American investors eager to build international portfolios continue to spur ADR growth, helping to set record after record
Appetites for greater real returns are being satisfied by a new breed of emerging market companies from Eastern Europe and the Middle East; and, in the meantime, new capital raisings from Europe have maintained the trend for companies from developed countries to act as the mainstay of a market that is growing wider and deeper. By David Lake and Julie Kozma
Interesting new trends are emerging in the depositary receipt market this year. And, if the first half is anything to go by, it is progressing along its relentless growth path, knocking off records as it goes.
Three key trends leap out from the statistics available for the period January-June 1997. First, privatizations of state enterprises have picked up substantially as governments from nine countries raised $3 bn through DRs - more than triple the amount raised in the same period last year; second, ADRs are being used as an added value tool for corporate treasurers interested in making acquisitions in the US; and third, companies anxious to avoid onerous SEC and other US regulations are increasingly opting for GDRs.
The top 15 capital raisings for first half 1997 also show new emerging markets gaining attention and old favorites continuing to compete for investment. Latin America is on the comeback trail, with Brazil's Unibanco NYSE issue taking the top spot. And India's Videsh Shanchar Nigam Ltd (VSNL) came to market with its long-awaited GDR, the largest ever listed in London. The developed countries chimed in with three bank ADR issues in the top ten. Among European issuers, the UK's National Westminster came to market with a $300 mn issue, and it was joined by two Netherlands banks, ING Group and ABN Amro.
Statistically, growth in the DR market has been steady both in terms of capital raised and trading turnover. As of mid-1997, the total number of DR programs exceeded 1,700, representing over 60 countries. According to the Bank of New York, total capital raised through DR programs hit $6.7 bn in the first six months, up more than 12 percent over the same period in 1996.
'I see the continuation of this torrid capital raising trend in the second half of 1997,' says Ken Lopian, BoNY's senior vice president of DRs. 'We have seen substantial capital raising and privatizations, as well as a great demand for shares by investors.'
As to where investor interest is headed, Lopian sees it as balanced. 'Nonetheless, emerging markets, especially Latin America, are back in favor. We have seen a definite pick up in activity in this area last year, and that is backed by a strong performance during the first half.'
According to BoNY's latest figures, 110 new DR programs were established by 36 countries, with dollar trading volume growing rapidly on the NYSE, Nasdaq and the Amex - by some 27 percent to a total of $221 bn. About 1.5 bn DRs valued at over $30 bn traded in the OTC and European markets, up from $15 bn last year. Since 1990 compound annual growth of DR trading has reached 25 percent.
'Unlike what we experienced in the early 1990s where new issues were floated mainly from emerging markets, we have seen a tremendous resurgence in the creation of ADR programs from developed countries like the UK, Germany, France, Switzerland and Scandinavia,' says Marcus Barthe, first vice president at Merrill Lynch and senior international quantitative analyst, as well as creator of Merrill Lynch ADR Indices. 'In light of the fact that it has become easier for US investors to buy local shares, it would seem that ADRs from these markets would not be so prominent. However, volumes have been strong. It only proves that the companies issuing these programs want a presence in the US without worrying about whether investors can deal with local shares or custody issues.'
The first half of 1997 was very strong for western Europe - with 42 new DR programs from 15 countries and $3 bn raised in 32 new offerings.
However, led by Unibanco, Latin America has also taken a leap forward. The region saw 23 new programs from seven countries and nine offerings raising a total of $1.4 bn. This was more than twice the amount raised during the same period last year, providing a much needed Latin lift.
Asia weighed in close to Latin American totals, with 33 new programs from ten countries, and 13 companies from six countries raising $1.4 bn, a 13 percent increase.
'We're seeing high levels of investor interest in new programs, as well as a steadily increasing demand for shares in previously existing programs,' says James P Donovan, managing director at Citibank's depositary receipts business. 'The markets have shaken off the effects of the peso crisis that dampened ADR interest in 1995. Investors see excellent growth opportunities going forward in ADRs, and they are looking beyond the developed markets more and more, to new areas like Latin America, Asia, Central Europe and even Africa.'
According to Peter Duggan, vice president and global product manager responsible for DRs at Bankers Trust, Latin America has moved into a new category, where it is sometimes no longer considered an emerging market. This is due to the level of sophistication and the increased use of financial instruments, though Latin American markets still lack a certain maturity.
'Investors are seeing the real return potential offered by new emerging market issuers from places like Egypt, Lebanon, Morocco, Lithuania, and Croatia,' he says. 'From an emerging markets perspective, this is where investors are seeing return potential and are allocating portfolios. Latin America continues to be a good place to invest, but the appeal of higher returns from new markets overshadows that.'
One of the prominent trends coming out of the ADR picture is the use of DRs as a component of corporate strategy. A growing number of companies are upgrading Level One programs to listed programs, or creating a new program using an existing one. In both cases, they are choosing the DR vehicle to acquire a US company for stock. One example is ING, which listed a few months ago to acquire Equitable of Iowa.
'ING had a Level One for many years. Now, due to its new listing, it is in a good position to acquire a company for stock,' says Eric Frank of JP Morgan. 'You are seeing more cross-border transactions. When a foreign company is involved, they want to be listed so they can make an acquisition using a listed security. It's becoming a popular vehicle for large transactions of huge US companies. The ADR is playing a key role because it is the instrument that makes the acquisition possible. Without DRs these companies cannot compete to do tax-free acquisitions for stock.'
Other DR trends include more stock splits and ratio changes, due in large part to run-ups on global share prices. A number of ADR issuers, such as British Petroleum and Royal Dutch, have split stock, reflecting this run-up. As a result, they have realigned their stock prices to where peer companies are trading. Analysts are hoping this will serve to improve the liquidity of these shares - as they are brought more into the buying potential of the average retail investor - and so increase trading volumes.
On another front, emerging market players have continued their migration toward Global Depositary Receipts (GDRs). A GDR offers them a broader investor base, usually through a London Stock Exchange listing, thus diversifying their shareholder base and providing greater liquidity. Indian companies have been among the largest users of the GDR tool.
'For emerging market companies the idea of going for a GDR, which exposes the company in Europe and the US, is more attractive than going only with a US-listed ADR,' says Duggan at Bankers Trust. 'Within the GDR, companies prefer the London listing, with a Rule 144a placement in the US. These issuers are not in a position to go through all the reporting requirements of the SEC, which can be onerous and expensive. In addition, to fully list in the US they would have to convert accounting to international Gaap standards, which is not feasible for many.'
Another important trend is for long-established ADR programs to come to the market with new issues as companies which have been quiet for a time are suddenly being actively traded again. This reflects an increased diversification of US investors away from the more popular or most widely followed industries toward ADR companies that offer attractive value plays.
'This arises from the efforts of the many brokerage houses which have approached the investment community and pushed them to understand the value of these ADR companies as compared to the value of US counterparts,' says JP Morgan's Frank. 'There seems to be an increased desire on the part of US investors to continue to diversify and expand the scope of companies in their portfolios. There are more investors looking at ADRs, both on the individual and institutional side. We have also seen growth in passive index investing in the last year or two in the US.'
The recognition of the importance of investor relations in the DR formula is growing as fast as trading volumes. As US consultants, analysts, banks and brokers try to get this message across, more companies are taking steps to establish some form of communication prior to listing.
There are still stragglers, however, especially among recently-privatized companies that have had no previous experience with the investor community.
Away From the Crowd
'Many companies realize IR can separate them from the mass of companies trying to access capital,' says Donovan. 'And understanding the importance of IR for ADRs depends on the companies. The trend is for a more evolved understanding of IR's role today than even a year ago. There is a fair amount of inconsistency across the markets, and companies coming from areas that are just becoming industrialized are less sophisticated because of minimal exposure to developed capital markets or western styles of management.'
However, Donovan reckons the most important factor is their willingness and receptivity to the concept of investor relations. 'They are not telling us they do not want to do IR because it is not practiced in domestic markets. They are very aware of the requirement to reach investors. This means honing professional skills and many are hiring consulting firms to help them through the process. I have seen a massive sea change in this regard as companies realize the benefits that can be derived from a well-focused IR program.'
Investment banks and depositaries are doing a good job at letting issuers know that IR is important, and that companies should consider what impact their communication can have on investors. According to Duggan, 'International investors are a little more demanding since they do not have immediate access to the domestic market, so you need to do more hand holding. They have to realize the need for open communication, and have senior management available to field questions from investors through good and bad times. This is slowly changing as companies realize this fact.'
Top 15 DR Capital Raisings - first half 1997
|Rank||Company Name||Country||Structure||Exchange||Capital Raised|
|3||ING Group N V||Netherlands||ADR||NYSE||$347,460,425,00|
|4||National Westminster Bank||United Kingdom||ADR||NYSE||$300,000,000,00|
|5||Telefonica De Espana||Spain||ADR||NYSE||$298,553,830,00|
|6||ABN Amro Holdings||Netherlands||ADR||NYSE||$259,000,000,00|
|7||Banco Bilbao Vizcaya||Spain||ADR||NYSE||$250,000,000,00|
|11||Royal Bank of Scotland - Pref F||United Kingdom||ADR||NYSE||$200,000,000,00|
|12||China Steel Corporation||Taiwan||GDR||Portal||$186,607,573,00|
|13||Electricade De Portugal||Portugal||ADR||NYSE||$180,826,640,00|
|15||Compania Brasileira De Distribaicao - CBD||Brazil||ADR||NYSE||$172,500,000,00|
Source: Bankers Trust
Gallaher - A UK Firebrand
Financings related to cross-border activities are hot this year in the ADR arena, and the UK market is taking advantage. One such transaction is the spin-off of the Gallaher Group from American Brands, which at $3 bn is one of the largest ever deals of its kind. It is also the first time a UK company has demerged from a US parent; and the New York Stock Exchange's largest ADR cross-border transaction.
For every one American Brand share, a North American shareholder received one Gallaher ADR, equivalent to four ordinary shares. About 170 mn ADRs were issued and, at the same time, American Brands changed its name to Fortune Brands.
'It has been an exciting period for Gallaher,' says Claire Jenkins, manager of IR at Gallaher Group (third from right, below). 'The move was received well by the market, despite expectations of share flowback to the UK. As soon as Gallaher became the Gallaher Group plc, we were no longer part of the US index. So we knew some US investment funds would have to sell off a portion of their shares. But the degree of flowback was less than expected.'
Moreover, there's been strong buying of Gallaher shares by US institutions since the spin-off, especially by Fidelity, whose holding is now 6 percent. 'Originally, the market assumed the ADR volume would be primarily sales by US institutions, with ADRs being cancelled and buys registered by UK institutions. We're pleased there's been a degree of two-way business, with buying interest in the US.'
Gallaher, which is the largest manufacturer of tobacco products for the UK market, including Silk Cut and Benson & Hedges cigarettes, cigar, pipe and handrolled tobacco products, hails originally from Londonderry, Northern Ireland, where it was established in 1857.
Today, advertising, promotion and brand building play a key role in Gallaher's business and the company has won numerous awards for advertising innovation and creativity. But investors crave a different kind of attention, as Jenkins surely knows: 'A good IR program has the tangible benefit of shareholders understanding your strategy,' she says. 'As long as you deliver this strategy, any future intentions of the company will be more readily supported by the investment community. Though we knew that some of our US shareholders would have to sell shares, even before the demerger we were conscious that any IR program should look after current shareholders.'
The company embarked on a transatlantic roadshow before the demerger, with the CEO, CFO, sales and marketing director, financial controller, general manager of corporate affairs, and manager of IR all going along. In the UK, it concentrated on introducing the company to a financial community not too familiar with American Brands, despite Gallaher being its largest subsidiary. 'Although we were Gallaher, a UK company, our ADRs were still trading in the US, and we needed to communicate with our US shareholders. This had some positive effect on the flowback.'
Following the May ADR, a June roadshow was initiated to visit anyone left out on the first visit; and another trip is being planned for October to announce the first post-demerger results. In the US, IR firm Taylor Rafferty is helping disseminate information as quickly as possible, and is putting together a database of potential and current shareholders. In the UK, the firm uses financial PR company Cardew & Co to deal with the media and sell-side analysts. Dresdner Kleinwort Benson and Morgan Stanley are Gallaher's financial advisors.
'We take IR very seriously. We know it's management's responsibility to effectively communicate the message to its investors,' says Jenkins.
CSN - Finely Honed Steel
After years of trading in the American OTC market, Latin America's largest steel producer is now ready for a US listing. Preparing for the added scrutiny, Brazil's Companhia Siderugica Nacional (CSN) is building IR capacities and improving all aspects of its communications strategy. 'The role of IR is essential,' says Jose Marcos Treiger, head manager of IR at CSN. 'Through a higher level of transparency, IR can raise market capitalization and its value while reducing capital costs. We are currently converting financial statements into US Gaap which will allow us to have the necessary mechanisms in place to select an exchange for a Level Two ADR. The time horizon is this year.'
After privatizing in April 1993, CSN launched a Level One ADR in November of the same year. It has 75.2 bn shares outstanding with a float of about 35 percent. Its ADRs correspond to 7 percent of the shareholder base, or a market capitalization of about $2.6 bn. In CSN's OTC program one ADR represents 1,000 common shares with equivalent voting rights. Trading currently at around $33, the ADR produced a total return of 48 percent year-to-date in dollar terms.
The success of the OTC ADR is partly due to the company IR program. According to Treiger, a concerted IR effort began in January 1996, when only 9 percent of shares were held by foreign investors. Since the program was initiated, this has nearly doubled to 17 percent.
'This is a good example of how IR can contribute toward increasing the knowledge and confidence of investors in a company, both domestically and abroad,' says Treiger. 'Today, we are a company motivated by results. The IR person works with the treasury, and together they have completed major debt issues. In fact, over 18 months IR helped raise nearly $1 bn.'
In its own right, CSN is a giant among giants. In 1996, it ranked as the largest molten steel producer in Latin America as well as one of Brazil's largest exporters. Its market share is a plus when battling for investor confidence, but CSN has also restructured its corporate philosophy to propel it to the top of international ranks.
To compete aggressively on an international level, the former government-owned enterprise had to make crucial changes. It started the process to change its depositary bank to JP Morgan, whose established investor focus made it an attractive sell; and the company is working with Dewe Rogerson in New York to help with IR support and strategy.
'We are seeking value-added services with our IR program,' Treiger adds. 'One of our tasks is to explain to foreign investors how our company works, what our strategies are, and help them interpret our financial results, which are still in Brazilian Gaap. We do this by participation in a number of major international conferences and roadshows.' Part of the IR mandate includes outlining an investment strategy which takes advantage of Brazil's privatization wave, investing in the country's rail network, energy projects and port facilities, all aimed at reducing logistical costs and becoming more self-sufficient in power generation.
'When we began IR efforts, coverage of CSN was small,' concludes Treiger. 'Now we have 22 brokers covering us regularly, and Goldman Sachs released a buy recommendation. As a result of this intensive exchange of information and transparency, we have maintained a high level of buy recommendations. Going forward, with the future listing in mind, IR will continue to play a crucial role.'
New Zealand's Tranz Rail: on the Right Track
Among New Zealand's numerous government-owned institutions already sold off, or in the process of being packaged for the market, is Tranz Rail. And, like many other privatizations, Tranz Rail has chosen to take the DR route.
In June 1996, Tranz Rail went public via an IPO of 31.05 mn ordinary shares worth NZ$175 mn sold in New Zealand, the US and Europe. The ordinary shares were listed on the New Zealand Stock Exchange at a debut price of NZ$6.19 which has since reached a high of NZ$9. Today, Tranz Rail is one of the top ten NZSE companies by market capitalization and one of the constituents of the Top Ten Index.
As a mid-cap company, Tranz Rail chose Nasdaq for its US stock market listing. Investors there can buy either ordinary shares or American Depositary Shares (ADS), the latter representing three ordinary shares. Over 80 percent of the shares offered at the IPO were transformed into ADRs and the success of its ADR program encouraged Tranz Rail to go back in March 1997 with a secondary offering of 11.3 mn ordinary shares. All of these shares were consequently taken up by ADRs, raising another $59 mn.
'The ADR program gives Tranz Rail access to deep capital pools within the US,' says Ron Russ, CFO at Tranz Rail New Zealand. 'It is an effective instrument for foreign companies to participate in the American market, and it has worked for us. BoNY was chosen as our depositary because of its good track record with Wisconsin Central Transportation Co, one of our founding shareholders. It offers a quality product and its ADR program is used by a number of New Zealand companies listed in the United States.'
Tranz Rail Holdings Ltd is New Zealand's leading multi-modal transport company with a national network of trucking, rail and shipping freight and distribution services, as well as passenger rail and ferry services. Its transformation, begun in 1982, from an unprofitable and inefficient government department into a dynamic, profitable transport company is exceptional. 'The corporation increased productivity by some 373 percent, reduced staff numbers from 22,000 to under 5,000, and became a profitable company called New Zealand Rail,' says Russ proudly.
Impressive statistics, undoubtedly appealing to the investment community. And in 1993 the government sold the company to Tranz Rail Holding, a private consortium, including America's largest regional railroad, Wisconsin Central Transportation, Fay Richwhite, a New Zealand Merchant Bank, the Berkshire Partners, and Boston Investment Co. 'Since the acquisition, the company has further increased revenues and operating profit,' notes Russ.
One of Tranz Rail's prime IR strategies is telling the international investment community about New Zealand's success story, and how the company emerged as an improved and efficient winner in the privatization game.
'The challenge that the company faced during and since its IPO was getting a profitable railway company at the other end of the world noticed for the first time by US investors,' says Russ. 'The extensive global roadshow by senior management helped to put Tranz Rail on the map. In fact, such has been the interest in this stock that it was unnecessary to do a roadshow to sell the second public offering.'
The mechanics of the company's investor relations efforts are similar to those of many domestic US companies. Tranz Rail's investor roadshows consisted of one-on-one meetings, small group investor meetings and luncheons. Investors were presented with comprehensive information on company performance. Briefings began with a video about the company, then moved on to presentations by the managing director and CFO, supported by computer generated slide shows.
Apart from special events like the roadshow, the company regularly produces an annual report and a corporate profile. Fact books and copies of the investor presentations are available to both the ADR holders and the ordinary shareholders. The Internet is becoming an important tool for delivering information on a timely basis (www.tranzrail.co.nz). It includes the annual report, half-year report, product information as well as up-to-date media releases and share prices.
At the time of the IPO, Tranz Rail enlisted support from Goldman Sachs and Schroders, which coordinated the roadshow, bringing investors to meet with the managing director and CFO. Both the managing director and CFO continue to have regular contact with investors in New Zealand and the US.
'It is important that our investor relations program is led by the chief financial officer, Ronald Russ, with support from the corporate relations department,' says Nicola McFaull, manager of corporate affairs at Tranz Rail. 'We believe that investors should have direct access to senior management and access to the CFO is key to a successful program. The impact of the IPO roadshow on our secondary offering was proof of that.'