Recent ‘quick flip’ IPOs of private equity-backed companies may be widening the divide between some City fund managers and the private equity market, but on reflection, it is validation that private equity is just doing its job – and well at that. On closer inspection, such deals could precipitate a whole new way of thinking for institutional investors.
When a company is taken private by a private equity firm and then re-floated a couple years later, but at a higher valuation, one would think the private equity team responsible would be applauded, rather than criticised in City columns by disgruntled fund managers. Lately, fund managers felt a need to speak out in the Sunday Times at their discomfort with such deals. And unfortunately, the recent IPO of spread betting business IG Index took the brunt of the blow. IG was taken private by buyout house CVC in 2003 for £143m and re-floated in April 2005 with a market capitalisation of £393m, with CVC retaining a 24.7% stake.
The deal created some red faces among fund managers, especially those that had sold the company to CVC in the first place and were now being asked to buy shares in the company, but at a much higher
valuation and were having to explain to trustees why this had happened. Despite what some fund managers might have led people to believe about the valuation of the business, it is questionable that any IPO could come to market over-priced, given the current book building methodology for pricing IPOs, says one City source. One of the main reasons these quick flip IPOs occur is to pay back the highly leveraged debt that went into the original take-private.
Many in the private equity industry, and those that advise it, believe it’s time the private equity industry gets a pat on the back rather than harsh criticism for re-floating stronger companies onto global stock markets. “The institutions who sell on a take-private do so because they want to take the cash premium at the time- they do not have to accept the offer,” says Charlie Geffen, head of private equity at law firm Ashurst. “If the company is then re-floated, they also have a free choice as to whether to subscribe for shares on the IPO. The market may not be perfect, but most people accept that IPOs only get away if they are priced sensibly. There may be many different reasons why value is added during ownership by a private equity firm – restructuring, consolidation, better management or even a re-rating of the sector.”
In the case of IG, the management and CVC thought it was a good time to float to reduce its debt. The company wanted to be in a prime position to finance future acquisitions to build scale, which is possible due to the fragmented nature of the spread betting industry. IG’s management felt comfortable that it could sell its story due to the pronounced difference in its performance since undergoing a stringent cashflow management regime under CVC’s guidance. Its revenues have grown at an annual compound rate of 45% since being taken private and it has decreased its revenue volatility by changing its business model.
Prior to being taken private, IG conducted 80% of bids over the telephone, but now that figure has dropped to less than 20% with the majority of the business’ activities conducted online – drastically cutting costs and boosting revenues. Under CVC’s ownership IG became an intermediary rather than a broker placing bets themselves and taking on clients’ risks onto their own balance sheet. But one of the most dynamic changes to the business has been the launch of its online non-professional stock market and sports spread betting business, www.binarybet.com, which accounted for 10% of IG’s revenues in 2004.
According to Simon Boadle, head of the public company advisory team at PricewaterhouseCoopers, these quick flips illustrate how, under private equity ownership, companies can go through some fundamental changes by restructuring (re-financing debt, performing sale and leasebacks or changing management). “The private equity community has a massive amount of experience in owning companies and directing management teams to focus on cashflow, which in itself is a value-adding exercise,” says Boadle. “And public companies thereafter can sustain strong performance when re-floated,” he says.
Others argue that it’s just easier and cost-effective to make a giant management or commercial transformation when under private ownership. If a public company starts changing its management and commercial strategy those shareholders not close to the business could get nervous and negative share swings could be the result. Privately-owned businesses also have a lower level of administration compared to listed companies which may have to seek shareholder approval for deals, which can be both time consuming and expensive. Rugby Estates, for example, moved from the main market to AIM to save having to pay £300,000 in administration costs every time it does a deal, according to an industry observer.
While the institution-initiated accelerated IPO can squeeze the VCs out of the equation, it will not stop VC-backed management teams coming back onto the market with stronger balance sheets. There’s a pattern of shareholder activism that institutional investors have failed to replicate from the US and European buyout houses. There must be more ways in which fund managers and institutions can attain the type of results that private equity managers often achieve. But until institutions start becoming more proactive, private equity firms will continue to reap the benefits.