In today’s murky economic environment, leveraged buyout firms caught between a dried-up debt market and a much-maligned equity capital market – may fare better looking for an exit in a labryinth.
It’s no surprise that the avenues through which buyout shops exit their portfolio companies are all currently closed or impassable. With both Nasdaq and Dow Jones indices struggling to revive investors’ interests, sources say that it’s problematic for firms to exit their investments in the public market. Additionally, few industries have been able to escape the wrath of the public market and, as a result, buyout shops are seeing potential strategic buyers underperforming and unable to acquire companies. And the lending market is making matters worse – banks are lending at lower multiples, forcing buyers and sellers alike to accept lower returns in the private market.
Healthcare Gets Bad Treatment
However, for certain industries, such as health care and energy, sources say there may be good news on the exit front. Health-care and energy companies are gaining support from investors in the public market because of their non-cyclical and defensible characteristics. “I’ve heard that there’s a bit of interest in health-care companies, and that market has been stone cold until now,” says Greg Barr, a managing director at Navis Partners. “That is a sector that may have some resurgence and there may be an opportunity to take some of those companies public.”
Christopher Behrens, a general partner at J.P. Morgan Partners, says he has seen six health-care and biotech companies tap the IPO market in the last six months, but suggests erring on the side of caution. “We remain cautious and sober-minded about the next couple of months. Whenever you have the new-issue market not doing well, the overall appetite for new stock issues will remain pretty modest even while the appetite in some sectors may be robust,” he says.
As for the performance in the public market, certain areas within health-care, including hospitals, seem to be performing better than other segments, such as home care, sources say.
Mark Francis, the director in the health-care investment banking group at Houlihan, Lokey, Howard & Zukin, says that out of the five or six health-care companies that have tried to go public in the second quarter, only Select Medical Corp., an operator of specialty acute care hospitals for long-term patients, made it through – but not without some difficulties. The company, which had planned to offer 12.5 million shares at $11 to $13 per share, had to scale back its offering to 9 million shares at $9 each amid the slump in new stock offerings.
“This is a billion dollar company, and they were backed by a couple of the big-name shops and, from that perspective, they barely made it out,” Francis says. “And the others are either in limbo or pulled their offering. Right now there are about 70 public health-care companies the vast majority of which are in the micro-cap space not being valued appropriately.”
Indeed, an informal survey of publicly listed health-care companies reveals a host of companies fallen prey to an ailing stock market. Included among them are: ARV Assisted Living Inc., a provider of assisted living accommodations, which was recently trading at $.86 per share; Bio-Imaging Technologies, Inc.; a pharmaceutical contracts service organization, which was recently trading at $.75 per share; and Coram Healthcare Corp., a deliverer of home or alternative site infusion therapies, which was recently trading at a paltry $.15 per share.
Energy Fuels Warm Reception
Despite investors’ general apathy toward new stock issues, energy companies are seemingly attracting more attention than most others in the public and private market and just in time for heightened interest from LBO firms. Recently, J.P. Morgan was able to take its portfolio company Encore Acquisition, an energy company engaged in the acquisition, development, exploitation and marketing of North American oil and natural gas reserves, public and, thus, double its investment in the company. Encore Acquisition, which in March priced its initial public offering of 7.15 million shares of common stock at $14.00 per share, was recently trading at $14.15 per share. J.P. Morgan Partners has invested approximately $50 million in Encore since forming the company in August 1998 with Warburg Pincus & Co. and Natural Gas Partners.
J.P. Morgan Partners has also seen some of its energy divestitures through strategic sales garner good returns. Since the beginning months of this year, the firm has realized approximately $500 million in proceeds from sales of its energy and power assets. Most recently, the firm sold its stake in Bear Paw Energy to Northern Border Partners LP in a transaction totaling $370 million. The sale generated a return of more than four times J.P. Morgan’s original investment.
In a previous interview with Buyouts, Behrens said his firm decided to exit Bear Paw after studying trends in the industry and realizing that natural gas prices would stay relatively high compared to previous years, and that deliverability and the ability for other companies to have a secure source of natural gas would be valued.
The firm also divested itself of Granite Power, a portfolio of operating and developing projects that employ natural gas-fueled combustion technology, to NRG Energy, gaining more than 50 times its investment with the close of the transaction. In addition, Patina Oil & Gas Corp. recently repurchased 758,500 shares of its common stock from J.P. Morgan Partners for $20.50 per share, or $15.8 million. As part of the transaction, the company received an option to purchase more shares for the same price through May 1, which would cover all of J.P. Morgan’s stock in the company. J.P. Morgan’s return is in the upper 30% range on Patina, Behrens said.
Other energy and energy-related companies that are currently soaking up interest from the public market include Oil States International, Inc., a provider of specialty products and services to oil and gas drilling and production companies, which was recently trading at $10.78 per share; Key Energy Services, Inc., an onshore, rig-based well servicing contractor, which was recently trading at $13.25; Carbo Ceramics Inc., a producer of ceramic used in hydraulic fracturing of natural gas and oil wells, which was recently trading at $43.87 per share; and Horizon Offshore, Inc., a provider of marine construction services to the offshore oil and gas industry, which was recently trading at $24.50 per share.
GPs, Sellers Wait it Out
But the overall unforgiving public market conditions have GPs opting to spend more time on the farm, tending to their crops, rather than seeing the fruits of their labor selling for less than what they want. “Some people we’ve been talking to are holding and focusing on their own operations before they go back to the market,” Behrens says.
And as the lending market continues on its winter hibernation, more firms are using the IPO market as a financing tool for their companies rather than an exit opportunity. “As we make investments, we spend a lot of time looking at the range of available financing strategies, such as debt refinancing or an IPO,” Behrens says.
Other GPs share the same sentiment. “You shouldn’t go public unless you need the cash,” Barr says.
The private market as a place to exit investments is also proving challenging for buyout shops – senior lenders are not willing to lend more than 3.5 times earnings before interest, taxes, depreciation, and amortization.
“For firms that are planning to exit to a leveraged buyout fund, valuations are going to be lower than they were a year ago just because they can’t borrow as much as they could,” says Robert Newbold, a principal at Graham Partners. “I would much rather be buying than selling in today’s market,” he adds.
Francis says he’s also seen an unwillingness on the part of private equity firms to depart with their holdings in current market conditions. “Even the firms that are ready for an exit don’t find [the market] attractive so they’re building up their companies revenue-wise to create more value,” he says.
“There are a lot of situations where a lot of private sellers are being patient trying to see if the market will improve,” says Robert Frost, vice president of middle-market mergers and acquisitions at U.S. Bancorp Piper Jaffray. “There are a lot of people out there who are sitting on the sidelines waiting for valuations to come back.”