Hot or not in the IPO market

Investors are giving William Hill and Yell very different treatment in the build-up to their respective floats. Breakingviews finds out why.

Yield stocks: What are institutional investors thinking? The question is vexing many of the companies – and their bankers and private shareholders – attempting initial public offerings. But the reactions of big investors to companies now on the launch pad give an idea of what's on their minds. In short, it is income they are after, not `investment stories.'

Consider the contrasting reception funds are giving to William Hill, the British chain of betting shops, and Yell, the former British Telecommunications yellow pages unit. William Hill is further along in the process, with its IPO expected to close at the end of the week. Its bankers have already taken orders for more than four times the amount of stock on offer, which may inspire its private equity backers to put more on the table.

There are lots of reasons institutions are keen on William Hill. For one, at the mid-range of the offer, it is priced more or less in line with its two closest listed rivals. And for a mature company – it's been around since the reign of George V – it has decent growth prospects with the relaxation of gambling restrictions. All of this might be enough to interest investors. But the icing on the cake is the near 4% dividend yield of the stock.

By contrast, Yell's backers – also leveraged buyout groups – are putting forward a different story, and apparently getting a cooler response. Yell's big UK business is a mature, cash generative near-monopoly, but its US directories, Yellow Book and McLeod, are fast-growing independents toughing it out against established rivals owned by the big regional telephone companies.

Unlike William Hill, Yell is proposing a measly dividend yield of maybe less than 1%. The reason? Any cash not retained to service its £1.2bn debt burden is to be retained in the business to acquire US rivals. All this may make for a good investment story. Indeed, Yell's underwriters envision compound annual growth in earnings per share of 25% from this year to 2005. But good growth stories are not the yarns institutions are looking to hear.

In part this reflects investors' scepticism towards M&A-led strategies. Warchests, in particular, are out of fashion: just think of the way investors have hammered away at the likes of Six Continents. But it also reflects investors' determination to achieve a positive return on any new equity investments they make. A 15% IPO discount and a 4% yield provide a reasonable cushion against the vicissitudes of the market. And in current markets, a big, squashy cushion is what is required to get an IPO away.