Thomas Bartlett was no stranger to the capital markets when he became CFO of Boston-based American Tower in April 2009. Over the course of a 25-year career with Verizon Communications, he had served as corporate controller, treasurer, and senior vice president of investor relations.
Still, American Tower was no Verizon. The former was a $1.7 billion owner and operator of wireless and broadcast communications towers still working to shed a high-yield debt rating, while Verizon was a blue-chip, $108 billion telecommunications behemoth. So when Bartlett was called on just after arriving at American Tower to oversee a $300 million private placement of unsecured senior notes, he brought in a ringer to help out: Reuben Daniels, a veteran investment banker who two years ago co-founded EA Markets, an independent capital-markets advisory firm.
“I’d never done a high-yield deal, and I didn’t have a lot of treasury experience in my new organization,” Bartlett recalls. “So I brought in Reuben to help our treasurer work through the process of picking the banks and negotiating the fees.”
It paid off. When the banks started talking about the fee structure, he says, Daniels immediately weighed in and described how it could be much lower. In the end, it was. “I know we saved money,” Bartlett says.
This isn’t how such negotiations usually get done. Sure, plenty of companies hire consultants to help with initial public offerings, and some seek out independent product specialists to walk them through esoteric derivatives transactions. But most companies handle secondary offerings of stocks, bonds, or convertibles on their own, taking direct responsibility for finding the right investment bank to structure and price the deal and lead the underwriting syndicate. The same goes for negotiating a credit facility.
There are two problems with the standard go-it-alone approach, though. First, no matter how big or good the bank that is hired, it ultimately serves two masters: the issuer itself, and the institutional investors it must court to buy the issuer’s stocks or bonds.
Second, the banks have far more knowledge about market conditions than their corporate clients do, and a greater appreciation for all the subtleties embedded in deal terms that can affect an issuer’s costs and balance-sheet flexibility — from liquidity covenants on bond offerings to make-whole tables on convertible-debt transactions.
“The process of executing a transaction is a complex one, and very opaque for corporate issuers,” says David Pritchard, another veteran capital-markets banker who recently helped launch a capital-markets advisory firm, Aequitas Advisors. “And there’s some degree of intent behind that opacity in that banks, like any party in a financial transaction, like to be in a position where they have more information than the other guy.”
Increasingly, however, companies are leveling the playing field by tapping a new breed of capital-markets adviser, like Reuben Daniels and David Pritchard, who have substantial investment-banking experience. They promise to represent an issuer’s interests free of any potential conflict, and to help structure deals and underwriting syndicates in ways favorable to the issuer.
Competitive, up to a Point
Lawyers say it would be hard to argue that an investment bank has a legal conflict of interest when representing an underwriting client, or that it has any formal fiduciary duty to that client (see “Legal Liability: Little to None” at the end of this article). Still, its role as a go-between for issuers and investors is a legitimate concern.
“The investment bank is clearly in the position of having two customers at the same time in the same transaction,” says attorney Daniel Berick, a partner at Squire, Sanders & Dempsey. “It’s got a product it wants to sell to its buy-side customers, and it’s also going to get a fee for arranging that sale from the issuer.”
Corporations, Berick suggests, can easily lose sight of the bank’s dual allegiance. “They’re spending an awful lot of time in conference rooms with lawyers and their investment bankers working on either structuring a transaction or preparing an offering for the market,” he notes. “I think it’s human nature to assume, well, these guys are our guys, like our lawyers are our guys.”
But they’re not. Their role is more like that of a real estate agent selling someone’s house on commission. Both agent and seller gain from a higher sale price, but their interests are not wholly aligned. The homeowner may want to hold out for the highest possible price no matter how long it takes, for example, while the agent may want a quick sale to generate a higher return on his investment of time and marketing dollars.
Competition helps keep banks focused on the issuers’ needs, of course, but only to a point. And that point, Pritchard argues, is reached when the banks have finished drafting their pitch books and the client has chosen its lead underwriter.
“The first part of the process is extremely competitive,” says Pritchard, who before launching Aequitas was co-head of equity capital markets for CIBC World Markets in New York. “An enormous amount of thinking and analysis goes into the creation of those pitch books, which reflect the best ideas the banks have for you as an issuer: how they suggest you do things, how the market looks, how your offering might break down between institutional and retail investors, why they are the best bank to represent your deal in the market. But often, as soon as that process is done and the corporate client selects an investment bank, the competitive dynamics of the process fall away — in most cases, almost entirely.”
Daniels, formerly co-head of U.S. investment banking for Barclays Capital in New York, agrees. “Once the banks get the underwriting mandate from the client, many are often focused on supporting their investor clients who pay the day-to-day bills,” he says.
It’s worth noting that no one interviewed for this article ascribes any dishonorable intent to investment banks. “Obviously, they have a lot of reputation capital at risk in terms of doing a good job for both sets of customers,” Berick notes. “They’re trying to arrange a transaction between buyer and seller; that’s what they do. Their special sauce is coming up with what they would call the market-clearing price — the transaction that meets, as closely as possible, the issuer’s needs and can get good execution on the sell side.”
Nonetheless, Pritchard says firms like his can bring greater transparency and deal experience to the process to help companies improve transactions’ efficiency and pricing. To encourage competition even after a lead underwriter is chosen, for example, his firm may argue for keeping a portion of the fees in a pool to be allocated among all the banks in the syndicate at the issuer’s discretion, based on their performance. His firm also will encourage companies to solicit frequent updates on the order book from the deal’s co-managers rather than solely from the lead underwriter. The more information the issuer has on that front, he says, the better it can understand its pricing leverage.
Theoretically, a savvy CFO or treasurer knows all these tricks — as well as what kinds of deals investors are receptive to buying at the time the company goes to market, what sorts of covenants those investors are demanding, and what similar issuers are paying for similar transactions. In reality, few CFOs or treasurers are in the market enough to have that sort of insight, nor do they have staff they can dedicate to that space — no matter how big their employer is. Daniels notes that two of his clients rank in the Fortune 10.
“I’ve had CFOs who have been very good, but they don’t have the time or the background to be experts in all areas,” observes private-equity investor Vincent Wasik, a principal at MCG Global. Wasik has run a slew of high-profile companies over the course of his career, including National Car Rental System and Holland America Line. “I have a lot of friends in the investment-banking arena, and I’ve got tremendous admiration for them,” he says. “But I always like to have a consigliere, so to speak, who can help me and my CFO make the right decisions.”
“I spend a lot of my time with banks,” adds Martin Geller, CEO of Geller & Co., a financial advisory firm that, among other things, provides interim CFO services for corporate clients. “But the world’s gotten complicated. Even someone like me can’t spend 100% of his time on this.”
Geller hired EA Markets late last year to help a multi-billion-dollar client restructure its credit revolver. The company had negotiated its existing revolver several years earlier when interest rates were much higher, and its bank was trying to use the rate on that facility as a starting point for the new negotiations. The bank was pushing for a rate of 150 basis points over LIBOR, Geller says, but with the help of Daniels — who argued that the previous deal wasn’t an appropriate starting point — the deal got done at a significantly lower premium.
Pricing isn’t the only area where a capital-markets adviser can help. Pritchard recalls learning of a financially struggling company (not a client) that was having trouble clearing a debt offering until an institutional investor offered to buy the final $25 million of its deal. The catch? The investor wanted a covenant precluding the company from issuing any subsequent debt pari passu (equal in seniority) to the current deal.
The company agreed. It then experienced a strong financial recovery over the ensuing two years, whereupon it asked its existing bondholders to waive the pari passu covenant. They refused, and with all the leverage on their side, negotiated to buy up an entirely new offering immediately junior to their existing debt, but yielding an additional 400 basis points. A savvy adviser, Pritchard says, would have sought language in the original deal allowing a pari passu offering if the company’s earnings hit certain milestones.
“The buy side looks at umpteen deals a month,” comments Pritchard. “You will not craft a deal that is so favorable to the issuer that you get investors to buy something they would really rather not buy. However, the very sophisticated investor can put provisions in place that cannot be fully appreciated and understood by issuers.”
All That, and More
Bartlett says Daniels was helpful on his company’s notes offering in ways that went beyond pricing, too. American Tower was just in the process of getting an investment-grade rating, he says, “and he helped us dissect the different products the banks were proposing we might use, and to get his advice on our overall financial policy, not just in terms of where our leverage should be, but also in terms of how much fixed-rate versus floating-rate debt we should have and how much cash we should have on the balance sheet.” With Daniels, he says, he was able to “knock stuff around that I generally couldn’t with a banker, not because they’re not good people with good ideas but because I really wanted an objective view.”
Bartlett also consulted with Daniels’s firm when American Tower initiated a new notes offering, and says its advice helped convince the company to expand the number of bookrunners on that deal, not just to do a better job of spreading fee income among its banks but also to encourage more input from their traders and sales desks.
To be sure, not every capital-raising transaction requires the services of an independent adviser. “If a public company that’s been in the market a couple of times is issuing common stock, it’s not hard to understand how it gets priced and that underwriting discounts are pretty much the same,” says Berick of Squire, Sanders. “You’re picking an underwriting syndicate based on industry coverage and all the other usual sorts of factors.”
“A Cheap Date”
But companies undertaking more-complex transactions may benefit from having an independent adviser. “If you’re evaluating different kinds of debt offerings — for instance, whether to do a convertible-preferred rather than a convertible-debt offering, or a PIPE [private investment in public equity] or rights offering — then I think companies may be more inclined to want some kind of market check from somebody who really is just working for them,” Berick says.
While neither Daniels nor Pritchard will say exactly how much their firms charge, Pritchard notes that it is a fraction of what investment banks earn on a capital-markets transaction. Bartlett says the price of Daniels’s help at American Tower was a relative bargain compared with the cost of building the same expertise in-house. “It’s a very effective way to get an objective view of the world, and I don’t need to build or create a tremendous treasury function within my own organization to get it,” he says.
Wasik, too, says that rather than spend money on permanent staff, he’d prefer to keep an independent adviser on retainer. “That,” he says, “is a cheap date.”
Randy Myers is a contributing editor of CFO.
Legal Liability: Little to None
Investment banks and their corporate clients have strong legal protections from lawsuits over debt and equity issuances.
Investment banks may cater to two sets of customers in capital-raising transactions, but from a legal standpoint securities attorneys say there’s not much reason for them, or their corporate clients, to worry about conflict-of-interest liabilities.
For starters, most lawsuits alleging such conflicts on the part of investment banks have revolved around mergers and acquisitions, usually in the context of fairness opinions, notes Daniel Berick, a partner with law firm Squire, Sanders & Dempsey. And rather than issue broad rulings in these cases, he says, courts have usually settled them on issues of fact particular to the individual transaction, or on the basis of the language of the engagement letter signed by the bank and its client.
By contrast, in a capital-raising context, “particularly for secondary offerings, companies generally don’t sign an engagement letter with an underwriter to retain them as their agent and structure an offering for them,” says Berick. “In fact, there usually isn’t a contract signed until the pricing of the offering. So the investment-banking firm isn’t acting as the agent of the issuer in quite the same way, in a legal sense, that it is when a company hires an investment bank to help it arrange an M&A transaction.”
As for the liability of corporate officers and directors, if a lawsuit did claim that they entered into a poor deal, an important factor in their defense would likely be whether the transaction was consistent with a “pretty broad range” of what other bankers would have advised or offered in that situation, notes Alex Gendzier, a capital-markets partner with Jones Day. In that case, he says, they would likely have a strong defense based on the business judgment rule that governs many corporate decisions and presumes good faith in decision making, particularly if there is evidence that the parties did exercise good faith and performed reasonable due diligence.
Still, Gendzier notes, the law is always evolving, and any company or CFO that did use an independent adviser effectively could have a stronger defense if a deal were challenged in court.
That extra protection would make all the more sense, adds Berick, in the case of complex transactions.
“A plain-vanilla offering of securities sold at market price by a company that isn’t in financial distress, has at least some experience as a capital-markets participant, and has a CFO who has been through the process a bunch of times doesn’t create a lot of risk to the board or its executives from a fiduciary standpoint,” Berick says. “But once you move away from that to an offering that’s more complex — or if the board can’t really tell itself with a straight face that the CFO is all over this stuff and knows exactly how it works — they might want to get some help.” — R.M.