Fund managers definitely want to avoid bringing a company public, only to have it miss its earnings target the following quarter, Perricelli says. The stock price will take a hit, and may be left with little to no analyst coverage, he adds.
However, the returns on PE-backed IPOs tend to beat, albeit slightly, the returns on other types of initial public offerings. That was the finding of a 2008 study by Lerner of Harvard and Jerry Cao of Singapore Management University. The two analyzed 500-some reverse LBOs, or initial public offerings of firms that had previously been bought by private equity investors, along with 5,700 other IPOs over the period 1981 through 2003. The private equity-backed IPOs slightly outperformed the return on the S&P 500, while the remaining IPOs slightly underperformed.
“A lot of companies go public that aren’t really ready for prime-time,” says Lerner in explaining the difference. “They don’t have the systems in place to be effective in dealing with all the stresses associated with being a public company.” On the other hand, most companies held by private equity investors have had to face investors and answer pointed questions about their performance. Most also have a governance structure in place and experience preparing quarterly financial statements.
SolarWinds, a provider of network management software, is one example. The company, based in Austin, Texas and founded in 1999, was backed by several venture capital and private equity firms. Its board of directors includes several veterans of other public companies. SolarWinds went public in May at $12.50, above the target range of $9.50 to $11.50. Revenue and profits for the quarter ending June 30 both topped 2008 results, and its stock has steadily risen to about $18.
While predicting the IPO market is iffy, the current interest in public offerings by private equity-backed companies probably is more of a short-term blip than an enduring change in strategy, Lerner says. For one thing, the universe of companies ready for an IPO at any point in time is relatively small. That includes companies in private equity portfolios.
In addition, the tight credit environment is making negotiated sales more difficult to complete, and is prompting private equity managers to look for another exit, Dolvin says. “This may be the single offsetting factor driving firms to IPOs in a market that is otherwise at the bottom end of the cycle.”
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