Players doubt the IPO window will reopen for another two years and so by 2004 private equity firms that need to return money to investors will have a huge demand for public capital. Firms can do a lot to improve the value of a business while they wait, but the reality is many funds are under pressure to return money to disgruntled LPs who are waiting for impressive returns. And so an alternative solution must be sought. Thomas Kuhr of T-Venture, speaking in a session at the recent EVCA conference on Creative Alternatives to IPOs, said of both the venture and buyout markets: “There are definitely no quick exits in the current market situation. The IPO market will not reopen at least for the next two years, so we need some good alternatives and also good advice on how to manage our funds.”
Many earlier stage players consider the IPO the one and only exit channel and preferred method of exit, but buyout players can afford to be more flexible and creative with their exit strategies. George Anson, managing director, HarbourVest Partners says: “I am not saying the buyout business is easier than the venture business to exit, but traditionally it is used to finding alternative exit routes.”
There is not the same kind of urgency to exit coming from the buyout players as from the venture investors. There’s a healthy backlog of deals that in a normal market would pursue an IPO, but buyout houses are realistic and will look at other routes. “We’ve got deals in our portfolio which we think – why not hold onto it and releverage, rather than rushing to exit? If you can do that on a regular basis, you are keeping investors happy. We encourage clients to think of money multiples rather than IRR,” says Anson.
When the IPO window does eventually reopen there will be less of an appetite for small cap, high growth venture capital backed companies. This leaves the door open for mid-market and large buyouts. The advantages of an IPO is that it provides liquidity for both the entrepreneurs and the private equity firms transforming paper value into cash and subsequently driving returns and also fund raising. This is all part of the investment cycle. Now is a good time to invest, but a tough time for exits.
Robert Donaldson, part of the corporate finance team at Baker Tilly, says: “There’s a huge question mark. Should private equity houses be exiting at all at the moment? It’s a great time for investing for those who have raised the funds, but not so good for exits.” Thomas Kuhr says: “There is certainly a correlation between a growing number of IPOs and funds. New funds follow IPOs.” But as the queue of IPO-ready businesses forms, there will be a limited capacity of capital and it will be a case of quality rather than first come first served, says Toby Boyle of Henderson Private Capital Limited.
This is nothing new. The IPO market has been difficult for buyouts for quite some time now, says Boyle. Floats were being postponed even in the boom period of 1997/1998. What has happened is a long-term trend. The IPO market has become choosier. The trend has been for bigger businesses to float and investors are more inquisitive about the future growth prospects of companies, he says. “The IPO market is only open for large deals anything sub EURO300 million to EURO400 million, you won’t get away in the current climate,” says Robert Donaldson who is cautiously optimistic. “But nothing is impossible, it’s all a question of price. For the large funds like the Cinvens and CVCs of this world I’d say the IPO is alive, but I wouldn’t say it’s well.”
But it’s never been straightforward for private equity firms, says Toby Boyle. Fund managers in the public markets are often wary that private equity firms have milked the juices out of companies. It needs to be a certain type of business to qualify for a listing, he says. Clearly at the moment there are a lot of deals that haven’t exited due to the markets being closed, but equally performance issues come into play and how much private equity firms had paid for businesses in the first place.
He also adds that an IPO is not necessarily always a successful exit. There have been a lot of instances where MBOs have floated and then didn’t do particularly well. Private equity firms often lose out during the lock-in period and having to wait to exit while they watch their share price fall.
EVCA figures reveal public offerings have over the last five years, accounted for between 11 per cent and 21 per cent of all exits by value. In 2001 this number was down to a mere two per cent. Divestment by IPO declined 56 per cent to EURO250 million in 2001 with just 47 companies divested compared to 249 in 2000. But the total amount at cost of divestments made in 2001 at EURO12.5 billion was up 37 per cent from last year’s total of EURO9.1 billion.
Are buyout houses still focused on IPOs as a possible exit route? No. They are more likely to think about a trade sale, a refinancing or a secondary buyout. Their interest in the public markets at the moment is more likely to be on the buy-side with companies seeking to delist because their valuations have fallen creating growing opportunities for the public-to-private market. A recent high profile example is Leicester City Football Club’s plans to abandon its listing and return to the private sector. If the proposed GBP5 million sale to a consortium led by former club striker Gary Lineker does go ahead, it will become the fourteenth company to leave the main exchange this year, according to the Centre for Management Buyout Research.
George Anson says: “Certainly, we are seeing an increase in [public-to-private] activity. In some cases these companies had no business being publicly listed in the first place. But the problem with public-to-privates away from the UK is that they’re costly, time-consuming and the degree or likelihood of success can be lower than expected. Jefferson Smurfit will be the biggest public-to-private in a long time.”
Toby Boyle stresses: “It is a matter of finding the right business there should be a good reason to take a company private. The trick in public-to-privates is finding where the business is undervalued. At the moment there are more of these opportunities. You have to have a good exit strategy in place right from the beginning probably a break-up or expansion through acquisition. It is very difficult to bring a delisted company back to the public markets.”
Signs of life
But it is not all doom and gloom. While players are not relying solely on the stock market for exits, this year has nevertheless seen some high profile IPOs, a signal at least of some sign of market recovery see table. Sweden’s Stockholmsborsen led the way to this recovery earlier this year. Industri Kapital benefited from two listings, Intrum Justitia and Nobia and EQT celebrated a successful listing with Ballingslv International.
But the two landmark listings of the year were HMV and William Hill. Advent International achieved a partial realisation from HMV with a 100 per cent return on its investment. HMV raised GBP375 million, the largest retail IPO on the London Stock Exchange for over a year. William Hill also managed a successful float for Cinven and CVC Capital Partners raising GBP326.3 million. This has enabled the group to pay down debt, including an offer to buy back its sterling high yield bonds.
Candover has had a good year in terms of exits, celebrating two listings – IT services company Detica, which raised GBP13.3 million in the first half of this year, and Inveresk, which Candover listed on Nasdaq in June. Candover retained a 50 per cent stake in the company. Candover managing director Colin Buffin is upbeat: “We’ve actually had quite a good spell of exits this year five including one listing. If we look at the stock market over two years, the collapse in activity is from 2000 until September 2001. Then up until July 2002, the markets were on a growth curve. You really need a rising stock market for a good flow of exits.”
Candover was actually hoping for another two stock listings this year, but was forced to postpone plans until the markets recover. The two companies waiting in the IPO departure lounge are a relisting of HLF Insurance, which Candover took private in 1997 in a EURO148 million transaction, and frozen food chain Picard Surgeles, which Candover backed in March 2001 in a EURO920 million buyout.
For both companies Buffin says the firm’s preferred exit route would still be an IPO. “In the late 1980s, early 1990s two thirds of our exits were through IPO. Today it is one in ten. There has been quite a shift away from IPOs the stock markets are less willing to take on smaller companies, but they are still happening,” he says. He cites reverse mergers as an alternative opportunity to obtain a listing.
What next?
When the IPO window reopens, companies are going to have to be bigger and better to survive on the stock market, said Stephen Schweich, managing director of Sea Lion Ventures, speaking in the session on Creative Alternatives to IPOs at the recent EVCA conference in Barcelona. “This is a great time for private companies to seek mergers with public companies because public companies valuations are so depressed. You’ve got an arbitrage opportunity right now. Take advantage of it!”
A recent example is Swiss biotech company Cytos, which has merged with publicly traded healthcare company Asklia. As a result of the merger, Cytos will apply to the Swiss stock exchange for registration and request to begin public trading. The transaction reflects the increasing creativity needed by private equity players to exit their investments by looking to routes other than a straightforward flotation or trade sale.
As far as other exit routes are concerned according to the EVCA, divestment by trade sale (the largest category by amount) increased to EURO4.2 billion in 2001 from EURO3 billion in 2000 with 1,534 divestments compared to 1,542 in 2000. Write-offs represented 23 per cent of total divestment amount in 2001 at EURO2.8 billion, up substantially from EURO0.7 billion in 2000, and representing 26 per cent by number of all divestments. Secondaries accounted for just four per cent of total divestment amount in 2001 at EURO0.5 billion compared to EURO1.1 billion (12 per cent) in 2000.
But even the trade route, which accounted for the majority of divestments last year, is suffering. Robert Donaldson of Baker Tilly says: “The trade route is maybe even more difficult at the moment. Firstly the market punishes companies that take risks. If a public company makes an acquisition outside of its core, the public markets punish that company by selling shares and forcing its price lower. Secondly there is a pricing issue. The buyers don’t have easy access to cash and want to keep their hands in their pockets in the current climate.”
As many players have predicted, with the maturity of the private equity market, secondary and even tertiary buyouts have become popular exit strategies. George Anson of HarbourVest says: “In Europe for buyouts the public markets are not regarded as the major exit route. Alternative methods are recapitalisation, secondary or even tertiary buyouts.” He mentions PAI’s recent acquisition of Elis from BC Partners as a classic example. The deal was worth around EURO1.5 billion.
“I think from a banking perspective the banks are probably more comfortable with these transactions because they know the company has been in good hands i.e. with a private equity house which has the company’s best interests for growth at heart,” says Anson.
He also highlights recapitalisation of deals growing in popularity primarily due to low interest rates. “Private equity houses want to derisk a deal in a certain period of time. Part of many firm’s strategies at the moment is to get money off the table as quickly as possible. Recapitalisation of a deal is a popular route.”
One firm that wasn’t so lucky with its flotation plans this year and has instead gone for a recap is Duke Street Capital’s do-it-yourself retailer Focus Wickes. The IPO, planned for this summer, was pulled due to poor equity market conditions. Duke Street Capital is keen to realise some cash from the business this year and an IPO cannot now be rescheduled in time. So the company is progressing with the refinancing of the GBP375 million senior debt financing put in place in early 2001 to back Focus Do It All’s acquisition of Wickes. There are also rumours that Duke Street is looking to sell its stake to another private equity house. Apax Partners is said to be in the running.
Another company seeking a leveraged recap in lieu of a failed listing is UK bingo and casino operator Gala Group. There had been talk this summer that the CSFB private equity-backed Gala was planning a GBP1.3 billion IPO. However, in the face of the poor stock markets, those plans were shelved. In addition to its high yield bonds, the company has a GBP340 million senior debt financing outstanding. That leveraged loan was put in place in April 2001 by mandated arrangers CSFB, JP Morgan and RBS, when the company refinanced following its acquisition of 29 casinos from the Hilton Group. CSFB Private Equity bought out the company from PPM Ventures in May 2000 and is now keen to get back some of its equity investment and realise some of the value created.
Oliver Brind of the financial sponsors coverage team at Cazenove, says: “I hope that the market will begin to reopen next year, but it will be a selective market for IPOs in terms of the nature of the company coming to the market. In particular investors will be looking for realistic valuations, robust business models and sustainable real growth. There are some signs of greater stability. However the lead time for an IPO is quite long and it is highly unlikely that there will be an IPO of any size before the end of the year.”
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