How Latitude Financial’s IPO lost its bearings on a day of market drama

On Tuesday afternoon, the market fizzed with whispers Latitude Financial’s backers were preparing to pull the offer.

Latitude Financial boss Ahmed Fahour. Picture: Stuart McEvoy.

In the end it was just too much for the market to swallow.

On Tuesday afternoon, as the clock ticked down to closing time for the biggest share issue of the year, the market fizzed with whispers Latitude Financial’s backers were preparing to pull the offer.

The asking price had already been cut by as much as 20 per cent and investor feedback was that it was still too expensive. At $1.78 a share, it was being offered on a multiple of 11 times earnings and institutional investors wanted that cut further to 10 times.

Earlier that day the three top-tier investment banks managing the float — Macquarie Group, UBS and Goldman Sachs — sent out a message to investors that ­demand, which included firm ­orders and also early indications, “currently exceeds the expected offer size” of just over $1bn.

But it included a caveat that ­demand included $330m — roughly a third of the offer — was allocated to retail and that the ­networks spruiking the share to mum and dad investors had been asked to confirm their broker firm allocations.

That statement is now being scrutinised by the Australian ­Securities & Investments Commission as part of a regulation ­review of the failed share offering.

“ASIC would always examine the circumstances of any attempted or completed IPO, and this one is no different,” an ASIC spokesman said on Wednesday.

By early evening it would seem the news coming back from those networks was not good.

On the sidelines of the Citi ­annual investment conference in Sydney on Wednesday, one fund manager said his fund had made an indication of interest in buying shares in Latitude but never actually put in a firm bid. “A lot of people were bidding at 10 times PE (forecasted annual net cash profit of $287m),” he said.

Some said retail investor interest was also less than expected.

The owners — Deutsche Bank, private equity firm KKR and Varde Partners — already felt they were not getting fair value from the institutional market and began to fret about how the after-market would fare, and how it would reflect on them.

For the second time in just over 12 months, the owners have watched a big payday go begging. An attempt to sell in October last year was pulled because of the CEO’s poor health, and Ahmed Fahour, the former CEO of Australia Post and before that a top executive with National Australia Bank, was parachuted in with generous incentives to get the company listed.

That’s now a distant prospect. A second fail is expected to make investors wary of another approach in the near term.

Even so, a transaction remains particularly pressing for Deutsche Bank, which announced a radical downsizing in July that includes quitting the global equities business and exiting €74bn ($121bn) of assets and €288bn of leverage ­exposure.

As DataRoom has reported, a possible plan B would see KKR and Varde buy out Deutsche’s stake. Yet ­another alternative would be to sell the business to another private equity firm.

A float provided a path to a full exit, with Deutsche, Varde and KKR — which bought the GE consumer lending business in 2015 for $8.6bn — agreeing to hold the remaining 70 per cent of shares only until August. They would want a strong secondary market in the shares as much for ensuring a profitable exit from the company as for keeping the market open for other exits.

But as one fund manager put it, investors have now seen the vendors coming. He would have been prepared to buy shares at a market value of $2.5bn before Tuesday’s dramatic events.

“After this debacle, I’m at $2bn,” he told The Australian.

In the back of the vendors’ minds, and prospective buyers’, too, is what might be called the private equity discount. It's a lingering suspicion that private equity sponsors are getting the better end of the deal when they are selling you something. And its fuelled by a handful of prominent duds including the 2009 Myer float from TPG that never recovered its $4.10 issue price and the quick flip of Dick Smith Electronics that went into liquidation two years after being flipped by Anchorage. Estia, iSelect and ­Inghams are all trading well under their issue price after being sold by private equity sponsors.

Despite lining up 16 brokers and advisers to sell the stock and split about $69m in selling fees, Latitude faced some devastating critiques from fund managers and stock pickers. Atlas Funds Management portfolio manager Hugh Dive wrote that the Latitude offer document reminded him of the prospectus to float RAMS Home Loans: “namely, a financial company built on arbitraging the difference between wholesale and retail interest rates that ultimately depends on the goodwill of banks to continue to lend to them”.

RAMS went bust just weeks after raising $500m from investors as the first wave of the global financial crisis hit in late 2007, earning it the title of the worst float ever.

Dive’s critique included concerns that Latitude’s model of borrowing short and lending long to largely low-income consumers could hit trouble in another market downturn without the insurance of retail deposits that its competitors in consumer finance, the big banks, have in place.

James Greenhalgh, writing for the Intelligent Investor, was even more scathing, noting that Latitude had a risky lending business and would lose 24c in the dollar of operating income to impaired loans, compared to 5c at Commonwealth Bank.

“If you were going to consider a risky consumer lending business like Latitude, you wouldn’t do it 27 years into Australia’s ­record-breaking economic expan­sion. You’d look to buy after a crisis when it might be cheap,” Greenhalgh wrote.

How Latitude proceeds from here remains to be seen.

One consequence is that the current owners wear the expense of a big step up in spending on technology in 2020 that was forecast in the prospectus and would have weighed on the new owners had the float gotten away.

In the year between its first and second attempts at a float, Latitude has also made a pivot to offering a buy now-pay later product, LatitudePay, to match Afterpay Touch and its growing list of imitators. If and when Latitude comes back to market, investors will at least have a much better view of how that business has performed.