Striking a balance

Over the past couple of years, the sponsor community has been at the heart of some of the most controversial ECM deals completed, whether the now infamous competitive IPOs, or dual-track processes in which other sponsors or trade buyers are canvassed alongside public market investors.

With a strong equity market recovery across the world, the traditional three to five-year private equity investment has been turned on its head by “quick-flips”. Witness the flotation of Hertz, which is due to price this week having been bought by Merrill Lynch, Clayton Dubilier & Rice and the Carlyle Group less than a year ago.

But decisions on the timing of a monetisation are a function of the nature and quality of the company concerned rather than secondary market conditions, according to Charles Sherwood, one of Permira’s five-strong operating committee, the closest the firm comes to having a board.

“The overriding aspects that affect timing are the nature of the portfolio company, the state of the industry in which it operates, the attitude of management and the extent to which we think we can continue to create value for the company,” said Sherwood. “None of these is to do with public equity market conditions.”

Keeping one’s options open is the key, and that goes right back to the original LBO of an asset. “We prefer to own companies where we feel that there are multiple exits down the road,” said Sherwood. “Generally, to be attractive to the public markets, assets need to be of a sufficient size, scale and have good enough growth prospects.”

Having determined that it is the right time to sell, the state of the public markets obviously plays some part in the decision as to the choice of disposal method, but it is still not the starting point. For Sherwood, there is one overriding determinant – the management team, its aspirations and ambitions.

“If you have a management team that has worked in their industry for a long time, and are completely committed to completing their careers in that company, then that is a situation that is appropriate to a public company,” said Sherwood. “But if the management is made up of serial entrepreneurs that have experience in a range of industries, then that is more likely to lead to a private sale.”

The size and growth profile of the business is the next most important factor, followed by the state of the markets. Hedging one’s bets by opting for a dual-track process might seem a smart move in uncertain markets, but such an approach brings its own risks.

“We have a fiduciary responsibility to our investors to choose the best value transaction available,” said Sherwood. “Is there a risk that public investors can feel used if we eventually choose to sell an asset privately? Yes, there can be that perception, but it all comes down to the attractiveness and saleability of the asset.”

If it is an attractive business where the valuation is reasonably clear, and it is not a complicated disposal, sellers can create some positive tension between the two methods, according to Sherwood.

“Coral, which we bought from Charterhouse when they had also expressed an interest in floating it, was an example of that. You have to have a situation where you are not asking the potential public investors to make a huge effort to understand the story, because they will not make that effort if they know that there are also potential private buyers.”

A common perception when sponsors float a business is that they have taken everything they can out of it, leaving little or no upside for others. Sherwood argues that this view is a mistake. “If we take a company public, we see it as a statement that we have confidence in its future and that there is value ahead,” he said.

“Don’t forget that the investors in our funds are the same as the investors in the public markets – two of our biggest investors are two state pension funds in California. But owning a company through a private equity firm is an expensive way of owning it. When we float it we are saying that we now consider this is the best way for you as investors to own it.”

If the public route is chosen, the valuation objectives will depend on how serious an ongoing shareholder the sponsor intends to be. But the competitive IPO model has attracted criticism for its tendency to encourage banks to promise overambitious valuations in order to secure the coveted bookrunner roles that are only awarded after pricing feedback has been gathered from the market.

The IPO of Inmarsat (owned by Permira and Apax), while widely acknowledged to have been a success, brought the process to the attention of the FSA, which was concerned about threats to the independence of research (IFR 1611).

Deals such as Telenet (one of whose owners was GIMV) and Eutelsat (Eurazeo, Texas Pacific Group, Spectrum Equity Investors, Cinven and Goldman Sachs Capital Partners) both struggled with the format last year, and Permira’s own flotation of Hogg Robinson in October had to be scrapped and then revived at a much lower valuation (see IFR 1653). Last week, Hogg shares fell back to their IPO price.

But Sherwood remains unrepentant. “We were happy to get Hogg public,” he says. “Yes, some banks and investors do not like the process, but that is to be expected. You have to bear in mind that a large part of investment banks’ revenues is dependent on their dealings with hedge funds and other institutional investors, and they are very conscious of their interests.

“This method is an attempt to redress the balance a bit,” he adds. “When you take an asset to the public market, you effectively have a group of buyers who club together and dictate terms. It is not easy to create a level playing field.”