REFILE-Royal Mail to lead retail revival for IPOs?

By Graham Fahy

March 11 (IFR) - After being largely ignored by the IPOmarket for many years, UK retail investors are set to become animportant piece of the puzzle once again.

Political considerations dictate that three large sales bythe UK government - the sell-downs of Royal Mail Group, Lloyds Banking Group and RBS - willhave to include retail, while bankers are keen to tap thisprice-insensitive investor base in order to put the IPO marketback on its feet.

In fact, some companies coming to market have alreadystarted looking to retail buyers. In October, Direct Lineincluded an intermediary offer - in which retail could subscribethrough 29 brokers - in its £905.6m IPO.

Without any advertising, the deal attracted 25,000 retailorders (for £177m of the available stock). Fellow car insurerEsure is also tapping retail investors through intermediaries inits IPO, which began bookbuilding on Friday.

Both offers are a long way from the previous high-profileeffort to attract British retail participation - the 2010listing of Ocado - when the online retailer largelyfailed to convince customers to take part.

But conditions now are much more favourable. Low interestrates have severely depressed annuity rates, prodding cash-richpensioners to look elsewhere to supplement their retirementincomes. And bankers are sniffing around the reservoir of retailmoney in the belief that state-sponsored offers will seduceinvestors who cannot find decent yield elsewhere.

"Compared with a decade ago, there is a colossal amount ofmoney available," said Jim Renwick, chairman of ECM, EMEA atBarclays. "It is concentrated among the retired or nearlyretired - people who have investible assets. There is around£500bn under administration by this segment of the market."

At the same time, the line-up of government assets to besold is a perfect fit for the retail market, with yield set tobe the driver for each transaction. Royal Mail's £1bn-plus IPOis due first. UBS is advising the government, whileBarclays, Bank of America Merrill Lynch and Goldman Sachs areworking with the company.

The deal is expected later this year. Mobile phone operatorEE, a joint venture of France Telecom and DeutscheTelekom is another yield-play looking to float latethis year - although 2014 is more likely - that would benefitfrom the retail interest aroused by Royal Mail.

Of course, it is not just the amount of potential investmentthat makes retail investors so desirable, it is also theirexpected behaviour.

"Retail money is less sensitive to pricing and incrediblysticky, usually staying with investments through good times andbad as long as they generate a good yield," said a senior UKbanker.

Another reason for bankers to look favourably on retailparticipation is that all the downside that used to come fromlarge retail components of shareholder registers has diminishedsince they were last a major part of UK flotations.

"Fifteen years ago, everything had to be donetelephonically, prospectuses had to be printed and sent by post;share certificates had to be printed and dispatched," saidRenwick. "Now applications are processed online, shares aredematerialised and held in nominee names, communications are byemail and, correspondingly, the costs per shareholder havefallen to less than a tenth of what they were in the 90s."

80s THROWBACK

Before the renaissance of the UK retail investor can begin,however, the government has to settle on a method ofdistribution. It must choose between the low cost and ease of anintermediary offer, which would be sold through brokers toactive and informed investors, and the more expensive full-onretail offer (complete with advertising campaign) that wouldattract a wider range of UK taxpayers.

Bankers, at least, know which they prefer. They believe thatthe open offers of the 1980s and 1990s have been made obsoleteby the efficiency and economics of intermediary offers, in whichbrokers specialising in private clients promote the offers totheir existing client base.

Nigel Morris of Solid Solutions Associates, which has workedon nearly all the UK retail offers in the past 20 years, saidtoday's retail investor differs significantly from the investorof 20 years ago, and is better served by intermediaries.

"We are living longer and pension schemes are not keepingup. The government and financial advisers are encouraging peopleto take responsibility for their retirement incomes by managingtheir own portfolios. The retail investor that participated inpublic offers hoping to make an overnight return is a thing ofthe past," Morris said.

Decisions also need to be made on whether to give retailinvestors special treatment to encourage participation. In the90s, the UK government used partly-paid offers to retail. Butbankers doubt whether today's investors would appreciate thetime-value of the discount. Among other things, the partly paidstructure makes it essential to ensure a positive aftermarket.

One option favoured by some bankers is to lock in retail byoffering bonus shares after one, two or more years of ownership.This could help retail investors to get over the potentiallyunpalatable aspects of a deal such as RBS, for example, whichmany investors may feel they have already paid for as a resultof the government bailout.

"There could be a perception that the government is askingthe public to pay twice for the bailed-out banks. To make thiswork, investors will have to be incentivised," said the seniorbanker.

Discounts are the bluntest instrument with which to favourretail, but they encourage flipping.

TELL SID, NOT HUGO

From the government's point of view, intermediary offerscould be seen as deepening - but not widening - the shareholderbase by selling to investors who already participate in thestock market, rather than reaching all taxpayers.

Bankers question whether there would actually be muchdifference in outcome between the two options, because aneffective marketing campaign could garner mass participation(through the brokers). But such details may be unimportant,because decisions will be ultimately dictated by politics, notby ECM considerations.

A full retail offer will be a mixed bag for the banksrunning an IPO. The Direct Line offer ran for just 10 days, buta fully blown retail roll-out would take much longer. On theother hand, market risk should be less of an issue. In appealingto retail, the government could not risk pricing the deal toohigh - and thus setting up the possibility of a negativeaftermarket.

In any case, it will need to be careful not to promise toomuch to investors.

To generate interest when Railtrack was privatised in 1996,the government used partly-paid shares, cash discounts and bonusshares - and an astonishing promised dividend yield of 19%(which was upped during the marketing). Five years later, thegovernment forced Railtrack's nationalisation, unleashing afierce and chaotic battle to win compensation for shareholders.The current government will seek to minimise any opportunity forcomparison with Railtrack.