MARKET ACTIVITY/TRADING NOTES FOR DAY ENDING TUESDAY, JANUARY 27, 1998 (2)
The Dealmakers: -- Rating the Underwriters...
Tops in a tight race -- By DAN WESTELL - The Financial Post
CIBC Wood Gundy beats close competition for second year in a row
In 1996, investment dealers brought a record number of underwriting deals to market in Canada. But results for 1996 pale in comparison with last year.
According to The Financial Post's annual overview of corporate and government financings, in 1997 the top 10 underwriters raised more than $66 billion for clients, up about 50% from the 1996 amount. ÿAmong the top 10, the gain includes a 6% drop in government bond sales, to about $15 billion; a 60% increase in corporate debt underwritings, to $21 billion; and a near doubling of equity placements, to more than $30 billion.
Based on the bonus-credit-to-lead-manager formula, CIBC Wood Gundy Securities Inc. was the top underwriter for the second year in a row, according to the Post's ranking methods. ÿIn the rankings, Gundy not only held on to the top spot, but also improved relative to its three closest competitors: RBC Dominion Securities Inc., Nesbitt Burns Inc. and ScotiaMcLeod Inc. (See page 23 for an explanation of the methods used to rank dealers.) ÿThe figures were compiled by Financial Post DataGroup, and evaluate where firms stood in relation to each other across a number of widely accepted categories. ÿ
The rise in overall equity sales was helped by several factors. A record number of companies made initial public offerings, and large firms initiated massive spinoffs as they attempted to hone their business focus. A revival in the real estate market also played a role. ÿDeclining interest rates encouraged companies to borrow more, while the public sector's efforts to control its debt produced a drop in government financings. ÿ
Matching clients that need capital with buyers who want to invest is a key part of the securities business, providing investment dealers with about 21% of their revenue in a normal year. ÿBut 1997 was not normal. In the nine months ended Sept. 30, underwriting deals accounted for 26% of dealers' revenue, and in the third quarter, it hit 28%, according to statistics prepared by the Investment Dealers' Association. ÿBy the end of the third quarter, underwriting revenue for the whole industry was up 44%, to $1.6 billion from $1.1 billion in the 1996 period. ÿThe rising tide in the investment business lifted all the players, but among the four leaders only Gundy maintained its percentage share of the top 10 underwriting deals. ÿ
Its deals accounted for 16.7%, or almost one-sixth of the total number of financings completed. The firms in the next three positions maintained their rankings from 1996, but all lost between 0.7 and 1.4 percentage points' worth of deals to competitors farther down the list. ÿ"It's nice to be No. 1," says John Hunkin, who as president of CIBC World Markets is Gundy's top investment banker. However, he adds, "there is a real horse race." ÿTo hold the top position, "you have to be in the top three in everything," said Wayne Fox, head of global capital markets.
FP DataGroup numbers place Gundy first in both corporate debt and equity underwriting, and third in government debt. ÿThe rankings do not necessarily correlate with dealers' revenue or profit. Nonetheless, according to the 1997 annual report from Canadian Imperial Bank of Commerce, CIBC World Markets reported a 31% profit increase for the fiscal year ended Oct. 31, 1997, to $691 million, on a 30.4% revenue gain at $3.1 billion. ÿ
As another measure of Gundy's success, Hunkin became a $10-million man last year. On top of his base pay of $300,000, he was awarded a $4-million bonus and $6 million worth of CIBC shares, to be paid out over three years as part of a long-term incentive plan. ÿGundy, which came in with a total of almost $11 billion in underwritings - up about 56% from its 1996 total - opened its lead over No. 2 DS to $762 million by widening the gap in corporate debt sales. The two firms were almost equal in 1996, at close to $7 billion in total underwritings. ÿ
In government debt sales, Gundy stood still while DS gained $270 million, and in the equity area, both firms sold $2.5 billion more worth of stock than in 1996. ÿBut in one key area, DS moved ahead. It was the lead manager in 88 issues last year (up from 72 in 1996), compared with 78 at Gundy (up from 73 in 1996). ÿLead manager is a coveted position because the lead has the closest relationship with the client and runs the sale, although it must also work harder and incur more costs to get the issue to market. ÿ
While the almost $800-million gap between the top two firms for all financings is not negligible, it would only take a couple of large deals for DS and Gundy to reverse positions. ÿFor No. 3 Nesbitt Burns or No. 4 ScotiaMcLeod to make a run at the top position, they would have to increase deals by $1.9 billion and $2.8 billion, respectively. ÿBut ranking changes are possible, as shown in the case of TD Securities Inc. Last year it vaulted to fifth place from eighth the year before, by increasing its corporate equity underwritings more than threefold, to $3 billion from $875 million. ÿ
"We have worked tremendously hard at increasing our equity and debt distribution, our research and trading," said TD chairman and chief executive Kym Anthony. ÿAmong the top 10, there is only one new name. Salomon Smith Barney took the tenth spot from First Marathon Securities Ltd., mostly on the strength of underwriting $2 billion in corporate debt. ÿSalomon Smith Barney's move was just one example of the gains made in the corporate debt market by U.S.-based dealers. ÿFour of them - Goldman Sachs & Co., Merrill Lynch & Co., Salomon Smith Barney and Morgan Stanley, Dean Witter Discover & Co. - last year accounted for more than one third of the total $27.5 billion in corporate debt financings. This was up from just more than one third of $13.1 billion in 1996. These firms respectively held the second, third, fifth and ninth positions as corporate debt underwriters in 1997, compared with third, fifth, ninth and unranked in 1996. ÿ
Until last year, there was no domestic high yield market, which meant Canadian companies had to go to New York. CIBC Wood Gundy now ranks among the top 10 in the U.S. high-yield market, the only non-U.S. company to do so, its executives say. ÿThrough that connection, U.S. dealers gained a toehold with Canadian companies which last year resulted in $9.8 billion of corporate debt underwriting.
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DS dominates full credit -- By GREG CRONE-- The Financial Post ÿ
After closing a record number of financing deals worth more than $16 billion, RBC Dominion Securities Inc. has for a second year been rated the No. 1 underwriter in Canada, when full credit is accorded to the lead underwriter of a team. ÿ"It was a banner year," says Gord Nixon, vice-president and director of global investment banking. ÿ
According to data compiled by FP DataGroup, DS reported 88 financing deals at the end of 1997, well ahead of its next two competitors. Second-place CIBC Wood Gundy Inc. completed 78 deals worth $13 billion, and Nesbitt Burns Inc. placed third, with 58 deals worth $11 billion. Strong markets were very accommodating to financing new issues, Nixon says, and new issue volumes were extremely high. ÿ
RBC Dominion was the lead on a $1-billion deal leading to Canadian Pacific Ltd.'s sale of its control block of Laidlaw Inc. shares. DS was also the stickhandler as CP put 11 hotels into a new real estate investment trust (REIT), the Legacy Hotels REIT, valued at $393-million worth of trust units.
In 1996, DS recorded 72 corporate and government deals, worth a total of $11.2 billion. ÿThe 78 corporate financings completed by DS in 1997 were worth $12.6 billion, almost double the $6.9-billion value of deals completed the previous year. ÿ
Nixon said 1997 was the second year in which the income trust and the royalty trust dominated the equity markets. ÿIncome trusts, royalty trusts and REITs became very popular as financing vehicles in 1996, and continued to be active in 1997. ÿ"That led to very significant new issue volumes for the industry and our firm in particular," Nixon says. ÿ"From our firm's perspective, there was a very high degree of new issue financing activity in the areas of real estate and oil and gas." ÿ
The high volume of activity was in part due to last year's economic upswing and to improvements in the markets. "When you cut right through it all, it's a lot easier to finance in a strong market, and it's a lot easier to get issuers to finance when their share prices or the value of their companies are at attractive levels." ÿ
Nixon says RBC Dominion's merger with Richardson Greenshields of Canada Ltd. came at the right time, raising the combined organization's strength to 170 staff in the investment banking division. ÿNixon says the high point for DS last year was the sale by Alberta-based holding company Loram Corp. of its three primary businesses. ÿ
The combined deal raised more than $2 billion, and included two sales on the market. RBC Dominion led the sale of 87 million trust units in Manalta Coal Income Trust, at $10 a share, as well as the issue of 62.4 million trust units by Pembina Pipeline Income Fund, worth $624 million. The rest of the $2 billion was from the sale of Loram's oil and gas assets. ÿ"It was arguably one of the largest single transactions in investment banking history," Nixon says. "Although it was done in three separate deals, it was a transaction to sell all of their assets. It was very much a highlight of last year." ÿ
Aside from its merger with Rich Green, another factor crucial to RBC Dominion's success in 1997 was coordinating more effectively with its corporate bank, Nixon says. "The strong co-operation of a powerful corporate [partner] was something that was very beneficial to us in achieving our success." ÿThis year is already proving to be a very different environment, with a significant decline in new issues, Nixon says. "A lot of that is [because] markets have been very volatile and quite weak.... There is an inability to finance for new companies, even if they wanted to. The valuations of their share prices are such that the markets are just unattractive." ÿThat means 1998 will be a much slower year, Nixon says. He says that in 1997 valuations moved to a level where public markets were generally produced better value than private sales. ÿThere will tend to be a higher relative level of merger and acquisition activity in 1998 than there was in 1997, he says, adding that "financing in this environment is going to remain quite difficult." ÿ
In the category of full credit corporate debt financing, DS ranked second in terms of the value of its deals, but first in the number of deals. ÿGoldman Sachs & Co. led the value field, with 20 deals worth $4.9 billion, while Merrill Lynch & Co. took third place, with 14 deals worth $3.8 billion. ÿIn the category of full credit corporate equity financing, DS was No. 1 again, completing 52 deals worth $8.4 billion. ÿGundy ranked second in full credit corporate equity, completing 54 deals worth a total of about $8.12 billion. ÿDS led in the category of full credit initial public offering (IPO) financing, with 18 deals worth a total of $3.6 billion. ÿRBC Dominion also led in the full-credit category of government debt financing. L‚vesque Beaubien Geoffrion Inc. completed 11 deals, worth almost $3.3 billion and good for second place. ÿAmong foreign firms, U.S.-based Merrill Lynch & Co. emerged as the full credit leader, completing 15 debt and equity financings worth $4.3 billion. ÿFor a full ranking of top underwriters using the full-credit method, see page 28. ÿ
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GTAA debt deal soars -- By JOHN GREENWOOD -- The Financial Post
Nesbitt Burns pilots Canada's largest bond issue to date
On Dec. 2 last year, the Greater Toronto Airports Authority made history when it completed Canada's biggest corporate bond issue to date. With Nesbitt Burns Inc. acting as lead underwriter, the GTAA raised a total of $950 million, edging out former record-holder NAV Canada, a non-share capital corporation which closed a $750-million bond issue in March 1997. ÿ
The issue by the GTAA was broken down into three tranches: $200 million in five-year bonds at 5.4%; $375 million in 10-year bonds at 5.95%; and another $375 million in 30-year bonds at 6.45%. ÿ
The deal was unique not just because of its size, but also because it was one of the rare instances in Canada in which a corporation has issued revenue bonds. Although common in the U.S., revenue bonds are rare in Canada. NAV Canada's 1996 deal was to finance its acquisition of the country's civil air navigation system Nesbitt was consulted in determining NAV's structure. ÿ
Running the show for Nesbitt on the GTAA deal were Rick Byers, vice-president and director of investment banking, and Colleen Campbell, managing director of debt capital markets. The underwriting team spent nearly six months ironing out the wrinkles of the deal. ÿThat in itself meant more risk for both underwriter and issuer. "You do all that work well in advance of knowing what the market conditions are going to be [when the issue goes to market]," Campbell says. "You never know what the pricing is going to be and you don't know how it's going to be received. As it turned out, we entered into very difficult market conditions." ÿ
Proceeds will be used to repay debt related to the GTAA's acquisition of Terminal Three at Toronto's Pearson International Airport. The deal's Dec. 2, 1997 closing date fell on the one-year anniversary of when the GTAA took over operation of the airport. ÿThe GTAA was set up by the federal government as part of its plan to cut down on spending by transferring the operation and maintenance of the country's 26 largest airports to local airport management authorities. ÿThey are run on a not-for-profit basis by government-appointed managers, but they are structured in the same way as a corporation structure and their debt is not guaranteed by the government. ÿ
Unencumbered by government bureaucracy, the authorities are theoretically able to achieve a level of efficiency comparable to that of the corporate system. This way, airport users benefit from the best aspects of both the public and private sector. ÿ
Incorporated in March 1993, the GTAA is a corporation without share capital under Part II of the Canada Corporations Act. The GTAA opted to issue revenue bonds to raise the money required to buy Terminal 3, because it has no share capital and leases its assets from the government. ÿThe bonds are secured by the revenue stream the assets generate, rather than by the assets themselves. ÿ"This was a Canadian solution that, from a bond point of view, works very well. It's very financeable," Campbell says. "Once investors understood the not-for-profit aspect, they found [the issue] appealing." ÿBecause the GTAA's debt is not guaranteed by the government, one of the big questions investors were asking was how the GTAA would be held accountable, if it was a not-for-profit entity. ÿOnce investors understood that revenue would stay within the airport, Byers said, accountability ceased to be an issue. ÿBy the December close, 87% of the bonds had been sold in Canada, the rest in the U.S. Moody's Investors Service, Inc. has rated the issue A2. Canadian Bond Rating Service Ltd. gave it an A+ (Low) and Dominion Bond Rating Service Ltd. gave it an A (high). ÿ
Shortly after it took over Pearson in 1996, the GTAA management team set the wheels in motion to buy Terminal Three. After unofficially approaching potential underwriters both in Canada and the U.S. the authority launched a formal tender for offers in February 1997. ÿBy March, the team from Nesbitt had been chosen to lead the deal and also as financial advisors. Salomon Smith Barney International Inc. (formerly Smith Barney Canada Inc.) was selected as co-adviser and a member of the underwriting syndicate. ÿByers says Salomon Smith Barney's contribution to the team was key, because it is one of the most successful underwriters for airport authorities in the U.S. Airports in the U.S. are run on a not-for-profit basis by local municipalities, which act as guarantors for their debt. ÿ
Another aspect of this deal that was borrowed from the U.S. model was the role of the airport feasibility consultant. In the U.S., the opinion of the consultant carries a lot of weight both with airport management and with the investment community. Their report is relied on very heavily by the rating agencies. In this instance the consultant's report was incorporated into the prospectus. ÿSince the value of the GTAA's bonds will depend on the airport's ability to generate a long-term stream of revenue, investors were obviously concerned with factors such as the health of the airline industry overall, Toronto's economic future and the airport's ability to continue to meet the demands of travelers. ÿ
The roadshow to promote the bond issue kicked off on Nov. 12 in Montreal. From there, the team zigzagged west, stopping along the way in Boston, New York, Toronto and Winnipeg before wrapping up in Vancouver. ÿThe process was as much about education as it was about selling. "In Canada, investors were more aware of the Canadian business structure, and the banking and credit environment, but they were less familiar with airport financings," Byers says. "In the U.S., it was the other way around. Investors were familiar with airport financings but didn't know the Canadian model." ÿDespite running into what Campbell describes as a "huge headwind" from the Asian fallout, the issue quickly turned into a hit, and was oversubscribed by nearly $300 million. Moreover, with more than 70 investors in the book, buyers were broadly distributed across the whole spectrum of institutions. ÿ
The deal's success is more than just a feather in Nesbitt's cap. Over the next few years, Byers expects Canadian governments to begin privatizing not just airports but other large holdings as well. As that movement takes hold, the authorities being created to manage these ventures will need financing. ÿByers figures the time and effort his team has put into structuring the GTAA deal will land Nesbitt at the head of the line of potential underwriters for these upcoming deals. ÿ
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Where to invest -- By WILLIAM HANLEY -- The Financial Post
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Is the Street having trouble making up its mind which way the stock market will go in 1998? Well, yes and no.
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After three years of a remarkable upleg in the secular bull market that is widely judged to have begun in 1982, North American market watchers are torn between wondering how long this splendid party can last and wondering if they will be punished for being wallflowers, as those of bearish persuasion have been in the past.
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At one end of the spectrum is the gung-ho approach embodied in a statement from TD Evergreen president Jeff Carney, who declared: "The only risk for investors in the year ahead is not being invested at all." investors in the year ahead is not being invested at all."
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Contrast that breezy assessment with the prophets of doom who see -- and, to be fair, have been seeing for some time -- all the signs of an "a-stock-alypse" in the making. Some doomsters are forecasting falls of 50% or more for equities.
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More typical of the Street's iffy mood is Merrill Lynch & Co.'s chief market analyst, Richard McCabe. He told reporters that a 25% decline in stock prices is possible this year, yet he steers clear of making an outright prediction.
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"The October decline was likely a wake-up call that markets, like trees, do not grow to the sky," McCabe said, referring to Oct. 27, when the Dow Jones industrial average plunged 554 points, its biggest one-day point drop inhistory.
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McCabe says the current bull market began in late 1994 and that bull markets usually run no longer than 31 1/82 years. He says stocks would be vulnerable to a "cyclical decline" in 1998.
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Even the Toronto-based Successful Investor newsletter, successfully bullish for the past three years, has reservations.
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"Stock prices are likely to move sideways to downward through the middle of [1998]," it said, adding that volatility will increase.
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Although the year may prove as profitable to many investors as past years, "it's also likely to be much more unnerving," the report continued.
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Merrill's chief investment strategist, Charles Clough, says bonds will be the best investment in 1998. He predicts global economies and U.S. corporate profits will slow because of economic turmoil in Asia. "The definitive financial event in 1998 will be lower interest rates," Clough said.
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Which way the stock market will swing this year appears to hinge on a combination of interest rates, bond prices, earnings growth, Asia and that most indefinable and most important of elements, sentiment. In Canada, throw in the shaky C$ and the outlook for natural resources.
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And yet as strategists and traders assess the risks and the rewards of staying in stocks, the buy-and-hold investor, rewarded for his patience these past three years with a doubling of his money in the U.S. market, is sticking to his plan despite a market that has been looking vulnerable now for months. If the new-age pundits are correct, the buy-and-hold brigade will continue to fare well into the next millennium.
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The Dow added 1459.98 or 22.6% to 7908.75 in 1997, but failed to recapture the high close of 8259.41 set all the way back on Aug. 6. The broader S&P 500-stock index fared even better, but also struggled to keep its gains toward the end of the year.
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On Bay Street, the Toronto Stock Exchange 300 composite index -- the benchmark for the Canadian market -- rose only 772.41 or 13% to 6699.44, the victim of a lacklustre resource sector that was supposed to be kicking in at this late stage of the economic cycle and providing the afterburners to catch the U.S. market.
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But analysts by and large are sticking to the script. A recent Reuters poll has found that analysts believe the Toronto market will gain substantially this year and into 1999 as commodities stocks rally. On average, the analysts see the TSE 300 up 17% from the close of 6641.9 on Dec. 12.
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While the TSE's 1997 gain of 13% (plus dividends reinvested) beat GICs and term deposits, the gap is not that great when, say, mutual fund fees are taken into account.
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Many of those in stocks were GIC refugees who had been persuaded to overcome their fear of risk by the lucrative rewards available in equities and equity dominated mutual funds. But as the Canadian market stumbles along about 10% below its record high, interest rates rise and RRSP season looms, it would be reasonable to expect that some refugees will return to GIC country.
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And if not out entirely out of stocks, a defensive position may suit. As 1997 drew to a close, mutual fund operators noted a lowering of risk tolerance.
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The North American bulls point to the following factors to explain their bullishness:
* Continuing favorable demographics see millions of baby-boomers pouring their savings into equity mutual funds and making rich returns.
* The lack of an alternative to the stock market while fixed-income instruments, such as GICs, are paying peanuts.
* An environment of solid growth and low inflation promises continued gains in earnings, which in turn fuel stock prices.
* Continued outstanding productivity gains for industry through technology applications.
* Continued benefits from globalization of trade, despite the warningsignals thrown up by the Asian crisis.
* The relatively stable world geopolitical scene.
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The bears, having spent most of the past three years in the wilderness living off scraps, are more than ever convinced their time is coming in 1998:
* The market is overvalued, and that indisputable fact will finally sink in with investors, although it has yet to do so on a consistent basis.
* Earnings growth cannot be maintained and earnings will not support such high valuations.
* Along a similar line, the Asian crisis is not about to go away, meaning that deflationary pressures -- not inflationary ones -- will set the agenda.
* The market has had three remarkable years. The odds against a fourth are very high.
For Michael Metz, chief investment strategist at CIBC Oppenheimer Inc., the odds are stacked against the U.S. market, because earnings expectations are far too high as conditions deteriorate in the face of the Asian crisis and a possible run-up of wage inflation in the services sector.
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As Moody's Investor Services Inc. said in a recent commentary: "The current mix of very low bond yields and steep price-to-earnings multiples underscores the vulnerability of both asset classes to a labor-cost-driven rise by inflation risks."
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Metz envisions a choppy market that could end up flat on the year.
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For some investors, the TSE's 13% gain in '97 will feel like a flat performance versus the Dow and the S&P 500. But the average annual total return since 1982 has been just 11% on the TSE against 15% for the S&P 500.
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One recent Wall Street poll suggested the consensus expectation was for U.S. stocks to fall back below a 10% return this year.
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Indeed, a return to more normal rates of return would not be surprising. But the market's mounting volatility as 1997 progressed was likely a precursor to a wild ride in 1998, a year in which anything can happen and probably will.
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