For Exits, Firms Turn To Private Placements

Confronted with unsettled times, buyout firms may want to consider the fast exits possible in the 144a private placement market.

Last month, New York LBO shop Welsh Carson Anderson & Stowe exited its 93.5 percent stake in BancTec, a Texas data processing company, through a 144a sale, earning $345 million. A month earlier, Austin, Texas-based buyout firm TGF Management used the 144a market to liquidate its position in Orion Marine, generating $214 million for a 6.8x return on invested capital.

And the 144a market appears primed to handle many more deals like these. With much fanfare, Goldman Sachs earlier this year launched a 144a trading platform, which so far trades only one security, a stake in Oaktree Capital Management‘s partnership, although Apollo Management is due to make its debut on the Goldman platform later this year. In July, Morgan Stanley, Lehman Brothers and Citigroup announced their intention to build a rival 144a trading platform, while JPMorgan Chase is also creating its own. Nasdaq, meanwhile, has said it plans to beef up its 144a products. The leader in 144a equity issuance is FBR Capital Markets, which handles nearly three-quarters of new issuances and also offers a trading platform.

Named for the Securities and Exchange Commission rule governing private securities, the 144a market is open only to institutional investors with more than $100 million in assets. The market is most often used for debt issuances, especially high-yield bonds. Last year, 144a issuances totaled $1.2 trillion, about $1.1 trillion of which were new debt securities, according to Thomson Financial (publisher of Buyouts). But companies also are using 144a’s for equity offerings.Last year, the top six investment banks led 17 144a equity offerings, raising $3.2 billion, according to Dealogic, including several from financial sponsors. That’s twice the number of offerings in 2004, according to Dealogic. Rick Hendrix, president of FBR Capital Markets, estimates that his firm is on pace to raise $6 billion through 20 equity issuances in 2007. In the second quarter of 2007, FBR Capital Markets led six equity offerings, totaling $1.6 billion. In the cases of Welsh Carson and TGF management, market-maker FBR Capital Markets lined up institutional investors—largely the same groups that would participate in a garden-variety IPO—to buy the shares in the new private securities. Shares issued through 144as are usually destined for a public market, most likely after six months or a year of private trading.

Pursuing an exit through a 144a transaction has its pluses and minuses. On the plus side, the nine-month registration period for a full-blown IPO typically shrinks to as little as 45 days on the private market. What’s more, a normal IPO requires a sponsor to maintain a significant position in a portfolio company following the offering. Lock-up agreements often force firms to maintain at least 20 percent to 30 percent stakes in their companies for months and even years, whereas a private placement can lead to an immediate and complete exit.

“It’s not just the ability to sell 100 percent, although that is appealing,” Hendrix said. “It’s also the speed to market. If you’re a private equity firm and you want an exit on a particular portfolio company, and you think you can get it done in the next month and a half, you’re going to go for a month and a half.”

On the other hand, private placements limit the number of investors. In its first year of trading, a 144a issuance might achieve half the trading volume it would as a public listing, although it’s often less, Hendrix said. Consequently, the diminished liquidity means the equity doesn’t always fetch the same price as it would on the NYSE or Nasdaq.

“There’s a tradeoff,” said Michael Kalb, managing director of buyout firm Sun Capital Partners. “You probably might lose a turn or some degree of value.”

Still, that wasn’t enough to keep Sun Capital from exiting zinc producer Horsehead Holdings in two privately placed tranches in November 2006 and April 2007. Kalb said that any value Sun Capital lost in the private placement was compensated by the fact that the firm completely realized its investment several months before Horsehead would have begun trading on a public platform.

Demand for the 144a market will increase among buyout shops, Hendrix predicted, as more firms seek to cash out of some portion of their partnerships and as they look for liquidation in a market that’s growing more troublesome by the day. “As we get to the back side of this private equity cycle, when sponsors have to exit all these portfolio companies, I think the 144a market will be used extensively as the vehicle for liquidity,” he said.