Cornerstone Investments in Ipos the New Normal for European Markets?

CORNERSTONE INVESTMENTS IN IPOS THE NEW NORMAL FOR EUROPEAN MARKETS?

Ross McNaughton and James Cole of Paul Hastings (Europe) LLP and David Gossen of Deutsche Bank AG, London branch examine the key features and development of cornerstone investments in the European IPO markets.

Cornerstone investments, where one or more characteristics with their counterparts in the use of cornerstone investments in Europe, investors agree in advance to subscribe for Hong Kong. For example, they: examines the law and regulation governing a certain number of shares in a forthcoming these investments, and highlights prevailing initial public offering (IPO), are a relatively • Typically included a lock-up period that market trends and developments regarding new feature of the European IPO markets. restricted a cornerstone investor from their typical commercial terms. They were fi rst seen in Europe around 2011, selling its shares for a particular length most notably in the Glencore IPO and have of time after the offering. MARKET DEVELOPMENT since become an increasingly common feature of European IPOs. • Were disclosed in the prospectus. Cornerstone investments have been a prominent feature of equity capital markets While cornerstone investments are relatively • Were always made at the IPO price. in Asia, and particularly Hong Kong, for new in Europe, they have been prevalent in several years. Historically, they were used Hong Kong for some time. The Hong Kong • Did not come with any board member by investors to secure their share allocations Stock Exchange (HKSE), unlike European nomination rights. in particularly “hot” deals. They were also regulators, directly regulates cornerstone and used for marketing purposes to seek to give other pre-IPO investments, and has issued The absence of specifi c regulation of European a positive perception to offerings, particularly guidance on the specifi c features for pre-IPO cornerstone investments has provided greater among retail investors. However, this practice investments, including regulation of their key fl exibility for their commercial terms. drew criticism from various commentators commercial terms, such as lock-up periods, who questioned the fairness of selected disclosure, price and board nominations. This article analyses the development of investors receiving a guaranteed allocation cornerstone investments and compares and in shares that later soared in value, while In Europe, the fi rst examples of cornerstone contrasts them to other forms of pre-IPO and other investors missed out or were subject investments shared similar features and concurrent IPO investments. It also considers to their orders being scaled back. This

• Wall Receive Submit draft crossing draft cornerstone • Sign cornerstone Moral prospectus non-disclosure investment commitment agreement language to agreement from investors regulator

• Receive Conﬁrm Receive Receive watermarked price fact pack draft draft and sign (presentation prospectus prospectus cornerstone Price and ﬁnancials) extracts • Comment on cornerstone investment range investment agreement set agreement

Final Management Valuation valuation meetings discussions discussions

• Bookbuild Pre-IPO preparations Pre-deal investor education • Roadshow

• Make intention to ﬂoat • Publish Pricing announcement prospectus • Distribute draft prospectus • Books open

criticism led to the HKSE Listing Committee In contrast with Asia, cornerstone fi xed monetary amount of shares in an introducing specifi c rules governing certain investments in Europe are relatively new, IPO. This agreement is usually defi nitively features of pre-IPO investments in the form of and are not subject to specifi c regulation. committed to shortly before the IPO price interim guidance in October 2010, which was During the relatively quiet new issuance range is announced and the prospectus is supplemented by further guidance in October market in the period following the fi nancial published (see box “Cornerstone timeline”). 2012 and February 2013 (the HKSE rules) crisis of 2008, market participants in The price at which a cornerstone investor (www.hkex.com.hk/eng/rulesreg/listrules/ Europe considered ways that cornerstone will invest is usually at, or determined by listguid/iporq/guidance1.htm). investments could be used to enhance reference to, the IPO price. There is typically deal certainty in the uncertain markets a lock-up period preventing the investor from The HKSE rules derive from the HKSE’s that were prevalent at the time. However, selling its shares for a set period following underlying principle of fair and equal it was not until the Glencore IPO of 2011, the IPO, and the principal commercial terms treatment of all shareholders in an IPO. which involved both a London and Hong of the cornerstone investment are generally Among other things, the HKSE rules require Kong listing, that a European IPO featured disclosed in the prospectus (see “Lock-ups” that: cornerstone investors. Since then, there and “Disclosure” below). have been several European IPOs featuring • Any placing to cornerstone investors cornerstones, including the recent examples Importantly from an investor’s perspective, must be made at the IPO price. of: NN Group NV in the Netherlands in 2014; a cornerstone investment brings with it a Rocket Internet AG in Germany in 2014; guaranteed allocation of shares; that is, the • Placings to cornerstone investors should Zalando SE in Germany in 2014; Euronext investor’s order will not be subject to scaling- be subject to a lock-up period of at least NV in the Netherlands in 2014; Lifco AB in back, as might otherwise be the case in the six months following the listing date. Sweden in 2014; Dustin Group AB in Sweden context of a successful IPO bookbuilding in 2015; Eltel AB in Sweden in 2015; and process (see box “Bookbuilding”). • Cornerstone investors should not have Integrated Diagnostics Holdings Plc in the right to nominate directors following London in 2015. From an issuer’s perspective, having one or the listing. several cornerstone investors can increase KEY FEATURES deal execution certainty by pre-selling a • Details of the cornerstone investment, portion of the shares to be sold in the IPO including the identity and background A cornerstone investment is an agreement and reducing the amount of shares required of the investors, must be disclosed in the by an investor, usually a large institutional to be sold in the bookbuilding process. It listing document. or sovereign investor, to subscribe for a also has the added benefit of driving

of documentary and management due Bookbuilding diligence. While cornerstone investors can obtain information in advance, usually in the In a bookbuilding structure, the lead bank markets the securities without naming form of a near-fi nal draft prospectus, as a the exact price and before the prospectus is fi nalised. The banks “build a book” general rule it is important that cornerstone by obtaining non-binding expressions of interest from potential investors in which investors do not receive any material they indicate the likely level and price at which they would participate. At the end information that is not ultimately included of this bookbuilding period, the price is fi xed, the prospectus is fi nalised, the shares in the prospectus, as they will not want to are allotted and dealings in the shares commence. An important feature of the run the risk of becoming an insider, and more bookbuilding structure is the ability to create price tension between investors, with importantly from the issuer’s perspective, all investors competing against each other in a single offer. the prospectus must include all material information for an investment decision in the IPO. marketing momentum by providing a level • Do not come with a lock-up. of endorsement for the IPO, particularly if For this reason, the investment decision a well-known investor publicly attaches its • Do not generally require disclosure in for the cornerstone investor is generally name to the deal. This can be of particular the prospectus. predicated on receipt of the fi nal prospectus, importance in certain geographic sectors, for and a marked version of the prospectus is example, emerging markets issuers, or for • Do not come with a guaranteed often provided to the cornerstone investor to certain industry sectors such as healthcare, allocation. highlight any changes against the draft of the and real estate investment trusts. prospectus, or sections of the prospectus, that • May be subject to scaling back in the it reviewed as part of its due diligence. This A cornerstone investment can be compared bookbuilding process. creates a timing tension, as the cornerstone to, and contrasted against, pre-IPO strategic investor must be committed in principle investments and anchor investments (see MAKING A CORNERSTONE ideally well before the launch of the IPO and, box “The IPO timeline: investment options”). INVESTMENT accordingly, the key disclosure sections of the prospectus should be substantially complete Pre-IPO strategic investments In Europe, a traditional IPO timeline typically before they are shared with the cornerstone Pre-IPO strategic investments are consists of: a preparatory stage; pre-deal investor. investments made in companies when an investor education; and a bookbuilding IPO is contemplated but well before the period. The cornerstone investment due diligence preparatory stage has commenced. These process, and the questions and answers typically, although not exclusively, have more Preparatory stage that typically follow, may help to frame and fl exibility than a cornerstone investment The preparatory stage of an IPO generally craft the fi nal prospectus content. From a and may be structured by way of a pre-IPO takes at least three months. During this commercial perspective, the cornerstone convertible bond or similar instrument. As time, the issuer prepares to go public investors’ views on valuation will also help they are not made within the context of an and undertakes any required corporate to refi ne the price or price range at which the IPO process, these investments contain fewer reorganisation, implements governance IPO is ultimately launched. restrictions on the disclosure of information to measures (such as identifying and appointing an investor in a pre-IPO strategic investment additional board members and appointing At the end of the preparatory stage, as compared to a cornerstone investor. This is committees), prepares the prospectus and and before a public launch of the offer due to the absence of signifi cant disclosure briefs the analysts, who then write pre-deal through publication of an intention to fl oat requirements for private companies and, as research on the issuer. There may also be announcement (ITF), the issuer and the the IPO is not imminent, the absence of the early-look or pilot fi shing meetings with underwriters for the offering will require some inside information-related concern that an investors to start to expose the issuer to the form of commitment from the cornerstone investor should only receive information that broader investment community and explore investor(s) to invest, subject to confi rmation is to be disclosed in the IPO prospectus (see market appetite for the IPO. as to the eventual price range. This would “Disclosure” below). ideally be contractual but, in practice, During this preparatory stage, an issuer cornerstone investors will typically want to Anchor investments may identify and approach prospective cross-check their valuation and views on the As with cornerstone investments, anchor cornerstone investors, generally with the issuer with those of the investment analysts investments are made in the context of an assistance of the underwriters involved and so this agreement more usually takes IPO process. They constitute a commitment in the IPO. Once interested, investors are the form of a so-called “moral commitment”. from an investor to place a sizeable order in made subject to appropriate confi dentiality the order book at, or towards the beginning undertakings, following which they will carry Pre-deal investor education of, the bookbuilding process. Anchor out their due diligence and valuation work Pre-deal investor education immediately investments are also designed to add on the issuer. follows the publication of the ITF, when immediate momentum to the bookbuilding the underwriters’ analysts release their process, but unlike cornerstone investments, Due diligence undertaken by a cornerstone investment research on the issuer and they: investor generally includes a mixture hold investor education meetings with

practicallaw.com / September 2015 / PLC Magazine 41 © 2015 Thomson Reuters (Professional) UK Limited. This article first appeared in the September 2015 issue of PLC Magazine. The IPO timeline: investment options

Strategic or Cornerstone Anchor Order book “crossover” investment

Up to three years Around two months pre-initial public offer pre-intention to ﬂoat (ITF) About one month pre-ITF Post IPO launch (IPO) announcement

IPO timeline

IPO launch or ITF

• Investment at a point • Pre-IPO agreement for a • Commitment from an • Investors place orders when an IPO is cornerstone investor to invest investor to place a sizable during the bookbuilding contemplated, but not yet a ﬁxed amount in the IPO. order in the book at the period. imminent. • Participation generally beginning of the • No guaranteed allocation. • Can involve one or more disclosed in the prospectus. bookbuilding process investors. • Price set by reference to (generally no separate • Usually in the form of indicative IPO price range. investment agreement). common equity, • Usually accompanied by a • No lock-up period. preference shares or lock-up period. • No guaranteed allocation. convertible bonds. • Guaranteed allocation. • No public disclosure.

Advantages

• A private process, with • Increased IPO certainty, • Drives bookbuilding • Transparent sale process. product ﬂexibility and which drives bookbuilding momentum. • No overhang. fewer disclosure momentum and provides • May provide an • Relies on traditional price restrictions. endorsement for the IPO and opportunity for certain discovery process, with no • Allows early stage improves credibility at stipulations as regards additional management engagement between the launch. corporate governance (for meetings, due diligence or issuer and the investor • May provide an opportunity example, in roadshow required. community without a full for certain stipulations as privatisations). IPO. regards corporate • No lock-up period or • May allow the issuer to governance (for example, in overhang. reduce leverage. privatisations). • May signal a strategic relationship. • Can assist with price discovery.

Disadvantages

• A riskier investment: the • Usually requires a post-IPO • Generally a weaker • Inﬂuenced by market liquidity event may not be lock-up period. message to the market conditions. forthcoming. • Due diligence is required, than a cornerstone • Orders may only come in • A relatively illiquid although information will not investment. towards the end of the investment. go beyond what is in the • May require additional bookbuilding period. • May be at a relatively high prospectus or what other access to management. cost to the issuer in terms investors ultimately receive. of price and/or coupon, • For investors, their commit- and other terms may be ment may span several days required to compensate or weeks while the IPO is if the IPO does not marketed. materialise. • May be limitations on counting towards free ﬂoat.

key investors. This process typically lasts cornerstone investor will sign a binding a price range prospectus is published around two weeks. Using feedback from the cornerstone investment agreement. The containing the disclosure of the cornerstone meetings, the issuer and the underwriters cornerstone investor will also agree on the investor(s), and a bookbuilding period will use this time to ﬁ nalise and determine form and content of its description and its commences. The bookbuilding period the price range at which the IPO should cornerstone investment commitment that generally lasts for two weeks, during be made. will be included in the IPO prospectus. which investors submit their orders into the bookrunners’ order book. The issuer Assuming that the price range is within the Bookbuilding period and the bookrunners determine the final range expected by a cornerstone investor, Following pre-deal investor education, the price at the end of the bookbuilding period, at this point, if it has not already, the price range for the offering is announced, which is then communicated to the market.

The final price determines the price that DEVELOPMENTS IN THE EUROPEAN cornerstone investors have subscribed for the cornerstone investor must pay for its MARKET their shares at a discount to the IPO price. stake, subject to any price thresholds that the cornerstone investor negotiated into Given the absence of specifi c regulation For example, the “reference” shareholders its agreement. of cornerstone investments in Europe, the in the Euronext IPO subscribed for their development of cornerstone investments shares at a 4% discount to the ultimate IPO Given the binding nature of the investment in Europe has been largely market-driven. price, although they were subject to a three- agreement, cornerstone investors are on risk An analysis of the details of recent deals year lock-up period (see “Lock-ups” above). during the two-week bookbuilding period involving cornerstone investors reveals some Similarly, in the NN Group’s IPO in 2014, for any movements in the market that might interesting trends, particularly as regards key cornerstone investments were structured affect the size of the offering and ultimate commercial terms such as lock-up periods, through an exchangeable bond, where purchase price of the shares offered in the price, disclosure and board nominations. the cornerstone investors also benefi tted IPO. During stable markets this risk is low from a discount to the IPO price. Both of but it may become more acute during times Lock-ups these offerings were listed on the Euronext of increased volatility. This was seen, for The inclusion of a lock-up period for Amsterdam Stock Market. Whether similar example, in the October to November pricing cornerstone investors is a typical feature in pricing structures could be used on IPOs listed window in 2014, as a result of, among other Europe. This originally stemmed from the fact on other exchanges should be assessed at things, declining oil prices. that lock-up periods are mandatory in Hong an early stage, as they could be restricted Kong. However, lock-ups are not applied by both local listing rules and corporate law. To meet this risk, regardless of market consistently across Asia; for example, in volatility, a cornerstone investment agreement Singapore, lock-ups are not typically imposed Where regulations allow for a differential will usually include a provision, as an express on cornerstone investors. between the IPO price and cornerstone condition to subscription, that the fi nal offer subscription price, there are several price per share is within the agreed price Although European IPOs have included a commercial factors to be considered in range. While it would be very unusual for a lock-up for cornerstone investors, there is whether such a discount would be merited. cornerstone investor to commit without the now an increasing trend not to have them. Cornerstone investors are at risk of market benefi t of this condition, there has been at least None of the cornerstone investments movements for a longer period than one example (Polymetal International Plc’s IPO in the Kennedy Wilson, Hispania, Merlin investors who place their order through the in 2011), where one of the underwriters, VTB Properties, Pershing Square, Lifco, Eltel, bookbuilding process, given that a binding Capital, agreed to subscribe for $100 million Dustin or Malin IPOs made reference to lock- cornerstone investment agreement, which is in the offering in light of, among other things, up arrangements. generally subject to few conditions, is entered the long-standing relationship between the into before the price range is announced and VTB group and Polymetal. In addition, where there is a lock-up period, the roadshow and order taking begins. a six-month period is not necessarily market Another way in which cornerstone investors standard. For example, in the Rocket Internet In some circumstances, the promise of have sought to mitigate market risk is to insert IPO and the Aena IPO, cornerstone investors guaranteed allocation may not be enough a specifi c maximum subscription price. The were subject to a one-year lock-up period, to compensate for the amount of on-market IPO of Aena, the Spanish airport operator, and the “reference” investors in Euronext’s risk. However, as discussed, there may be a involved three cornerstone investors: IPO were subject to an even longer lock-up perception that the mere fact of a cornerstone Corporacion Financiera Alba; Ferrovial; and period of three years. investor’s participation is an endorsement The Children’s Investment Trust. When Aena’s of the offering. This may give momentum to IPO initially launched in October 2014 with The benefi ts of lock-ups are well known. the order taking and potentially increase the a price range of €41.50 to €53.50, market They provide greater stability or confi dence ultimate IPO price and, therefore, the discount conditions were relatively unstable and each in post-IPO share performance and as the at which that cornerstone investor is obliged of the cornerstone investors committed lock-up results in lower liquidity, fewer free to invest under the terms of the cornerstone to their investments subject to different fl oat shares are available to buy after an IPO, investment agreement. Ultimately, however, maximum price caps: €53.33 for Corporacion which helps to drive demand. Lock-ups also the amount, if any, of an IPO discount will Financiera Alba; €48.66 for Ferrovial; and provide a managed overhang so the market depend on the expected level of demand €51.60 for The Children’s Investment Trust. can anticipate when a secondary exit from for the shares and how important it is to the the lock-up is likely to occur. cornerstone investor to receive a guaranteed Ultimately, the IPO failed to price after allocation in the offering. its initial launch and was postponed until Price markets had stabilised, relaunching in There has generally been an expectation in Disclosure January 2015 with a revised price range of the European market, derived from the Hong While there is a specifi c requirement for €43 to €55. Shortly following the relaunch, Kong market, that cornerstone investors disclosure of the identity of cornerstone the price range was again revised upwards would invest in an IPO at the same price as investors and the amount of shares that they to €53 to €58, with the IPO ultimately investors participating through the order have committed to buy under HKSE rules, pricing at the top of the range and above book (see box “The IPO timeline: investment in Europe, the inclusion of such disclosure the maximum price condition imposed by options”). While this is usually the case, is determined under general disclosure two of the cornerstone investors. there have been recent examples where principles.

practicallaw.com / September 2015 / PLC Magazine 43 © 2015 Thomson Reuters (Professional) UK Limited. This article first appeared in the September 2015 issue of PLC Magazine. From a legal perspective, in the UK, the applicable disclosure requirement is that a Related information prospectus should contain all information This article is at practicallaw.com/7-617-5844 necessary to enable investors to make an Other links from practicallaw.com/ informed assessment of the assets and liabilities, fi nancial position, profi ts and Topics losses, and prospects of the issuer and the Cross-border: equity capital markets topic5-103-1376 rights attaching to the transferrable securities Initial public offerings topic3-103-1377 (section 87A(2), Financial Service and Markets Listing, Prospectus, Disclosure and Transparency Rules topic8-103-2096 Act 2000). If the offering is also to be made Prospectus and marketing topic7-103-1380 into the US, disclosure standards under the US Securities Exchange Act of 1934 will apply, Practice notes meaning that the offering document should Due diligence and verifi cation for an initial public offering (IPO) 8-107-3992 not contain an untrue statement of a material Initial public offerings (IPOs): overview 4-107-3989 fact or omit to state a material fact necessary Intention to fl oat announcements (ITFs) 8-522-2247 in order to make the statements, in light of Marketing an initial public offering (IPO) 9-107-3996 the circumstances under which they were Preparing a company for an initial public offering (IPO) 7-107-3997 made, not misleading. Prospectus Directive: overview 2-503-7573 Structure and timetable of an initial public offering (IPO) 2-107-3990 While the size of the cornerstone commitment Underwriting and bookbuilding (IPOs) 1-107-3995 is likely to be considered material in the context of the IPO for liquidity purposes, the Previous articles identity of the cornerstone investor may not European IPOs: back on track or the end of a good run? (2015) 0-599-6168 be material. However, from a commercial Preparing for a main market IPO: great expectations (2013) 7-531-6878 perspective, including this disclosure may Pre-marketing: threading the needle (2013) 1-524-0551 give a positive perception to the marketing The European IPO market: signs of life (2012) 1-522-6220 of the issue and the offering as a whole. By Year of the dragon: listing in Hong Kong and Shanghai (2012) 4-520-4815 analogy, the identity, and even existence, of anchor commitments are not generally Resources disclosed to the market, and investors are not What’s Market: IPOs: AIM 7-386-8829 told of other investors’ individual positions What’s Market: IPOs: Main Market 9-386-8913 when they subscribe to an IPO through the order book. For subscription enquiries to Practical Law web materials please call +44 207 202 1200

The 2014 IPO of Pershing Square refl ects this approach. While details of the total number be listed is starting to feature in the European shareholders in that deal, which bought their of cornerstone investors and their aggregate IPO market. This is not permitted under interests in the company shortly before its IPO investments were disclosed, the identity of the HKSE rules and did not feature when at a discount to the IPO price, had the right to only those cornerstone investors that would cornerstone investments were fi rst adopted nominate one-third of Euronext’s supervisory hold more than 3% of the issuer’s voting in Europe. board for so long as they held at least 25% rights and share capital following the IPO of the issued share capital of the company. (of which there were four) were disclosed. In Merlin Properties’ 2014 IPO, two of the This was presumably on the basis that this cornerstone investors were each entitled to FUTURE TRENDS constituted a threshold ownership notifi cation nominate one person to the board for so long requirement in the Netherlands (as it would as they held at least 3% of the company’s While cornerstone investments are now a in the UK for UK-incorporated issuers under share capital for at least the first year relatively established feature of European Disclosure and Transparency Rule 5.1.2R) and following the IPO. IPO markets, similar arrangements are disclosure of the identity of the remainder beginning to be seen in secondary and was presumably held to be immaterial on Similarly, the largest cornerstone investor follow-on offerings. For example, at the time this basis. in the Eltel IPO, subscribing for 10.5% of the of writing, Dufry AG’s recent takeover offer offering, was entitled to nominate a board for World Duty Free, fi nanced in part by a Any lock-up of a signifi cant IPO cornerstone member candidate at the fi rst AGM following CHF 2.2 billion rights issue, includes a CHF investor is likely to be considered material the company’s listing. In that case, Eltel’s two 850 million underwritten portion with GIC from a liquidity perspective and would largest shareholders, also selling shares in Pte, Temasek Holdings Pte and the Qatar generally be disclosed in the IPO prospectus. the offering, agreed to vote in favour of the Investment Authority (QIA) each committing appointment of the cornerstone’s nominee to backstop CHF 450 million of shares that Board nominations to the board. existing shareholders did not take up. In The ability for cornerstone investors to effect, GIC, Temasek and QIA are acting as nominate or put forward a nominee for A nomination right was also included in sub-underwriting cornerstone investors in membership of the board of the company to the Euronext IPO, where the reference the rights issue.

Given the absence of speciﬁ c regulation in price range conditions are exceeded in case, the interplay in their respective terms Europe, the commercial terms attaching view of high demand for the shares and will need to be carefully considered. In the to cornerstone investments are likely to a subsequent increase in the price range internet and technology IPO boom of the continue to evolve. For example, for IPOs occurs. late 1990s, a number of US IPOs featured where guaranteed allocation is not a key concurrent private placements to strategic concern, cornerstone investors may require Pre-IPO strategic “crossover” investments, investors. With cornerstone investments increasingly favourable pricing terms, where investors invest before, during and featuring in US IPOs such as Markit Ltd although this trend is likely to require careful after an IPO, are increasingly used in biotech in 2014 and Jumai International Holding consideration of the relevant overriding and healthcare IPOs to reduce the levels of Limited in 2015, these investments now offer legal principles of equality of treatment of risk. Valuations in this sector are generally an important concurrent liquidity option for shareholders and other stakeholders in order positively affected by the use of these US IPO issuers, both in the technology and to avoid favouring one group of shareholders investments by sector specialists, whose other sectors. over another. validation of a name can be highly persuasive in the subsequent IPO. Ross McNaughton and James Cole are Other contractual features may also partners at Paul Hastings (Europe) LLP and begin to become more commonplace. While these types of IPO investments are David Gossen is a lawyer in the Global Capital For example, cornerstone investors may generally made before the IPO preparatory Markets team of Deutsche Bank AG’s London request a “right to match” provision in their stage, there are cases in which their use legal department. The authors are grateful to investment agreements in circumstances may need to be considered with subsequent Michele Cohen of Deutsche Bank for his input such as Aena’s, where the maximum IPO cornerstone style investments. If this is the into the article.

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