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In a Bull Market, Bought Deals Soar

Companies looking for a sure thing seek out “bought deals.”

During periods of low volatility, bought deals are viewed as an attractive option for companies, shareholders and investment banks alike. To execute this type of equity offering, banks bid on a large block of stock and then re-offer the shares to investors.

In bought deals, an investment bank purchases a set amount of stock at an agreed-upon discount, placing the risk of selling shares on the investment bank rather than the seller. Bought deals can generate primary proceeds for a company issuing stock or secondary proceeds for a selling shareholder, generally a private equity firm. Energy and real estate companies are at the forefront of the trend on the primary market, while secondary blocks are common across all sectors. In any case, bought deals provide sellers with the certainty of price, proceeds and execution.

A company or selling shareholder has several options to initiate a bought deal. These options include a competitive bid process, a reverse inquiry from an investor, a proactive bid by a bank, or a negotiated process between the company or seller and the bank. Banks place bids at a slight discount to the closing price of the stock and generally only one bank executes the deal. After the bank commits to buy the entire offering, it markets the securities to investors at a price that typically enables the bank to make a modest profit.

The risk of distributing shares is placed on the investment bank, but all parties enjoy certain benefits. For sellers, the primary advantage is the certainty of the execution. The guarantee of price, size and timing outweighs the pricing risk of a standard underwritten offering. The issuer also enjoys a lower all-in cost and less procedural work compared to a traditional underwritten offering. For investment banks, the benefits include solely managing a transaction for a client, thus gaining mind-share; providing buy-side clients with the opportunity to buy publicly registered stock at a discount to market; and exercising the firm’s muscles with respect to distribution prowess.

On the primary market, energy companies increasingly are turning to bought deals. The certainty of price, size and execution gives issuers comfort to raise equity capital to reduce their debts, fortify their balance sheets and be acquisitive, as commodity prices remain depressed and volatile. In the first quarter of 2016 alone, oil and gas companies in the United States accounted for nearly 70% of all bought deals, raising $8.4 billion through 14 deals, according to Dealogic. In comparison, the same sector raised $10 billion through 30 bought deals in all of 2015, making up 16% of such offerings.

Bought deals are popular on the primary market among real estate companies as well. Real Estate Investment Trusts (REITs) are not operating companies and rely on capital markets offerings to fund property acquisitions and fuel growth. Proven management teams have earned the trust of investors and can raise opportunistic capital for future acquisitions. Many REITs utilize bought deals in lieu of standard underwritten offerings as a way to de-risk the financing. Although bought deals are typically executed by one bank, it is not uncommon for multiple banks to team up for primary REIT bought deals. The dedicated REIT investor universe also provides investment banks confidence in their ability to place the shares.

In the secondary market, private equity firms engage in bought deals to liquidate their positions in newly public companies. These bought deals generally occur after one or two traditional follow-on offerings. Bought deals allow private equity firms to be opportunistic in selling shares at attractive prices.

Rise of Bought Deals

Source: Dealogic; data as of 08/19/16.
  • Bought deal proceeds are up 30% YoYTD
  • Bought deal proceeds make up 61.3% of follow-on proceeds raised in 2016
  • Bought deals make up 33.9% of primary offerings and 75.0% of secondary offerings in 2016

When considering a bought deal, a company should take into account how the stock might perform in the aftermarket. With that in mind, a seller should hire an investment bank that deeply understands the company’s fundamentals and investor base to ensure that the stock is placed responsibly with long-term investors. Selecting an investment bank with the greatest level of expertise will lay the groundwork for future success.

Sources: Wall Street Journal, Reuters, Financial Times, Dealogic
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