Economic watch: Big IPOs may (eventually) produce liquidity for LPs

Limited partners that backed mega-buyouts during the height of the market are licking their chops at the thought of all the distributions heading in their direction as buyout firms contemplate IPOs.

The question is how long they’ll have to wait.

The pace of IPOs has perked up so far this year after almost two years of market immobility. Eight portfolio companies held IPOs in the second quarter, raising roughly $1.7 billion, following four in the first quarter, raising about $1 billion. Only one buyout-backed IPO took place in the first half of 2009—that of Rosetta Stone Inc., owned by ABS Capital Partners, Madison Capital Funding and Norwest Equity Partners.

Of the 10 largest mega-deals of the last decade, one, hospital owner HCA Inc., backed by Bain Capital, Kohlberg Kravis Roberts & Co. and Merrill Lynch Capital Partners, registered in May for an IPO of up to $4.6 billion. Meanwhile, energy company Kinder Morgan Inc., backed by AIG, The Carlyle Group and Goldman Sachs, is in registration, according to Thomson Reuters (publisher of PE Week). Toys “R” Us Inc., owned by Bain Capital, KKR and Vornado Realty Trust, has filed plans for a $205 million IPO. And gaming company Harrah’s, owned by Apollo Management, HarbourVest Partners and TPG, may choose the IPO route to help reduce its debt load of $22 billion.

As exit options go, right now an IPO is one of the best choices for buyout shops, said Alexander Lynch, a corporate partner in the capital markets practice in the New York-based office of Weil Gotshal and Manges.

The M&A market is not nearly as robust as it was three years ago, while it can still be tough for buyout firms to cobble together enough leverage to make secondary deals work. “The old way of just selling a portfolio company to a strategic buyer or to another buyout firm has been pretty limited,” Lynch said.

Meantime, Lynch said, the IPO market “has been reasonably receptive” to sponsor-backed deals, in large measure because of their track record.

Both buyout and venture capital-backed IPOs have outperformed their non-private-equity-backed counterparts over the last six months, as well as over the last five years, according to data provider Ipreo. One of the strongest recent performers has been STR Holdings, a plastics research and development company whose share price has more than doubled since its November 2009 IPO, to a current price of $24. DLJ Merchant Banking Partners had backed STR Holdings.

But LPs should not get their hopes too high just yet. Lynch said it’s fairly typical for a private equity sponsor to sell just 10% to 20% of its holdings in an IPO.

How long it takes to sell more than that depends on how well the company and its stock performs in the months following the IPO. In the mid-2000s it wasn’t unusual for the proceeds of stock offerings to go to paying shareholders a dividend. But those days are long gone.

Most IPO proceeds today go to paying down debt, funding acquisitions and other corporate purposes.

“A lot of general partners are looking at IPOs to provide their LPs with some liquidity,” said James Westra, co-head of Weil Gotshal and Manges’ private equity practice and managing partner of the firm’s Boston office. However, large offerings also often have transfer restrictions or lockups, meaning LPs cannot sell their shares quickly but must wait, often for six months, before doing so. —Nancy Gordon