The current state of the depositary receipt market, and profiles of one specialist ADR fund manager along with four ADR programmes: two Indonesian, one anglo-American; and one Mexican
In today's economy, more than two-thirds of the world's goods and services are produced outside the US, and American investors have shown that they, too, want to diversify by geography as well as by business sector. Most estimates reckon that in the next five years individual and institutional investors will increase the foreign content of their portfolios by $300 bn or more. The trend is clear: a massive flow of funds is slated for global markets.
This is one reason why depositary receipt banks and brokers are unconcerned by the slump in new issuance in the first half of 1995. Pointing to new records on the trading side, and the fact that some 35 issuers, mainly from Europe, raised a respectable $3.6 bn, the industry believes that the market is merely suffering from a little bout of Mexican malaise.
The recent European activity included capital-raisings for the telecom industry and for privatisations across the board, and German companies like Deutsche Bank establishing new ADR programmes. Fund raisings were not confined to continental Europe, however: three UK cable companies featured - General Cable, Videotron Holdings, and Nynex CableComms Group; but Indonesia bucked the emerging market slump in the first half with IPOs for two pulp and paper companies, April and APP.
Regardless of the numbers of issues and programme launches, the overcapacity on the ADR depositary side was made clear by a shakeout among the US banks engaged in the business. Chase Manhattan and Morgan Stanley both shut up shop, and Bank of New York snapped up all of BankAmerica's unsponsored programmes. Left fighting it out are BoNY, Citibank, Morgan Guaranty and Bankers Trust, with Midland Marine appearing as the only new GDR entrant.
Ken Lopian, senior vice president of Bank of New York, suggests that the depositary banks' biggest competition is actually from direct investment rather than from one another. 'We have seen more and more investors going to the home market,' says Lopian. 'However, ADR ownership is still growing fast. When a company establishes an ADR, it will attract all sorts of investors. Some go direct, some buy ADRs. The net result of doing an ADR is a net increase in total US investment.'
Lopian highlights the importance for companies of US-generated research. 'If analysts cover you, even though you may not be a listed ADR, you will have significant US ownership,' says Lopian. 'Many companies say they are researched in London, but that may be coming from a continental or UK-based bank without distribution in the US. We take care to point our clients in the right direction, suggesting they try to cultivate relationships with analysts so they may be able to get researched. On top of this, there is no question that listed ADRs have a better trading potential because they are more likely to be researched.'
One hot topic in the ADR community is the future role of the NYSE in international listings. Companies can trade successfully OTC, but a Big Board listing undoubtedly attracts a higher level of attention. Richard Grasso, new chairman of the NYSE, sees foreign listings as one the exchange's most fertile growth areas. And he envisages the possibility of offering the ordinary shares of foreign companies denominated in their local currency, side by side with the ADRs of those same companies.
Grasso admits that this remains some way off, and would only happen if investors showed clearly that they wanted it. He sees the NYSE becoming a truly global institution when the number of non-US companies, already over 200, reaches a critical mass of 450 to 600: this, he believes, would allow the NYSE to create and test products and services designed for the global investor.
Some observers say Grasso's plan would have a negative impact on the ADR market, but not Lopian. He is intrigued by Grasso's notion of trading ordinary shares in addition to a company's ADRs. 'The idea is fascinating and we want to learn more,' says Lopian. 'Anything that can focus and increase international trade in New York is worth looking at.'
However, Morgan Guaranty's Eric Frank questions the advantages: 'I don't see the benefit to the exchange and the investment community. Companies like Unilever are already listed here, not in ADR form, but as a share denominated in gilders issued by the New York register. I don't understand where the added value of Grasso's idea is. If you already have ADRs listed on the exchange, and the exchange has the volume, where is the benefit?'
Frank suggests that one reason for this NYSE move may be the cost to investors of the ADR format. 'There is no question that there are some programmes out there that are too expensive, whether it be the dividend fees charged by some depositaries, or the low ratios of ADRs to common stock that increase trading costs. Many people are getting more sensitive to these additional fees and are looking for alternatives. But will Grasso's structure really be a less expensive route? I doubt it.'
Whether Grasso progresses with this idea or not, there is certain to be more activity in foreign stocks from America. Russian ADRs are currently waiting in the wings for SEC approval, eastern European companies are coming to the fore, and Latin Americans are eager to get back into the picture. The upshot could well be that ADR new issuance will pick up in the months ahead, and that the trading boom will continue as usual.
In the following pages of this survey, we take an in-depth look at Brandes, a fund manager with a special predilection for foreign stocks in general and ADRs in particular; and at four companies with ADR programmes: Indonesia's April and APP; Nynex CableComms, the Anglo-American partnership; and Mexico's Bufete.CFOs peddling ADR offerings should not leave San Diego off their itinerary. Based in this pleasant city on the edge of the Mexican border is Brandes Investment Partners. With some $4.5 bn worth of global investment accounts for taxable and tax-exempt clients, Brandes is widely known as one of America's largest ADR investors.
Brandes' International Preference
In business since 1974, Brandes was among the first US fund managers to focus on a global approach. It is a bottom-up, value-oriented global equity manager with 110 employees under its umbrella. Essentially, it buys stocks which have determinable value, but are unpopular and undervalued. 'We look for bargains,' says Jeff Busby, Brandes' managing director and portfolio manager. 'We take advantage of mispricing. Our style is contrarian and that requires investors to overreact to bad and good news. We don't see the general investing public becoming an entirely rational body anytime soon.'
When the international equity market dipped after the Mexican crisis, Brandes was one of only a few US investors for whom this represented a buying opportunity. At end 1994, its biggest holding was Italian telecom company Stet, which accounted for 6.63 per cent of the total portfolio. Telefonica de Espana, Nestl, Telmex, Hanson, and Hong Kong's Hopewell Holdings all make up over 5 per cent of the portfolio and all have been accumulating over the last year. Other large holdings include BBC Brown Boveri, Alcatel Alsthom, HSBC Holdings and Brazil's Telebras.
In terms of portfolio adjustments by industry, last year saw additions among communications, financials and energy stocks; reductions among metals, health care and autos. In addition to its global equity portfolios, international equity was added in 1990, while a global balanced and a domestic equity programme were added in 1991. The firm launched its international small-cap fund last year, and a Brandes International mutual fund this year.
Brandes prefers markets with developed regulatory structures. It is reluctant to invest in China or Russia, wary of immature capital markets which Busby dubs 'gambling casinos.' However, it is looking at markets creating western-style regulatory schemes. 'We want to control risk by buying cheap companies,' says Busby. 'Emerging markets tend to be growth markets and trade at premiums, but they are volatile. So, if you are a value investor, you can pick up good bargains when everyone is running away.'
Brandes has been propelled by international diversification and Busby is upbeat about that trend continuing. 'The typical US pension fund has under 10 per cent committed to foreign stocks,' he says. 'But their intention is to reach 20 per cent, as two-thirds of the world's investment opportunities are located outside the US. Over time, a fund that does not have significant overseas positions will put itself at risk.'
In most firms, portfolio managers have responsibility for the success or failure of results. Not so at Brandes, where management is a controlled process. Decisions are the responsibility of an investment committee made up of 21 fund managers and researchers, including three senior members, Charles Brandes, Glenn Carlson and Busby. Decisions must be unanimous and the committee pegs targets for individual securities of between 2 per cent and 5 per cent, setting maximum percentages in accounts per security, country or industry.
Each investment has two people assigned, one with industry experience, one with regional experience. 'If a company visits us, they would meet with industry analysts as well as regional and country analysts,' says Busby. 'We have an electronic bulletin board where we advertise to the whole research/portfolio management staff who is coming to visit.'
Institutional portfolios hold 35-40 issues over some 12-15 countries and 15-20 industries. Brandes normally holds stocks for three to five years to realise full appreciation potential, and portfolio turnover is in a 10-35 per cent annual range. Equities are sold once they reach full value: sell points are set by the committee before the stock is bought but are subject to ongoing review. 'Time is an important element in what we do,' says Busby. 'Only time will allow a stock to reach its potential. That is why we are not looking for a quick hit.'
Brandes' ideas are developed on the basis of a range of sources: global financial and industry publications, internal research and outside contacts including international and domestic research houses. It uses computer screens for low price/cashflow, low price/ book, low price/earnings and low debt/equity ratios, using Compustat, Morgan Stanley, Datastream, Bloomberg and Worldscope databases. The process identifies companies ripe for more research, perhaps 250.
Securities are bought only if there is a large enough value discrepancy to provide a safety margin and an opportunity for appreciation. In addition, they must have strong balance sheets and cashflow. Brandes does not restrict itself to a set standard on market capitalisation, but its stocks tend to be over $250 mn and average $5 bn-$10 bn.
The firm has trading relationships with 40 brokers worldwide, all of whom compete for business. It uses Reuters and Bloomberg services to monitor markets, as well as services like Instinet and Autex to facilitate trading efficiency. No services are purchased on a soft dollar basis.
Brandes does not feel the need to have analysts based in financial centres around the world but Busby and his colleagues do say that company visits can help improve returns and/or reduce risk. 'We are a value investor,' says Busby. 'We are disciplined, rational analysers of information that is freely available, as opposed to growth investors who look into a crystal ball to spot trends. We visit companies prior to investing or shortly thereafter. However, many times when you meet with management, you tend to get a sales job. For us, the numbers tell us what we need to know.'
Nevertheless, visits to the firm's offices in San Diego by company executives are appreciated and a growing number of companies are opting to make the trek. 'I want to know management orientation - whether they are shareholder-oriented or not,' says Busby. 'We look at their share ownings and compensation structure.'
Brandes, while voting its proxies, generally does not get involved in the panoply of corporate governance issues. However, Busby says that it would vote against certain measures, including any that shelter the company from the operation of the market, such as poison pills.
Brandes will buy ADRs and underlying ordinary shares. But if the execution price is equivalent, ADRs are preferred because of the administrative ease and cost advantage in settlement and custody. While noting that sponsored ADRs tend to have better information flows than unsponsored, Busby is indifferent to the advantages of the former: 'We can do the work to translate it into an apple to apple situation so we can make cross-border comparisons.'
Brandes takes advantage of this. For example, it maintains about 3 per cent of its portfolio in Hong Kong-based Hopewell Holdings, an unsponsored ADR. When building this position, Brandes negotiated with the depositary to get rebates to defray part of the commission costs. 'Sometimes you get a liquidity advantage by trading on the home market,' notes Busby. 'If a client wants Hong Kong ADRs, we might purchase the shares in the home market and then have the executing broker deliver through the depositary bank and settle the trade in terms of ADRs with our various custodians. Often, depending on volume, we get a rebate from the depositary, because we are adding shares to the ADR programme.'
April & APP: the New Asian Lions
No offering in 1995 better emphasised the global nature of the ADR business than Asia Pacific Resources International Holdings Ltd (April). The diversity of April's structure is astounding: it has a pulp and paper company headquartered in Singapore, using the forest resources and operating facilities of Indonesia, with the final product slated for the PRC paper market and financing via an NYSE-listing for a Bermuda shell company.
Yet April's Level 3 $150 mn IPO/ADR faced a number of difficulties for its April 1995 offering. To start with, it was the first emerging market issue to join the ADR market since the Mexican shock of December 1994. Second, within days of launching its roadshow, April had to turn up the heat on its IR message to combat the entrance of APP, a Singapore-based Indonesian pulp and paper company eager to raise $250 mn on the NYSE (see below).
On the IR side, the challenge was met by Dewe Rogerson Inc, led by president Carol Ruth and supported by Asian expert Corey Cutler. 'It was the first emerging market offering in 1995, and it was designed to break the Mexican chill,' Ruth says. 'Everyone was watching the deal closely, but April convinced investors that Asia is not the same as Mexico. It was not an easy job.'
Scott Baird, vice president at Salomon Brothers, which led the April offering, says the issue was originally billed for December. But Salomon held off, waiting for a 'decoupling' of Asia and Latin America. While Mexico plunged into crisis, April was beginning production at its Riau pulp mill, the largest single-line pulp mill in the world.
'April is simply the lowest cost producer in the world, and it is expanding directly into the fastest growing markets of Asia,' says Baird. 'Whether up-cycle or down-cycle, this company is going to make its money. As for vaunted currency risk, with pulp and paper priced in US dollars any devaluation of the rupiah would put April in an even better position. All the dynamics were in place, and investors saw the opportunity.'
April's decision to list in the US was driven largely by rising institutional demand, and the company chose a Bermuda incorporation to make the market comfortable. 'Investors wanted all the comfort associated with SEC-registered and NYSE-listed securities,' Baird says. 'A dual listing was dismissed as complicated with no benefit, although it is likely that a Singapore listing will follow eventually.'
Global investors had been waiting years for Indonesian pulp to hit the world stage. With a paper crisis in the offing, and Asian publishing magnates worried about supplies, the Indonesian forests can be depended on for cheaper and faster supplies than Scandinavia or North America.
'Paper is a sector that grows with economic development,' notes Cutler. 'With no forests, China has a tremendous need for paper, and it has been importing it from around the world. Now they can source it out of Asia. As for why April chose to finance out of the US, it made sense because America has more pulp and paper experts than anywhere else.'
The only real glitch came within a week of April hitting the roadshow circuit when APP charged into the fray led by Morgan Stanley. Both companies are part of the batch of family-owned enterprises in Southeast Asia currently reorganising and going public. To catch up with April, APP launched an accelerated roadshow schedule, apparently on the assumption that a certain amount of money was out there for large Southeast Asian pulp and paper companies. APP and Morgan felt that the first one to market would get a better pricing.
With two Indonesian paper players blitzing the country, the first question at every presentation was, 'How is April different from APP?' The short answer was that April is positioned in international markets while APP focuses on the domestic market in Southeast Asia. Further, April was almost 100 per cent pulp with some rayon production, whereas APP covered paper products. A big part of April's appeal was its plan to build two joint venture paper mills in China, in Suzhou and Hangzhou.
The strongest selling point of April's roadshow was that founder Sukanto Tanoto was on hand to explain the April vision, along with brother Polar Tanoto, COO. Tanoto had a success story to tell. Unlike most second or third generation ethnic Chinese tycoons in Indonesia, Tanoto, 46, built April from scratch. 'It wasn't just management on the roadshow, it was the heads of the organisation - the entrepreneurs who built the company,' says Cutler. 'Investors like to meet the guy whose money is at risk alongside theirs.' As for the rest of management, investors were impressed by the international array of seasoned experts recruited from world-leading forest product players.
In the end, April closed days sooner than APP, with its $150 mn IPO bringing market capitalisation to over $1 bn. Meanwhile, APP came in with a tidy $250 mn, though the offering seemed to have sold at a lower premium than April's. Still, both have done well in the aftermarket, with April up $2 over its offering price of $71/2, outperforming the S&P forest and paper products index by a nice margin. As for April, its reception in America, and future expansion plans could encompass another trip to market soon.
The summer of 1995 is not one that many UK cable TV companies will wish to remember. None of the firms listed on Nasdaq or the London Stock Exchange (LSE) could boast stellar performances since their launch, and with investors depressed over results, it seemed like a bad moment for yet another one to come to market.
But Nynex CableComms had other ideas. With an ambitious build-out programme scheduled to incur some $3 bn in start-up costs, the company wanted new capital right away. Nynex Corp, the US Baby Bell parent of CableComms, had already provided structured financing and invested 330 mn since 1991. That was paying off, with the value per home in the UK cable franchise market growing at least three-fold; and the wholly-owned subsidiary apparently adding value to Nynex Corp's stock.
Management had a good IR story, but the environment for UK cable stocks was not cooperating. General Cable had had difficulties getting its smaller UK issue off the ground: investors had questioned its value and the company had been forced to reduce its pricing.
Nynex decided that if its issue was to fly, investors must be attracted from both the US and the UK. The finance team came up with the idea of 'stapling' two different CableComms stocks into one tradeable security. The concept had been tried on a major issue before, notably in the ill-fated Eurotunnel project.
So selling the structure was a sensitive job, and Nynex made a point of distancing itself from Eurotunnel. 'Investors have a long memory when it comes to losing money, and you want to steer clear of minefields,' says Colson Turner, VP and treasurer of Nynex Corp. It was vital to have two first-rate co-ordinators - Salomon Brothers and SG Warburg. Due to its complexity, everything about the issue had to be first rate.'
'When we decided on the IPO, we were looking at the requirements necessary to build out the UK cable operation while diversifying financing,' says Nicholas Mearing-Smith, CFO of Nynex CableComms. 'We wanted to take away the uncertainty about where the next dollar would come from.' In the event, the $660 mn issue was successfully digested, creating a company with a market cap of some 1.2 bn, one of the top 150 in the UK.
Some 60 per cent of the issue was bought in the UK and internationally (via the LSE); 40 per cent via ADRs traded on Nasdaq. CableComms units consist of 'stapled' securities of UK CableComms and US CableComms, separate legal entities. The principal assets of UK CableComms and US CableComms are 90 per cent and 10 per cent respectively of the outstanding capital stock of Nynex UK CableComms Holdings.
The dual approach was useful for a number of reasons in the UK. 'On one hand, the issue was structured to make sure we did not incur US tax costs in organising the entity,' says Mearing-Smith. 'On the other, getting the maximum number of UK investors was critical. The 90/10 mix met LSE listing requirements for a UK business, and qualifies us for the FT All-Share Index.'
Nynex could have tried to persuade UK investors to buy into a pure US listing but, as Turner notes, 'The number of UK investors that can invest in US-registered stock that is a UK business is much smaller than those who could invest in a UK-registered company listed on the LSE. If it was a purely US issue, the demand would not have materialised. The biggest investors to date in the UK cable industry are UK institutions.'
But the country with the most experience in cable is undoubtedly the US. 'You want US interest because the US has watched cable companies develop from nothing into major businesses,' says Mearing-Smith. 'US interest would undoubtedly pique UK interest in the stock.' Turner notes the reasons for going the ADR route: 'You use an ADR to make it simpler for US investors to transfer shares in the event of a sale.'
Once the structure was understood, Nynex had to explain why it was different from the other UK companies. Most other operators are joint ventures between cable companies and telcos, whereas Nynex was the sole owner and had demonstrated that it could build a new business out of its core competencies.
'The ability to start a new business on our own is a fundamental point that the world has not appreciated,' says Mearing-Smith. 'Especially given that the industry does not have a stellar track record of creating new businesses. One of the key reasons for doing the flotation was to explain that we had created a new business and added value.'
'We got a deal away in a difficult environment,' says Mearing-Smith. 'We have established a perception in the market that our business is a quality one that looks to the long-term and will win market share.'
Bufete Dishes UP IR New York-Style
Before the Mexican Christmas crisis, Bufete Industrial's NYSE-listed ADR was trading around a comfortable $38, up from its November 1993 IPO price of $23. In the wake of December's peso devaluation, Mexican spending was slashed and Bufete, along with its Mexican construction complaints, was slammed hard. Bufete wound up with a foreign currency loss for 1994 of some 100 mn new pesos ($16 mn), resulting from $83 mn of liabilities in foreign currency and $20 mn of monetary assets. By February 1995 the price of Bufete ADRs plunged to $5.
'Mexico, and US investors in Mexico, were in a state of shock,' says Peter Zambelli, vice president of Georgeson & Co, the New York-based IR consultant that handles Bufete's ADR. With stockholders' equity of some $133 mn, Bufete is capitalised at $366 mn. 'Bufete, like everybody else, was hit hard. Debt went sky high, interest rates were out of sight, and lending practically stopped. But Bufete had a story to tell different from most construction companies and, with some New York-style IR, rebounded in style.'
Bufete's crowning jewel came this June when Georgeson landed a media placement that most US companies would have given their CEO's right arm for. Craig Torres, Mexico City bureau chief of the Wall Street Journal, interviewed Bufete's top executives and ran a Heard on the Street column with the headline: Mexican construction firm Bufete Industrial is seen by some analysts as poised for rebound. The story was a self-fulfilling prophesy. Within ten days, Bufete's ADR, previously trading around $8-$10, rocketed to $20. 'US institutional investors are coming back to Mexico,' says Zambelli. 'The crisis has been weathered, and the status reports will be looking up.'
But the battle to pull Bufete out of the Mexican morass was waged long and hard. It started in January when a dozen Mexican companies surfaced to lick investor wounds at a Goldman Sachs conference in New York, entitled Recent Events in Mexico: A Corporate View. Bufete took the stage on the panel with infrastructure giants Empresas ICA and Grupo Tribasa. Analysts' questions began flying, many of them on the subject of toll roads. ICA and Tribasa had grown huge and registered record revenues on toll road construction in the early 1990s. But all that 'hit a brick wall', in the words of one analyst, in early 1994, when it became obvious the roads were being grossly underused.
Bufete, though, never built toll roads, and this became the 'germ of its positioning,' according to Zambelli. Bufete's expertise, unmatched in Mexico, is in process engineering - chemical plants, petrochemical complexes, thermoelectric plants, and pulp mills - and its assets are engineers and design technology that generate cash even in slow times. This sector dried up in Mexico just as toll road projects were booming, and luckily for Bufete, the company looked beyond Mexico's borders for work.
Quietly bidding on projects in Spain, the Far East and Latin America, Bufete's backlog at the end of 1994 was 39 per cent international projects, and 44 per cent denominated in foreign currency. It even had a contract to modernise a Houston, Texas sewag system. In other words, Bufete had at least 19 months of hard, non-peso cash to look forward to. This further differentiated it from ICA and Tribasa.
Another important move in terms of the Bufete's investor relations story was its purchase of Chilean construction company Ovalle Moore last August. A CS First Boston analyst points out that Chile has been 'going great guns' for several years. An estimated $42 bn will be invested in Chilean infrastructure over the next decade, and Ovalle has provided Bufete with significant new business over the last year.
Another foreign foothold is an equity partnership with MW Kellogg Co, a subsidiary of Dresser Industries and owner of 21 per cent of Bufete. The relationship goes back more than 20 years and was formalised in 1989. Since the Mexican crisis, Kellogg has been leasing some of Bufete's 1,800 engineers, benefiting from cheap labour costs and brightening Bufete's revenue stream.
Armed with the strong Bufete story, Georgeson organised three conference calls with analysts in first-half 1995, talking about earnings and new contracts. 'Everything in Mexico got painted with the same brush,' Zambelli comments. 'But Bufete was different, and it communicated better than the average Mexican company - with more than adequate disclosure and responsiveness to analysts' questions.'
One analyst at a leading investment bank says Bufete's recent campaign was an exception in Mexican IR: 'Most Mexican companies make analysts mad in terms of communications. They don't return phone calls and their disclosure is less than adequate. But Bufete did a good job.'
According to Stuart Sugarman, senior vice president at Marleau, Lemire USA, and one of the top Mexican market analysts in the US, many of Mexico's major industrials are trading at reasonable levels - if the investor is comfortable with the currency story. 'There are demands for infrastructure build-out, although Mexico's problem this year is inflation and some of the expected early spending will not occur at the same levels,' says Sugarman. 'Long-term, Mexico will come back.'