another relevant benchmark can also be used in reverse as feedback for the company’s current strategy. Does something need to be derisked before people look to buy?
In a shareholder analysis update, the investment bank will often list the top 10 or top 25 shareholders. This can be easily pulled from a data source such as Factset or Bloomberg (OWNH <GO>), which in turn lists the source of the data as many asset managers have to report their holdings.
From there, the investment bank can segment the shareholder base into relevant categories such as investor type, investor geography, investor mandate, and whether or not investors are activist threats (shareholder activism).
Investor Type – Institutional, Retail, Insider
Investor Geography – Canada, US, International
Fund Mandate (Institutional) – Growth, Value, Special Situtations
Institution Type – Hedge Fund, Mutual Fund, Index Fund, Pension
Passive versus Active Investing – Indexing to Benchmark or Active Security Selection (stock picking)
Shareholder Activism – Shareholders with activist history versus passive shareholders
Investment banks will also outline which investors are buying and which are selling, as well has how big the flows are so that the company can plan to appease or defend. Investment banks may offer strategy and tactics for how to market to certain investors depending on what they have historically liked to see.
Shareholder activism has become more newsworthy of late with famous hedge fund managers such as Bill Ackman (Pershing Square), Carl Icahn, David Einhorn (Greenlight Capital), Barry Rosenstein (Jana Partners) and Dan Loeb (Third Point) taking aim at companies and demanding change (by kicking out the Board of Directors and bringing in their own people).
Beyond these widely reported proxy battles, shareholder activism represents a real threat when the stock performance has not been top quartile (or relatively poorly compared to industry peers). Reasons for complaint can include the stock trading at a lower multiple (General Motors – Greenlight), management excess (Third Point – Sotheby’s), return of capital ideas (Icahn demanding a dividend from Apple), or sub-optimal capital structure.
If a known activist shareholder takes on a material shareholding, an investment bank may be hired by management or the board of directors to advise on how to deal with the situation.
Equity Capital Markets Update
ECM will be continuously putting out data on issue volume, where things priced, how many times covered demand was – etc. For every industry, they will have an assortment of tables and pies that illustrate appetite for equity issuance.
Given this, they will provide indicative numbers for where a company would price should it issue, depending on the size and other considerations. ECM will be in charge of their own league tables which showcase their bank’s performance (fiddling around with Bloomberg or other data provider criteria to make sure they are first or second).
On the converse, ECM will also offer commentary on repurchases and the merits of a Normal Course Issuer Bid (NCIB) or Substantial Issuer Bid (SIB) as well as providing a walkthrough of execution schedules should they take on a mandate – accretion/dilution analysis will be conducted by primary investment banking coverage.
Timing an Equity Issuance
ECM will comment on when it is a good time to issue equity. Generally, when equity markets are robust with investor appetite, valuations are frothy and stock markets are rising, the window is more attractive as it minimizes dilution to existing shareholders (which the corporate owes a fiduciary duty to). Issuers also want more certainty on price, so turbulent market movements or high volatility is not desirable. A good compromise on both of the above are times when several industry peers have already issued successfully – for resource companies in mining and oil & gas, one healthy issue usually leads to a string of issues.
Related Reading for Equity Capital Markets
|Equity Capital Markets|