Hedge Fund IPOs

Are managers calling the top of the market?

Ben Simpson, Partner, Withers LLP

Excitement is building in the investment banking community at the prospect of a series of hedge fund floats on the alternative investment market (‘AIM’). The most recent hedge fund to float is Absolute Capital Management Limited which floated on AIM on 3 March 2006. A number of other hedge fund managers are also rumoured to be considering floating including Thames River, Charlemagne Capital and Polar Capital. GLG was rumoured to have been considering an IPO and, in the past, was also courted by Lehman Brothers which already had a 20% stake. The recent fine of £750,000 for alleged market abuse by its star hedge fund manager Philippe Jabre may have put to bed any exit plans GLG may have for the time being.

The market has had to wait a long time for another firm to follow in the footsteps of RAB Capital which floated on AIM in 2004. There was discussion then about the likelihood of other managers following suit but none materialised. This time round there does seem to be greater momentum and investor appetite for further floats. Interest is also not confined to the UK as can be seen by the IPO of Partners Group, a Swiss-based alternative asset manager which commenced trading on 24 March 2006.

Hedge fund managers are being tempted to float because of the attractive valuations that their businesses are currently commanding. Traditional asset managers historically commanded a value of around 3% of funds under management, as a rule of thumb. Single hedge fund managers have, however, sold out to investment banks at price ranges of 15-20% of funds under management.

Funds of funds

AIM investors seem to be keen to invest in single hedge fund managers. Institutions on the other hand appear to be more interested in acquiring funds of funds groups rather than single manager hedge funds.

On 20 January 2006 ABN Amro acquired International Asset Management, one of the UK’s largest and oldest fund of fund managers with £1.5 billion under management. Commentators suggested that IAM would have sold for about 5% of assets under management or £75m. In December 2005 Bank of Ireland paid £105 million for a 71% stake in Guggenheim Alternative Asset Management, a New York based fund of funds.

Schroders recently paid around 4% of funds under management for New Finance Capital’s $2.5 billion of assets.

The prevailing price for funds of funds businesses has dropped from the 10% of funds under management which analysts indicate was on the table a year or so ago to around 4%. This may explain the recent wave of consolidation in the funds of funds sector in which more than eight acquisitions for funds exceeding $50 billion in total have been announced in the last year. Whilst funds of funds are being snapped up by institutional buyers, single manager hedge funds may be finding that only AIM delivers the valuation they are looking for. Perhaps this means that institutions believe that valuations on AIM are unsustainable?

Fund of funds groups have not so far looked to AIM as an exit route. This may be because investors are not so attracted by a business model which is more akin to a traditional asset management boutique. Funds of funds have been sold at around 11 times EBITDA which is less than some traditional managers have been sold for. This contrasts with single fund managers where investors would hope the stock to trade on a substantially higher multiple.

Issues for investors

Investors need to be aware that returns are highly dependent on performance and, of course, the retention of the key managers. Hedge funds commonly charge investors an annual management charge of 2% and also a 20% performance fee and it is the performance fee that drives earnings growth. Much of this performance fee will be paid to managers in the form of bonuses. It is not uncommon for managers to take home a bonus of in excess of £50m and there may therefore not be a great deal left over for investors.

By floating these businesses, managers are offering investors a share of returns after bonuses to managers have been paid. It is difficult to see, however, a compelling reason for a manager to want to do this unless they were calling the top of the market and looking to realise value. For managers, this may be a sensible thing to do if there are investors out there willing to commit to high valuations.

Why float a hedge fund on AIM?

Hedge fund managers give a number of reasons for looking to float their businesses. These include:

  • realising value
  • creating a heightened profile; and
  • providing access to capital for growth.

Obtaining an AIM listing does, however, involve significant costs and a substantial investment in time by management. In the context of hedge funds, it is the management time which is likely to be problematic, particularly in smaller groups, where the hedge fund managers may also be managing the business.

How much does an AIM listing cost and what advisers does an AIM listed company need to appoint?

The base level for admission costs would normally be in the region of £250,000 – £300,000. On top of these fees the company will need to pay the broker’s fees for raising funds, which may be in the region of 3 – 6% of funds raised. However, managers may decide not to raise funds on admission.

The key adviser that a company needs when seeking an AIM listing is a “nominated adviser”. One of the duties of the nominated adviser is to confirm to the Stock Exchange that the company is appropriate to be listed on AIM and that the requirements of the AIM rules have been complied with. The nominated adviser will carry out due diligence on the company and its directors to assess whether or not they would like to sponsor the company and to ascertain whether the company is suitable for an AIM listing.

A company will also need to retain a broker (although many nominated advisers will also be able to act as brokers). Part of the nominated adviser’s/broker’s assessment will be whether they can sell the company’s stock to investors at the price being demanded by the manager. Other advisers who will be involved in an AIM admission are lawyers to the company, reporting accountants, lawyers to the nominated adviser, public relations advisers, printers, and registrars who will administer the register of members.

Suitability

The directors of the company need to have confidence in the company’s future performance. The directors also need to be able to sell the company’s strategy and prospects to the nominated adviser. Once admitted to AIM, a company must publish annual audited accounts prepared in accordance with United Kingdom or United States generally accepted accounting practice or international financial reporting standards. A half yearly report also needs to be prepared although this does not need to be audited. A company’s AIM securities must be freely transferable (subject to limited exceptions). This means that any shareholders agreement will need to be cancelled.

Admission document

A prospectus style document called an admission document will need to be produced. A company may either include its last three years’ audited accounts in the admission document or an auditor’s report on the company’s state of affairs and profit and loss for the last threeyears. A nominated adviser will often require an auditor’s report to be included.

The AIM rules require a statement by a company’s directors to be included in the admission document which confirms that the company has sufficient working capital for a period of at least 12 months from the admission date. The company’s nominated adviser will therefore invariably require a working capital report to be prepared by the company in conjunction with its auditors. The company will also need to confirm that it has satisfactory reporting procedures in place to enable the directors to make judgments as to the financial position and prospects of the company.

The directors of the company will be personally responsible for the contents of the admission document and a detailed verification exercise will need to be carried out to ensure the accuracy of the document. The whole process from the appointment of advisers through to admission would normally take at least 12 weeks and often longer. Most companies therefore start planning an AIM float several months in advance.

What are the continuing obligations?

An AIM company is obliged to notify a regulatory information service without delay of any new developments which are not public knowledge concerning a change in its financial condition, sphere of activity, the performance of its business or its expectation of its performance which, if made public, would be likely to lead to a substantial movement in the price of its shares.

Directors will not be able to deal in the AIM company’s shares when they have information which might affect the company’s share price or in the two month period leading up to the company’s announcement of results.

Quite apart from the requirements of the AIM rules, the company’s nominated adviser may also impose additional restrictions on the company in order to make it more attractive to investors. An example is the common requirement for directors and substantial shareholders to be restricted from selling their shares for a period after admission. In addition, the nominated adviser may require the company to follow corporate governance best practice. At the very least, a nominated adviser is likely to insist upon the appointment of non-executive directors (assuming none are already in place).

If an AIM company does not comply with the AIM rules, the Exchange may suspend trading in the company’s shares and ultimately may seek to cancel the company’s AIM admission.

Should you be considering floating?

If you are looking to realise value and can persuade a nominated adviser/broker that your hedge fund business should command a high valuation, it must be tempting to consider a float. You are, however, going to then be subject to the full demands of being on a public market. You will need to, amongst other things, appoint non-executive directors, you will have to file half yearly financial statements and you will need to devote a substantial amount of time talking to investors.

One of your objectives may be to realise value by substantially selling down your equity interest in the business. You are likely to be locked in so that you cannot sell further shares than those you were allowed to sell on the IPO (if any) for one or possibly two years. You may also find that there is insufficient liquidity in the stock for you to sell down your holding after the expiry of the lock-in period without adversely affecting the share price. Even as regards an IPO, market sentiment changes very quickly and you could find yourself having expended great time and effort getting ready to come to the market, only to find that investor demand is not there at a price at which you are willing to sell.

Maintaining a listing does not come without additional direct costs and you will find that you are paying out several hundred thousand pounds a year on non-executive directors’ fees and additional professional fees incurred by virtue of maintaining the listing. You will also find that the distraction of being quoted will be greatly increased if and when performance is not as good as anticipated and investors demand answers from management to their questions.

Many managers may be better off concentrating on fund performance and retaining the equity in their business in the medium term. It will be interesting to see, therefore, whether the current wave of hedge fund businesses floating turns into a flood.