3 Offer price
Background
15. As has been noted by the press, politicians and
the National Audit Office, the performance of Royal Mail shares—both
on the day of flotation and beyond—has been significantly
above the 330p share price set by Ministers. This has prompted
a lengthy debate as to whether the Ministers agreed on a price
which was too low. The answer to that debate would have a significant
bearing on whether or not the Government extracted an appropriate
financial return for the taxpayer.
16. Our evidence sessions concentrated on how Ministers
came to decide on that price, the factors affecting it and whether
the advice they were given was accurate and in the best interests
of the taxpayer. In coming to a decision on the share price, Ministers
were advised by the Shareholder Executive (part of the Department
for Business, Innovation and Skills) and by Lazard, who the Shareholder
Executive appointed to be the Department's financial adviser.
In addition, Goldman Sachs and UBS were appointed as the Global
Coordinators to identify demand from institutional investors.
We therefore also questioned these organisations on the advice
that they gave. We also took evidence from a range of banks which
were unsuccessful in bidding for those roles.
The Process
17. In written evidence to us, the Secretary of State
set out the process by which the price was set:
Our Global Coordinators (Goldman Sachs and UBS,
together the "GloCos") recommended this price range
following an exhaustive process culminating in a final price range
recommendation provided ahead of the publication of the Prospectus.
Our independent advisor (Lazard) endorsed the price range.[10]
18. When he came before us in October 2013, the Secretary
of State explained that "various tests" were applied
to fix the price range of 260p to 330p, which included:
· A
long-term process of consultation with the big, long-term institutional
investors;
· Metrics
out in the market; and
· Comparable
situations including Belgium and Austria.[11]
19. The consultation with those long-term institutional
investors took the form of "pilot fishing" in which
the Global Coordinators sought to identify key investors who could
ensure sufficient demand to "cover the book of shares to
be sold".[12] At
the start of that process, the Secretary of State told us that
the demand indications were "generally in the lower part
of the price range" (260p to 330p) and that "some were
lower still".[13]
Subsequent advice from the GloCos gave a more positive outlook
and they advised that the top end of the range could be achieved.
The final demand indications from the GloCos, resulted in the
share price being set at 330p.[14]
RISKS
20. Although Ministers raised the possible price
range for shares, the Government also highlighted two key risks
as dampeners in terms of share price: the potential for a strike
by the Communication Workers Union (CWU) and the possible default
by the US Government. The prospectus highlighted the risk of industrial
relations in the following terms:
There is no way of reliably quantifying the financial
impact (including the ongoing impact) for the Group of any industrial
action with any certainty before the event. National industrial
action, or the threat of national industrial action, affecting
UKPIL could also have a material adverse effect on the success
of the Offer and, if it occurs after Admission, could cause the
price of Ordinary Shares to fall significantly.[15]
21. When the Global Coordinators gave evidence they
also highlighted the potential of an industrial dispute as a key
factor in the determination of the price. Goldman Sachs said that
feedback it had received was that "industrial relations were
a concern",[16]
and that it "certainly impacted the price that people were
prepared to pay".[17]
UBS agreed:
"From September [2013] it was the major
risk factor in respect of the price and the achievability of the
deal",[18]
22. According to the Secretary of State:
IR position meant that there were some potential
investors who stated that they were not willing to invest at all
and many others who focused on the business and financial implications
of strike action".[19]
23. Mr Fallon told us that he had met with the unions
at regular intervals between 2012 and 2013 and "very intensely
through the summer of 2013". He argued that it was clear
from those meetings that the Unions had "had absolutely no
interest in lifting the threat of strike action or in settling
the pay deal". This led him to conclude that "there
was no prospect of it being settled and being settled before privatisation".[20]
24. The Secretary of State told us that his Department
had estimated that any strike would have cost Royal Mail around
£30 million and that "after two weeks, the profits of
the company would have been wiped out".[21]
However, he acknowledged that the recent history of industrial
relations was not particularly bad and that "relatively few"
days had been lost to industrial action over the past 2 years.[22]
25. The performance of the share price before and
after the settlement of the dispute does not appear to reflect
the level of concern held by Ministers:
26. When questioned on whether it would have been
better to have delayed the IPO until the dispute had been resolved,
UBS said that it had considered this carefully:
Ideally, we would have done an IPO when the pay
and pensions discussions had concluded favourably, but the feedback
that we got was that it was unlikely that was going to happen,
even if we delayed until the following spring.[23]
However, Michael Fallon confirmed that he did
not have discussions with the Global Coordinators about delaying
the IPO because:
It was very clear to us by August that there
was no point in waiting for a deal. There was no real prospect
of any deal and nor was there really any interest or incentive,
actually, on the side of the union to reach such an agreement
before the IPO was launched.[24]
27. Ministers placed great emphasis on the negative
aspects of the industrial relations between Royal Mail and the
Communications Workers Union, and in particular on the threat
of strike action. While this was a significant factor for investors,
we believe that the Government over-emphasised the risk. The share
price before, during and after the Union's acceptance of a pay
deal demonstrates that industrial relations were less of an issue
for the market than they were for Government.
Demand for Shares
28. Notwithstanding the threat of strike action,
demand for shares grew in the run-up to the flotation. Increased
demand became apparent in both the institutional share offer (which
represented 70% of shares available) and the retail share offer
(the remaining 30%).
29. In its Report, the NAO highlighted the fact that
there was a high level of demand for both the Institutional Offer
and the Retail Offer. In respect of the former, the NAO said that
demand "accelerated rapidly":
By the end of the first day of book-building
the total demand from all institutional shareholders was 3.6 times
the number of shares available for institutions at the top of
the price range, increasing to 24 times at the final price by
the end of the process.[25]
30. The NAO Report also noted that while retail demand
grew slowly for the first five days it also increased rapidly
during the final two days of the book building period:
By the end of the book-building period on 8 October,
the value of retail demand was seven times the number of shares
available for individuals, and was sufficient to have purchased
the entire 60 per cent being sold at 330 pence per share.[26]
The NAO further noted unlike the privatisations of
the 1990s, the Government did not use this excess retail demand
to put upwards price pressure on the institutional investors.[27]
The Secretary of State, however, did not agree that demand could
have been used to increase the share price on offer:
The very strong unequivocal advice we received
was that, if we had attempted to push the price beyond £3.30,
the upper end of the range, there was a very high possibility
that a large number of the people who had hitherto expressed interest
would simply walk away from the transaction. That was the advice
we received and accepted.[28]
31. This position was repeated by William Rucker,
from the Shareholder executive. He said there was "no evidence"
that there was enough demand in excess of £3.30, to raise
the price.[29] When asked
if all of the over-demand would disappear above 3.30, Michael
Fallon replied "Absolutely".[30]
32. Both Mr Fallon and Mr Rucker used the experience
of Facebook as a reason for not relying on demand as an indicator
of price:
Michael Fallon: We do not yet know whether
the price was too low. What was really important here was to protect
the six-day-a-week service and minimise the risk to the taxpayer
that the taxpayer would have had to step in and finance this company
if the price had flopped and the company had been unable to return
to the capital markets, like Facebook.[31]
William Rucker: If I just take an example,
Facebook was 25 times oversubscribed—more heavily over-subscribed
than Royal Mail—and within three months the share price
had fallen 50%. The direct linkage between the level of over-subscription
and subsequent share price performance is not there. The other
thing to bear in mind is in a lot of the orders that go into the
books to try to assess how much the thing is over-subscribed by,
there is a heavy element of gaming. The three biggest orders were
$1 billion each. That would have represented 20% of the company.
Those institutions had no expectation of ever receiving anything
like that quantum of stock.[32]
33. When questioned in the House on the share price
on flotation the Secretary of State repeated his position that
there was no demand above the 330p share price:
A more aggressive approach to pricing would have
introduced significantly greater risk. The advice that we received
in this respect was unambiguous. There was no confidence that
a sufficient number of buyers would offer a significantly higher
price. A failed transaction and the retention of Royal Mail in
public ownership would have been a very poor outcome for the taxpayer,
as the NAO report confirms.[33]
34. The NAO did note the importance of a successful
flotation, but it also called into question the return on the
sale. It concluded that the process of identifying investor demand
at a set price delivered a level of certainty in demand but at
the cost of conceding price tension to the priority investors.[34]
It went on to state that the process limited the options to obtain
a better price in light of increased demand:
Once book-building starts, bidders are competing
to buy shares and at this point may have incentives to reveal
higher levels of demand. But by announcing that it is willing
to sell within the price range, the seller has effectively capped
the price at the top of the range: there is no mechanism and only
a limited incentive for bidders to reveal anything about demand
at higher prices.[35]
35. The level of the upper limit set for the potential
price of shares gave investors a price above which they had no
incentive to declare an interest. The Government's advisers must
have been aware of this but failed to gauge demand at higher price
levels. The fact that many long-term investors bought shares later
at a far higher price is evidence to us that there was demand
for Royal Mail shares at a higher price. We therefore do not accept
the Ministers' assertion that the demand for shares would have
disappeared at an offer price above 330p. The fact that both Ministers
and officials have refused to acknowledge any level of demand
for a higher price is, to say the least, disappointing.
"Froth"
36. The concerns raised by Ministers about demand
for shares at a higher price was not reflected by the performance
of the shares, either on the day of flotation or since that day.
When questioned shortly after the flotation, on the sharp increase
in the share price, the Secretary of State dismissed it as merely
the "froth" which often arose in the "immediate
aftermath of an IPO".[36]
He restated this view on the BBC on 11 October:
You get an enormous amount of froth and speculation
in the aftermath of a big IPO of this kind.[37]
His advice was to "totally ignore the froth
that will arise in the immediate aftermath".[38]
37. On the 20 November, the banks were questioned
on "froth" and whether they could put a price on it.
Citi believed that it would take time to assess whether this was
"froth" or whether the share price was "the fundamental
value".[39] Goldman
Sachs agreed, stating that the "sustainability" of the
share price level would be proved over time. In a similar vein,
Deutsche argued that it was "much too early to say where
the stock will eventually settle".[40]
UBS said that it was "not unusual to see those sorts of price
rises" but went on to state that "the bulk of views
were around £3.30".[41]
JP Morgan said that the "huge profile" around the privatisation
meant that there would be "a lot more volatility around this
particular deal than perhaps other ones".[42]
38. The only dissenting voice was that of Panmure
Gordon, who dismissed the Secretary of State's argument:
I do not think it is froth. These shares have
been trading on the market for nearly six weeks and several hundred
million shares have traded hands. Today's value of the company
is the value that the market attributes to it, and the markets
generally are fairly efficient. This is not froth.[43]
39. While the banks gave their opinions on the current
and future value of Royal Mail they were unable to shed any light
on a definition for "froth". We therefore asked the
Secretary of State to explain the term in more detail. He said
that froth was a way of describing the "irrational exuberance"
of the market, as argued by Robet Shiller:
The simple point he is trying to make is that
in these markets you get momentum up and down and the price of
these assets/shares diverge enormously from underlying value for
quite prolonged periods of time. That is a rather formal way of
describing what I described as "froth".
He went on to argue that while there were "some
people who believe that stock markets are efficient, in the language
of economics", he did not. In his view, the markets are "extremely
volatile and often highly irrational".[44]
40. When asked what the value of shares would be
without the "froth", the Secretary of State gave the
following response:
Circumstances change. The valuation of shares
reflects the information that is available at the time, and that
is based on fundamentals, which are going to change. As Mark Russell
said earlier, the whole purpose of this exercise was to improve
the performance of this company by allowing it to invest, and
that would raise its value. At some point, that will be captured
in the share price. It would be utterly foolish for me to start
predicting price or predicting turning points.[45]
41. In his first appearance, the Secretary of State
described "froth" in the context of the "immediate
aftermath". When he returned to us in November, the Secretary
of State extended the timescale:
It would be useful to start reflecting on this
three to six months out or possibly a year.[46]
This time frame is far longer than "immediate
aftermath" of the flotation to which the Secretary of State
first referred. The long-term value of Royal Mail shares will
be affected by a wide range of factors, many of which have been
discussed at length by our witnesses. However, those longer-term
influences are of little relevance in answering the question of
why the share price rose so markedly on the day of the flotation
and in the subsequent weeks and months.
42. The Secretary of State noted that the valuation
of shares reflected the information that is available at the time.
He also argued that "froth" had, in some way artificially
inflated the share price. Unfortunately, he was unable to provide
us with a meaningful explanation of its impact on the share price
in terms of time and value. The Secretary of State's initial use
of the term referred to the "immediate aftermath" of
the flotation. This was subsequently extended to months and then
possibly years. As a result we do not find the argument of "froth"
as a credible response to the significant increase in the share
price.
Level of discount
43. A different explanation for the rise in the share
price is the practice of discounting in an IPO. Discounting is
an established process in which the share price is set at a value
lower than the true value to ensure a successful flotation. Royal
Mail was no different, and Mr Fallon pointed out to us that the
Government "expected [the share price] to go for a premium
on the first day".[47]
However, as our witnesses pointed out, discounting is more of
an art than a science. In any IPO there can be a debate over whether
the subsequent rise in the share price after an IPO reflects an
appropriate level of discount, or indicates that the shares were
under-priced.
44. When they came before us, the representatives
of the banks gave a range of discount rates they would expect
for IPOs. Citi and JP Morgan believed that a discount of 10-15%
would be "reasonable", in particular in terms of the
first day's trading.[48]
Goldman Sachs noted that "20% of the IPOs that have been
executed globally this year have gone up by more than 30% on the
first day of trading".[49]
Deutsche said that in respect of Royal Mail, it had quoted a discount
of between 5% and 10%.[50]
45. UBS also highlighted the fact that volatility
of the market was also a factor in considering share price. As
examples it highlighted a number of recent UK IPOs:
Four of them are trading above 60% more than
their IPO price; two of them more than 25%; and two of them are
down 20%".[51]
46. Michael Fallon also emphasised the volatility
in the share price of IPOs:
Of the 43 major flotations in the last four years,
21 of them fell below the offer price on the very first day. 23
of them in fact are still below the offer price. Four of the six
large flotations since Christmas are below their offer price at
the moment. Floating a company successfully is not a particularly
easy thing to do. Most flotations that are successful involve
some kind of premium on the first day, and Royal Mail was no exception.[52]
47. In its Report, the NAO compared the flotation
of Royal Mail to other UK flotations over the past 3 years and
found that:
Royal Mail's 38 per cent share price increase
on its first day is greater than that of recent IPOs on the main
UK market. Based on data for recent UK IPOs, Royal Mail performed
much more strongly on the first day than the IPOs that preceded
it.[53]
48. It went on to note that this was not a short
term rise and that the price increase and the trading range throughout
the subsequent five months indicated that:
Royal Mail's shares are worth much more than
this process was able to extract.[54]
49. Despite this, Ministers, Lazard and the Shareholder
Executive all refuted the suggestion that the share price was
set to low. When challenged on the share price, Mr Fallon asserted
that he had "not seen any evidence that the shares were undervalued
at the time of flotation",[55]
and disputed the assertion that a 38% rise in the share price
was evidence of any undervalue.[56]
Equally, William Rucker declared "I do not accept that we
were wrong".[57]
50. It is accepted that all IPOs will be floated
at a discount, with the share price expected to rise when shares
are traded. This is important because a fall in the share price
on flotation would inhibit the company from raising further investment.
However, the rise in Royal Mail shares in the immediate aftermath
was significantly higher than the normal percentage increases
described by the banks.
Conclusion
51. Our scrutiny of the possible failings in the
share price have been met by a blanket refusal from Ministers,
officials and advisors to acknowledge any shortcomings in the
process. The following extract is a helpful summary of the arguments:
Mr Binley:
Can I question you on that, Mr Rucker? I feel desperately sorry
for the Secretary of State and for the Minister of State, because
I think that both the civil servants and particularly the bookbuilders
let these good people down. All the evidence that came from those
two sources was evidence of fear. That was the prime motive that
you two groups of people were operating on. Let me put this point:
Michael Fallon said that he had not any evidence that shares were
undervalued on the day, a quote that you made earlier on in this
particular set of questions. Yet when the Secretary of State went
back to the bookbuilders about price on Thursday 3 October,
those shares were already 10 times oversubscribed. On the
next day when those discussions were still taking place, Friday
4 October, they were over 15 times oversubscribed. Are you
genuinely telling me that all of that oversubscription would
have fallen away if those shares had been priced at higher than
£3.30? 15 times oversubscribed according to the book
on 4 October, and nobody would have paid more than £3.30
with that level of demand in the market. Are you really telling
me that?
Michael Fallon: Absolutely.
Mr Binley: Do not advise my company, Mr
Rucker. I find that remark amazing.
Michael Fallon: Can we just answer
this, Mr Binley? Facebook was oversubscribed 25 times. It
fell 10% on the first day of trading. There is no link between
oversubscription and the actual price.
Mr Binley: In the marketplace there is
no link? Mr Fallon, in a marketplace there is no link between
the number of customers and the value of the price of the goods?
Michael Fallon: Why do you think
Facebook then fell 10% on the first day?
Mr Binley: I have no idea about Facebook
and we are not talking about Facebook. We are talking about this
particular offer and, at the end of the day, all of the evidence
suggests to me that you were motivated by a fear of failure. I
understand that; I am happy with that viewpoint, but at least
the general public needs to know that that is the motivation.
By all accounts, the taxpayer lost between £1.1 billion
and £1.2 billion. Whatever you say about supporting
your argument, you were wrong. The very fact that it sold at the
price it did and the way the shares moved thereafter prove that
you were wrong. Are you going to admit that, so that at least
the taxpayers can have some satisfaction in knowing that the advisers
have learned a lesson?
William Rucker: I do not accept
that we were wrong.[58]
52. We conclude that the Department underestimated
the market value of Royal Mail and that the sustained increase
in the performance of Royal Mail shares points to a pricing decision
that was too influenced by perceived risks and fear of failure
rather than maximising value for money for the taxpayer.
10 http://www.parliament.uk/documents/commons-committees/business-innovation-and-skills/2013-18-10-Vince-Cable-to-Adrian-Bailey-BIS-Inquiry-into-Royal-Mail-Privitisation.pdf.pdf
Back
11
Q6 Back
12
http://www.parliament.uk/documents/commons-committees/business-innovation-and-skills/2013-18-10-Vince-Cable-to-Adrian-Bailey-BIS-Inquiry-into-Royal-Mail-Privitisation.pdf.pdf
Back
13
Ibid Back
14
Ibid Back
15
Royal Mail Prospectus, Summary, page 13 Back
16
Q166 Back
17
Q167 Back
18
Q169 Back
19
http://www.parliament.uk/documents/commons-committees/business-innovation-and-skills/2013-18-10-Vince-Cable-to-Adrian-Bailey-BIS-Inquiry-into-Royal-Mail-Privitisation.pdf.pdf
Back
20
Q397 Back
21
Q396 Back
22
Q395 Back
23
Q179 Back
24
Q339 Back
25
National Audit Office, The Privatisation of Royal Mail, HC (2013-14)
1182, page 38, para 4.4 Back
26
National Audit Office, The Privatisation of Royal Mail, HC (2013-14)
1182, page 40, para 4.5 Back
27
National Audit Office, The Privatisation of Royal Mail, HC (2013-14)
1182, page 40, para 4.5 Back
28
Q 407 Back
29
Q 420 Back
30
Q421 Back
31
Q368 Back
32
Q300 Back
33
HC Deb, 1 April 2014, col 725 Back
34
National Audit Office, The Privatisation of Royal Mail, HC (2013-14)
1182, page 36, para 3.29 Back
35
National Audit Office, The Privatisation of Royal Mail, HC (2013-14)
1182, page 41, para 4.8 Back
36
Q17 Back
37
http://www.bbc.co.uk/news/business-24488144 Back
38
Q 17 Back
39
Q189 Back
40
Q189 Back
41
Q188 Back
42
Q189 Back
43
Q189 Back
44
Q360 Back
45
Q353 Back
46
Q352 Back
47
Q389 Back
48
Q157 Back
49
Q158 Back
50
Q158 Back
51
Q157 Back
52
Q387 Back
53
National Audit Office, The Privatisation of Royal Mail, HC (2013-14)
1182, page 45, para 4.15 Back
54
National Audit Office, The Privatisation of Royal Mail, HC (2013-14)
1182, Summary, page 10, para 18 Back
55
Q387 Back
56
Q387 Back
57
Q423 Back
58
QQ421-423 Back
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