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Stock exchanges in Asia and Europe have made tremendous strides in raising equity capital for companies over the past three years. Is U.S. superiority at an end?
Randy Myers, CFO Magazine
October 1, 2008
Deep into the largest financial shock since the Great Depression, it is easy to imagine that the rise of the Chinese and Indian economies and the resurgence of London as a financial center could tilt the balance of capital-markets power. America's biggest global banks, desperate to rebuild capital ratios, are surviving on life-supporting cash infusions from sovereign wealth funds. Huge chunks of the once-vibrant securities markets in the United States, such as collateralized loan obligations and asset-backed mortgages, are moribund. And prominent international bankers, like HSBC group chairman Stephen Green, are declaring the end of Wall Street's "center of the universe" status.
The numbers speak volumes. The combined domestic market capitalization of Nasdaq, the New York Stock Exchange, and the American Stock Exchange ($18.2 trillion as of last June) accounted for just 35 percent of the total on exchanges worldwide. That's down from 52 percent in 2001, according to the Committee on Capital Markets Regulation (CCMR), an advocacy group. While the market capitalization of exchanges outside the United States has grown 22 percent since 2002, U.S. exchanges have seen their collective market cap rise only 9 percent. And today, when foreign companies go public outside their home countries, they choose the United States much less frequently.
"As recently as the late 1990s, the U.S. market was the envy of all other markets in terms of its liquidity, its access to capital, and the strength, once a company had gone public, that being public provided," says Murray Beach of TM Capital Corp., a Westwood, Massachusetts-based investment banking firm. "Today that's not the case."
Weaker public markets in the United States could make it tougher for CFOs to attract well-capitalized equity investors — the ones that give venture-capital and private-equity shops a way to underwrite start-ups. A market with lower liquidity can also exacerbate and sustain price-deflating market crises and make issuing follow-on deals dilutive. And if U.S.-bred CFOs have to sojourn abroad and educate emerging-market investors on their company's prospects, the learning curve will be steep.
Many bankers and other capital-markets players dismiss the idea that the United States is no longer at the pinnacle of equity markets, or that hordes of U.S. companies are about to export their listings abroad. Nasdaq senior vice president Bob McCooey of the exchange's capital-markets group insists that "the gloom and doom we hear almost constantly is very overblown." Says Don Ogilvie, independent chairman of the Deloitte Center for Banking Solutions: "We have the best, strongest, and most innovative financial system in the global economy."
To CFOs and other executives, however, a possible demotion of the United States in the global pecking order is real. "We've lost our edge," asserts John Sauickie, founder of money management firm Titanium Asset Management Corp., which went public last year.
CFOs have been voting against the United States with their feet. In the first half of 2008, of the 27 initial public offerings that CCMR identified as being executed by U.S. companies, 6 (22 percent) listed on a foreign exchange only, up from 8 percent in 2007. The big winner? London. During the first seven months of 2008, the London Stock Exchange (LSE) was home to 22 international IPOs that raised $5.8 billion. That was 3 IPOs and nearly $4 billion more than three of its biggest competitors — the U.S.-based NYSE Euronext and Nasdaq OMX, plus Germany's Deutsche Bourse — combined.
Experts credit the LSE's creation of the Alternative Investment Market, or AIM, to attract small, international growth businesses. The 13-year-old AIM offers minimal regulatory hassles and low-cost underwriting fees. Companies file financial reports only twice a year, and don't need to comply with the Sarbanes-Oxley Act.
Sauickie took Titanium Asset Management public on AIM in a $120 million IPO in June 2007. The process was faster and the upfront underwriting expenses were lower. Sauickie estimates his company's all-in cost was $700,000, roughly half the price tag of a U.S. listing. And as a special-purpose acquisition company (SPAC), Titanium found other advantages. In the United States, these shell companies with no operating assets are prohibited from talking with prospective acquisitions prior to their IPO. They also must spend at least 80 percent of IPO proceeds on their first deal. UK securities laws impose no such restrictions.
Chris Work, CFO of Resaca Exploitation Inc., a Houston-based oil-and-gas development company, says his company never seriously considered going public on a U.S. exchange. The company took its $106 million IPO to AIM last July. Beyond benefiting from lower underwriting costs and lighter regulations, he says, Resaca is now paying substantially less for directors'-and-officers' insurance than it would have in the litigation-happy States. Work also figures that if Resaca invests in foreign companies, its stock will enjoy a higher price from British investors, who, he says, with a long imperialistic history, tend to value the foreign reserves of small oil-and-gas companies higher than U.S. investors do.
It isn't just that U.S. stock exchanges are losing domestic listings. According to the CCMR, they captured only 6.9 percent of international IPOs in 2007 and a paltry 1.7 percent in the first half of the year — and missed out on all of the 20 largest international IPOs. That pales in comparison with previous years (see "Exporting Capital" at the end of this article).
Even when foreign equity issuers do come to the United States, the CCMR notes, they almost always bypass the exchanges and raise money directly with a 144A private placement. That lets them avoid Securities and Exchange Commission registration, but also limits the potential investor pool to qualified institutional buyers.
Not So Fast
It would be hasty to write the obituary for the U.S. financial markets just yet, however. History has shown, from the Great Depression to the savings-and-loan crisis of the 1980s, that they can take a punch. The Federal Reserve posits that the shrinking share of international business going to the United States reflects a maturing of foreign equity markets, not an erosion of U.S. platforms. Growing numbers of Chinese companies are starting to list their shares in Hong Kong and Shanghai, as evidenced by Shanghai's jumping from seventh to third in equity financing worldwide in 2007, according to Dealogic.
But as the Federal Reserve mouths confidence, it has been pumping billions of dollars into the U.S. banking system, determined to keep U.S. financial markets from crumbling. Likewise, the SEC, to keep the doors open to foreign companies, recognized international accounting standards for companies that want to list here, rather than forcing them to continue to reconcile their financial statements with U.S. generally accepted accounting principles.
The health of U.S. banks, of course, is key. They still dominate global equity dealmaking. Of the 10 banks handling the greatest volume of equity deals in the first half of 2008, 7 are based in the United States, including leader Citigroup. U.S. financial institutions handled a greater volume of equity and debt issuance in the first half of 2008 than the banks of any other nation, and in debt transactions outpaced Europe, the Middle East, and Africa combined. Why? As Peter Morici, a business professor at the University of Maryland, notes, U.S. banks have built up product and market expertise and technical capabilities that are difficult for newer competitors in developing economies to quickly replicate. Despite their sizzling economic growth, China, India, and the Middle East aren't yet fielding world-class banks that can siphon business away.
Still, regulators are under pressure to make the United States's capital markets more attractive. "Very high on our list is a need for tort reform," says Noreen Culhane, executive vice president, global corporate client group, for the NYSE Euronext. "One of the reasons companies resist listing on the U.S. exchanges has to do with concerns about frivolous lawsuits and liabilities that would not occur in other markets." The other action item: restructuring banking regulation to promote greater collaboration between various bodies that oversee U.S. financial markets.
But a new banking regulatory infrastructure will take years to create, if it happens at all. Tort reform is far from a shoo-in. The ability to sue for investment fraud under U.S. law is what draws capital from foreign investors into the United States, greatly boosting liquidity, notes former SEC commissioner Roel Campos. While down by more than half year-over-year, net foreign purchases of long-term U.S. securities totaled $62.7 billion in June alone, including $47.8 billion from private investors, reports the U.S. Treasury.
Liquidity is all important. U.S. exchanges were still the busiest market for raising equity this year (see "Run for the Money" at the end of this article). While London's AIM may be an accommodating platform, it offers virtually none of the liquidity that U.S. markets offer, a critical concern for companies interested in continually attracting new money, says Titanium Asset Management's Sauickie. That's one reason why Sauickie's firm, having just gone public in London last year, recently filed with the SEC to list shares in the United States, too, most likely on Nasdaq. "Our investors are 100 percent U.S. institutions and would like the liquidity that's available here in the U.S.," Sauickie explains. "Valuations in the U.S. and UK are comparable if you use an apples-to-apples comparison of long-only managers, but there are many more asset managers participating in a larger market here; thus, the marketplace for transactions is greater."
The growing number of companies looking to tap those U.S. investors poses an issue for finance chiefs. Research firm Renaissance Capital says the total IPO backlog in the United States, excluding SPACs, was 129 as of last August, compared with just 50 at the IPO market's trough in mid-2003.
The data invites numerous interpretations for CFOs wondering whether to join the queue. Nasdaq's McCooey sees the backlog as proof that companies see the United States as the most liquid market in the world. "I spend a good portion of my time speaking with companies we're soliciting to come to our market," McCooey says. "They have great businesses and they are ready to come to market. The only thing keeping them back is the overall psychology and negative sentiment in the market now."
But the unusually high filing rate this past July and August — 5.2 new filings for every deal priced — could also reflect the inability of companies to raise money in the credit markets or find an acquirer rather than a true turnaround in the U.S. equity markets, according to Renaissance Capital. And with the exchange indexes making a daily habit of swinging 1 percent or more, it can be hard to find the courage to pull the trigger on an offering.
"The market volatility of the past year, the sudden violence of the bursting housing bubble and financial downdraft, the extraordinary measures taken by the Federal Reserve and other central banks to prop up the financial system — all of these suggest that anyone claiming to know for sure the strength of the U.S. capital markets is either fooling himself or others," says Timothy Canova, professor of international economic law at the Chapman University School of Law in Orange, California.
U.S. companies waiting to go public could pull their offerings, of course (149 companies did just that in 2001's downturn), and move their capital-raising hopes to one of the several booming exchanges around the globe. The large investment banks, after all, are already forming joint ventures in markets like China. Whether U.S. companies go over or not, the question as to whether the United States has finally lost its edge may be settled.
Randy Myers is a contributing editor of CFO.
That Sinking Feeling
The percentage of U.S. issues in danger of being downgraded is climbing.
Even as debate continues regarding the preeminence of its stock markets, the United States is feeling a pinch in another sector: corporate bonds. Nearly a quarter of the entities that currently have rated debt are in danger of having that debt downgraded, according to the latest calculations by ratings service Standard & Poor's.
An S&P Global Fixed Income Research report (titled "Downgrade Potential across Credit Grades and Sectors") shows that 747 debt issues were facing possible downgrade in August — 18 percent higher than the total count a year ago, and double the number of issues poised for potential upgrades.
"This continues the trend that started last July, where a materialized housing slowdown coupled with large bank write-downs largely assisted in dislocating the credit markets," S&P notes in the report. The report defines potential downgrades as entities having either a negative outlook or ratings on CreditWatch with negative implications across rating categories AAA to B–.
Such a big slice of total U.S. issues hasn't been in danger of downgrade since December 2003, when 26 percent confronted that possibility. The all-time high for such downgrade-ready debt issues was December 2002, when 32 percent stood on the brink, according to S&P's Diane Vazza, managing director for Global Fixed Income Research.
June saw a momentary improvement, as the number of issues facing downgrade actually declined slightly, to 22 percent. But the upward trend soon resumed. The United States continues to top the list of potential bond downgrades globally.
Broken down by sector, forest products and building materials recorded the highest ratio of issuers with a negative bias relative to their total rated universe, followed by mortgage institutions and automotive. By rating designation, B-rated companies have the highest potential for downgrades, with 156 companies, or 21 percent of the total. Of the 747 issuers at risk for downgrades, 62 percent are speculative-grade, rated BB+ or below. — Stephen Taub and Roy Harris