After a dry spell of well over a year, the market for initial public offerings is slowly ramping up.
That’s welcome news for private-equity firms. While the IPO window may be just inching open, the prospects look enticing enough that a number of companies are taking the opportunity to move into the public markets, including a few firms held in private equity portfolios. Over the past several months, Dollar General, Rosetta Stone, and Avago Technologies, among other PE-backed ventures, have completed initial public offerings.
Between July 2008 and June 2009, only 58 companies filed to go public with the Securities and Exchange Commission, according to information from Renaissance Capital, a Greenwich, Conn.-based IPO research firm. That compares with 108 in just the first half of 2008, and 21 in July and August of this year.
To be sure, even with this increase, the current rate at which companies are going public doesn’t compare to the headier pace of IPOs prior to 2008. In 2006, for instance, 293 companies filed to go public. That number jumped to 373 in 2007, according to Renaissance.
“The concern with IPOs has always been that you’re really at the mercy of the overall market.” -Michael Laveman, partner, Eisner LLP
“The IPO market is intensely cyclical,” says Josh Lerner, professor of investment banking at Harvard Business School, Boston, and private equity-backed offerings aren’t immune to larger market forces. If the IPO market remains open, it’s likely that more private equity firms will take advantage of public offerings as an exit strategy for some of their portfolio companies, he adds.
Does this represent a shift in strategy for private equity firms? After all, most private equity investors prefer to sell their portfolio holdings to a strategic buyer, rather than take their chances on a public offering. “The concern with IPOs has always been that you’re really at the mercy of the overall market,” says Michael Laveman, partner with accounting firm Eisner LLP. “Privately negotiating with a strategic buyer offers sellers a greater level of control.”
In fact, private equity investors have targeted IPOs as exit strategies for only about 13 percent of their investments, according to an analysis of some 21,000 private equity transactions between 1970 and 2007 by the World Economic Forum, “The Globalization Impact of Private Equity Report 2008.” Selling to another company was the most common exit mechanism, accounting for 39 percent of exits.
At the moment however, finding buyers has become more difficult, says Jeremy Kloubec, senior client partner for private equity at Infosys Technologies Ltd., a business solutions provider. Private equity mergers and acquisitions in the U.S. this year totaled $13.6 billion through July, or less than one-fourth the amount for the same period last year, according to Thomson Reuters.
The drop-off in deals is due to a mismatch between sellers’ and buyers’ expectations, Kloubec says. In addition, potential buyers aren’t able to use as much debt to carry out acquisitions, which means their purchases are going to be smaller.
The current jump in PE-backed IPOs also reflects the skill of private equity fund managers in timing the market, says Steven D. Dolvin, Ph.D., and associate professor of finance at Butler University in Indianapolis. “They’re very good at coming to market at the best time for a particular sector.”
“When the window is closed, you build up a backlog, and have to release it at some point.” -Jeremy Kloubec, senior client partner for private equity, Infosys Technologies Ltd.
A case in point is Dollar General. On August 20, the operator of 8,600 discount stores filed form S-1 with the Securities and Exchange Commission to go public. Dollar General is owned by Buck Holdings, a limited partnership owned by Kohlberg Kravis Roberts & Co., L.P. The proposed offering totals $750 million. “In the case of Dollar General, you can’t be better primed for a down economy,” Kloubec says.
Even as private equity investors decide it’s a good time to wade into public waters, they can’t guarantee that investors will be receptive. Some are going to be concerned that at least a few of the firms are coming to market simply because the fund managers want to get their money out while they can. If that’s the case, they may be bringing companies public that should remain private a while longer. “When the window is closed, you build up a backlog, and have to release it at some point,” Kloubec says.
Others express more confidence that the firms coming to market will succeed. For starters, IPOs really aren’t the most effective way for fund managers to cash out, says Scott Perricelli, partner with private equity group LLR Partners in Philadelphia. Even once an initial public offering is completed, the owners can’t sell a significant portion of their holdings until the lockup period expires. Instead, an IPO really is a way of valuing a business and providing it with capital for growth.
Moreover, private equity firms want to avoid a repeat of the kind of experience that Rosetta Stone, Inc., is having. The language software company went public in April, and got off to a great start, with its shares rising from about $18 to $25 on the first day of trading. For a time, it traded at over $30.
Things aren’t quite as rosy now, however. In August, after the company cut its third quarter forecast, the stock fell to about $21 and management pulled a planned secondary offering. As of late August, Rosetta’s stock was trading at about $22.
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